In an era when superannuation returns have been disappointing, John Collett examines the pros and cons of taking charge of your own fund.
Savvy baby boomers are increasingly asking themselves whether or not to start a DIY superannuation fund. Woeful returns from providers and high fees are prompting people to ask whether they could possibly do any worse running a fund themselves. The returns of the average balanced fund during the past decade was just 5.1 per cent a year.
Apart from offering control and flexibility, there may also be tax advantages with a self-managed super fund (SMSF). With real business property allowed in a DIY fund, there's little doubt business owners stand to benefit. But for employees - even those with the $200,000 to $300,000 that most experts say is the minimum needed - would running their own fund be a smart option?
A survey suggests people with SMSFs are pleased to be running their own fund and are confident of achieving financial security in retirement.
Indeed, their trustees reported that they made better returns than those in large super funds.
These are just some of the findings that have emerged from a wide-ranging survey of more than 800 trustees of DIY super funds conducted by researcher CoreData and sponsored by Westpac.
Two-thirds of the trustees surveyed say they are also members of a large super fund. But that could be because they are retaining their old fund for the insurance cover.
Large funds can buy insurance - such as life and total and permanent disability insurance - at "wholesale" rates with automatic acceptance.
Buying an individual policy through a DIY fund may mean having to undertake a medical examination and pay higher premiums.
The managing director of CoreData, Andrew Inwood, says another reason that many DIY fund trustees are retaining their large funds is because they can be a very low-cost way of accessing investments.
Industry funds, in particular, can be very cheap and "they do the maths", he says.
SELF-DIRECTED AND ENGAGED
More than 90 per cent of trustees say they know the approximate balance and asset allocation of their funds.
Almost 80 per cent say they review their investment and asset allocation at least once a month.
The expertise of DIY fund trustees is in contrast to the knowledge of most members of large super funds.
A survey of 50- to 74-year-old members of large funds by the Centre for Pensions and Superannuation at the University of NSW found their knowledge of investing was poor.
A striking aspect of this survey is that trustees self-reported a 9 per cent return on their DIY funds over the past year.
According to researcher SuperRatings, the average balanced super option (where most people have their money) returned 0.1 per cent over the year to February 29.
The DIY fund trustees surveyed say they have an average allocation to shares of almost 45 per cent and a weighting to cash of almost 25 per cent.
SuperRatings says the typical balanced investment option has an exposure of about 55 per cent to shares and only 6 per cent to cash.
The big difference between those in large funds and those with their own funds is the level of cash. "DIY fund trustees are more active and are prepared to hold cash," Inwood says.
"The other factor [behind the good returns] is that they are more involved in the market and trade investments."
HIGHER CONTRIBUTION LEVELS
The technical services director at Multiport, Philip la Greca, is sceptical of the self-reported returns of DIY fund trustees. He says they are making big voluntary contributions into their funds and perhaps not deducting these contributions in their estimates of investment performance. "[The trustees] may look at the opening balance and closing balance and call the difference the earning rate," he says.
Australian Tax Office data shows that contributions levels into DIY funds were a staggering 45 per cent of total member contributions in the industry as a whole, when the number of members of DIY funds is only about 7 per cent of all super fund members.
In other words, the lion's share of contributions is being made by those with their own funds.
Most members of large super funds passively stick with their fund's employer-selected default option.
They have stuck with these balanced options with their high exposures to shares through the global financial crises, rather than moving to the safety of cash.
The typical balanced option has an average annual return of a little more than 5 per cent during the past 10 years, according to SuperRatings.
Just by holding a lot of cash, it is quite possible DIY fund trustees have done better than most of the members of large super funds.
The CoreData survey also polled 182 people who did not have DIY funds, whose household income is at least $200,000 a year and who have an average household investment portfolio (excluding residential property) of a little more than $1 million. More than half say they would consider starting a DIY fund.
For these higher earners, the most frequent reason they give for not having their own fund is insufficient size of assets. DIY funds can buy a rental property outright from a third party, for example, and benefit from the low taxes inside super. Even geared investment property can be held by a fund, although it is actually held in a separate legal structure where the SMSF is the "beneficial owner" of the property. The mortgage used to fund the purchase must be "limited recourse", where the lender has no call on the DIY fund's other assets if there is a default.
