Taking control of your retirement funds can be rewarding, but there are potential pitfalls, writes John Collett.
More people are leaving their large superannuation funds to start self-managed super funds (SMSFs) because they want more control over how their retirement savings are invested.
But SMSFs, or "DIY" funds, have potential pitfalls, especially for those who are not prepared to put in the effort required. The trustees of self-managed superannuation funds are legally responsible for everything to do with the fund. And self-managed funds are outside the federal government's compensation scheme should one of the fund investments collapse due to fraud or theft.
Despite these limitations, the drift of a few years ago to self-managed funds has become something of a tide. One of the reasons is likely to be the recent poor investment performance of large funds, though, with the resurgence in share prices around the world, the returns of these funds are improving.
Large funds are also responding to the challenge of self-managed superannuation funds. Retail funds were the first to provide members with do-it-yourself investment flexibility without the hassle of running their own super funds. And now more of the large not-for-profit funds are doing the same.
Members of many of the biggest funds can now buy and sell Australian-listed shares and other listed securities, such as exchange-traded funds, and invest directly in term deposits. Retail funds will often offer managed funds in addition to direct shares and term deposits. Retail fund members could opt for managed funds that invest in overseas shares, for example.
Legalsuper, the industry fund for the legal sector, has a direct investment option in which members can buy and sell Australian-listed shares and exchange-traded funds and invest in term deposits.
"There is no doubt that super funds like Legalsuper are better equipped to attract DIY investors by offering an expanded and more diverse range of investment options," the chief executive of Legalsuper, Andrew Proebstl, says. Members have the ability to build their own portfolio without the compliance and administrative requirements of an SMSF, he says.
Kirby Rappell, the research manager at SuperRatings, expects further growth in direct investment options from large funds. "Large funds are looking at ways of minimising the reasons why people may be looking to leave a fund, including leaving to start an SMSF," he says.
DIY funds can be well suited to those with higher account balances who want maximum control over how their retirement savings are invested; but with control comes responsibility. Much of the compliance can be outsourced to specialist SMSF administration companies, but the legal responsibility for the fund always remains with the trustees of the fund.
The natural fit for DIY funds includes those with their own businesses and senior professionals, but even they must have an interest in investing.
Dennis Eagles, a chartered accountant, financial adviser and partner with accountants Grant Thornton, says those setting up their own funds have definite ideas about how they want to invest their money, and it's usually outside shares and managed funds alone.
Business property can be put inside a fund, and other direct assets, such as residential and commercial real estate, can be inside the low-tax environment. The rules on borrowing with a DIY fund have been relaxed. DIY funds are allowed to borrow to invest in property, although there are restrictions on the borrowing arrangements.
DIY funds can be expensive to run if the account balance is relatively small. The head of technical services at AMP SMSF Administration, Philip La Greca, says the "absolute" minimum needed for a DIY fund is $200,000, and that's provided contributions are still being made to the fund and the account balance is growing.
With ongoing annual costs of a DIY fund of about $3000 a year, an account balance of $200,000 implies a cost of 1.5 per cent, which is about the same as large superannuation funds.
La Greca says there are many benefits of DIY funds, including estate-planning advantages. The death benefit can be paid as an income stream to a dependant with a drug problem, for example.
Usually, large super funds pay death benefits as a lump sum. Individual assets can even be distributed by a DIY fund. There may be a family business, for example, and the business property could be distributed to the child continuing the business.
But just as there are estate-planning advantages, there are potential disadvantages when it comes to life insurance, Eagles says. "Insurance cover can be more expensive and more difficult to obtain than for members of large funds," he says.
Large funds are bulk buyers of death and total and permanent disability insurance. Premiums can be very low and acceptance for cover can be automatic. Buying life insurance as a trustee of a DIY fund means buying as an individual, which is likely to be more expensive and will probably involve a medical examination or, at least, a medical history to be provided to the insurer.
A survey last year by researcher CoreData of trustees of DIY funds found many retained a small balance in their large funds to obtain the life insurance benefits.
On your own
Trustees of DIY funds are also outside the federal government's compensation scheme for super. After the collapse of Trio super in 2009, members of large funds invested in Trio were compensated. Under the rules of the scheme, if the loss can be shown to be the result of theft or fraudulent conduct, all members of large funds are levied to compensate those members of large funds who lost money.
DIY members are on their own if anything goes wrong. And DIY funds are not members of the Superannuation Complaints Tribunal, so if there is a dispute among dependants over the distribution of death benefits, their only recourse is through the courts.
Just as trustees are legally responsible for compliance and administration of the fund, they are also responsible for the investment strategy, which must be documented, says John Hewison, a financial planner and founder of Hewison Private Wealth. He is a supporter of SMSFs - most of his clients have one - but says they have to be done properly. Starting a DIY fund and then investing in managed funds is a "waste of time" because of the management fees, he says.
As a member of a large fund, the investment decision is relatively straightforward. Most members are invested in their fund's balanced option, which will have between 60 per cent and 80 per cent of the money invested in growth assets.
The remainder will predominantly be invested in assets that produce a steady income. For the majority of members, these are good options. But members have the choice of other pre-mixed investment options with more conservative asset allocations. Large funds also have a selection of options to invest in single asset classes, such as Australian shares, property or bonds.
Closer look at costs
The costs of a DIY fund can vary greatly because of the greater range of investments. On top of the investment costs and charges for financial advice, there are fees for the annual audit of the fund, the cost of the annual tax return and the SMSF Supervisory Levy of $191 in 2012-13. The levy will rise to $259 from 2013-14.
When using a DIY fund administrator, the cost can be expected to be about $3000 a year. When a DIY fund is in the pension phase, or partly in pension phase, there is an annual actuarial certificate costing from $200 to $400 in addition to other fees.
Accountants dominate the DIY superannuation sector. And they charge a combination of flat and hourly fees for the administration of self-managed super funds. Accountants are likely to cost more than using a DIY fund administrator.
Large funds will typically have administration fees of about 1.5 per cent of the account balance, not including investment costs or financial advice.
DIY fund trustees willing to make the effort can do a lot of the administration and compliance themselves. But there are many things that can go wrong and the consequences can be expensive. The legal responsibility remains with the trustees of the DIY fund.
For those who really want to get the costs down and do not want advice, there are now "discount" fund administrators, who will provide the documentation for the trustee to complete together with a guide, but there is no advice.
'I was overwhelmed by the paperwork'
Melbourne barrister Campbell Horsfall joined Legalsuper in 2009 after running his own super fund for 13 years. "I found it much better than an SMSF," he says. "I was getting overwhelmed by the compliance requirements and associated paperwork."
Legalsuper's direct investment option allows members to buy and sell Australian listed shares that are in the S&P/ASX 300 index and term deposits. It also allows members to invest in Australian sharemarket-listed exchange-traded funds.
The unit prices of exchange-traded funds track, or mirror, a particular market such as, among others, indexes covering Australian government bonds and Australian shares.
Campbell is not particularly interested in property investment. "My interest is primarily in the sharemarket," he says.
His investment strategy is to have about half of this retirement savings in cash and half in Australian shares, which he has been able to do with Legalsuper.
By holding shares directly he can join dividend-reinvestment schemes. Campbell says his strategy is paying off because most of his buying has been in higher-yielding shares, such as Telstra and the Commonwealth Bank. "I seem to have picked the market really well," he says.