Inwood says that many of these people are likely to have the assets to make a DIY fund worthwhile. "If they do not start a fund, it may be costing them thousands of dollars a year in lost tax advantages," he says.
"General guidelines are that for those with more than $200,000 in super assets and a desire to take more control of their retirement investments, an SMSF could be a worthwhile opportunity," the head of self-managed super at Westpac, Sinclair Taylor, says.
He points out that while the $200,000 may seem low, many trustees would be making significant contributions to the fund and increasing the balance quickly.
ATO data shows that about 25 per cent of SMSFs have less than $200,000 worth of assets in them and the median-sized DIY fund was about $500,000 in 2010. The ATO estimates the operating expenses of a fund with between $100,000 and $200,000 at about 2.25 per cent. For amounts of between $50,000 and $100,000, the operating expenses are about 3.5 per cent.
By contrast, most well-run large super funds have operating expenses of about 1 per cent, excluding advice costs.
La Greca says the cost advantages of running a DIY fund become "clear" for retirement savings of at least $300,000, as that is when DIY fund costs should be 1 per cent or less.
While there are advantages to running an SMSF, there are significant trustee obligations. Trustees are responsible by law to manage the fund responsibly, even if the trustees have advisers. If trustees breach any of the relevant tax and super laws, they will be exposed to severe penalties. The money must be invested with the sole purpose of saving for retirement and generally cannot be accessed before reaching preservation age, which is between 55 and 60 (depending on when you were born) and have retired.
DIY funds are certainly not for everyone, even if they have significant retirement savings.
The national practice manager of strategic clients at Industry Fund Financial Planning, Frank Gayton, says that those with DIY funds sometimes want to "unwind" them. Last year, he helped a couple unwind their DIY super fund.
An accountant had set up the fund for them in which the fund invested in a high-fee retail "wrap" platform. All of the investments held in the fund were from the same provider. The fees were about $14,000 a year.
"We have unwound the fund and put the money into an industry fund and an annuity," Gayton says.
"The couple get their regular money every fortnight and do not have to worry about anything and life is so much easier for them."
Skys the limit
Self-managed superannuation is the fastest-growing segment of the superannuation sector.
At the end of last year, SMSFs held the largest proportion of super assets, accounting for 30.6 per cent of total assets, followed by retail funds with 27.4 per cent and industry funds with 18.9 per cent of total assets.
The annual rate of growth in the number of SMSFs fell during the GFC to less than 6 per cent in 2010 from about 13 per cent just before the GFC in 2007.
The annual rate of growth in SMSFs by number is now about 7.5 per cent. As at June 30, 2011, there were about 456,000 SMSFs and $418 billion in assets, from about $100 billion in 2002. There are about 867,000 members in the SMSF sector, about 7 per cent of roughly 11.6 million members in Australian super funds.
On target for
The Barrauds own a property on Bribie Island, north of Brisbane, on which there is a childcare centre and they hope to buy more.
Paul and Janelle work full-time, but Paul hopes to retire in four years, when he turns 60.
They had some poor experiences with financial advisers before they went to see a planner at Westpac.
The planner advised them to set up a self-managed super fund and to roll both of their super balances into the fund.
They have Westpac's DIY Super Solution, which has a superannuation working account that also combines a savings account and online investing access.
They had a mortgage on their house and debt on the childcare centre.
Their planner advised them to sell the childcare centre into the fund and pay down the non-tax-deductible debt on their home as well as the debt on the childcare centre.
The couple has a tax-deductible debt on the investment property they also own.
The result is they pay less tax and have better cash flow.
Paul is sacrificing all of his salary into the fund and Janelle is sacrificing some of hers. They live off the remainder of Janelle's salary.
"The planner has really turned us around it is just magnificent what he has done for us," Paul says.
"We have got more money now than we have ever had and in three years' time, I can tell you now, we will be buying our next childcare centre."