Superannuation fund members are voting with their feet and setting up self-managed superannuation funds in greater numbers.
Australian Tax Office data shows that at June 30, 2012, there were about 478,000 SMSFs holding more than $439 billion in assets.
That is an increase of almost 8 per cent on the 443,000 SMSFs at June 30, 2011, and about 15 per cent higher than at June 30, 2010.
The natural constituency for do-it-yourself super are small-business owners and higher-income earners.
Many have come to run SMSFs as a natural outcome of their relationship with a trusted accountant. Business property can be put inside SMSFs and a lot more can be done with estate planning than with large superannuation funds, particularly beneficial to those with small businesses for their succession planning. But trustees of SMSFs need to be motivated and interested in investing and willing to shoulder the responsibilities of running their own funds.
However, the growth in numbers of those running their own funds suggests more rank-and-file employees are doing so. No doubt the poor performances of their large funds are helping drive the trend. Most fund members are in their funds' "balanced" investment option, with SuperRatings's data showing that during the past five years to August 31, the median-performing balanced option has produced an average annual return of 0.3 per cent. Over the past 10 years, the return is 5.9 per cent.
Focus on returns
Balanced options have big exposure to shares. Many SMSF investors hold higher levels of cash, avoiding the terrible returns from shares during the global financial crisis and outperforming the large funds. Many of these trustees will be holding high cash levels as part of a considered investment strategy. But it is also likely some trustees are holding cash because they are unsure how to invest the money.
The performances of large funds are improving as sharemarket returns pick up. The median-performing balanced option has returned 6.5 per cent in the past year. If the rally in world sharemarkets continues, in a few months' time there is every likelihood one-year returns from large superannuation funds will be in the double-digits. But the problem for older members in balanced options, for whom retirement is not far off, is the volatility of balanced options will continue as long as the options have big weightings to shares.
Those fund members are always free to switch to one of their funds or another fund's lower-risk investment options that have big exposures to income-paying investments.
Large super funds are responding to the threat of SMSFs by adding more investment choices. The 1.9-million-member AustralianSuper, for example, offers members access to individual Australian shares, index-tracking exchange-traded funds and term deposits. Large funds are also increasing the range of retirement-income products and adding more features. And large funds, particularly industry funds and other not-for-profit funds, can be very cheap. Most well-run large super funds have operating expenses of about 1 per cent. An SMSF would need assets of at least $300,000 to get operating expenses down to about 1 per cent. Yet, ATO data for the 2010-11 year shows 22 per cent of SMSFs had assets of less than $200,000.
However, the appeal of SMSFs is likely to increase even more now they are allowed to borrow to buy property.
It is too early for the expected increase in holding of residential real estate in SMSFs to show up in ATO data. But with financial planning firms - as well as mortgage brokers, real estate agents and property developers - running seminars on how to borrow to buy a property inside super and not pay any, or very little, capital gains tax on selling, it is inevitable more people will start their own funds to hold real estate.
Property
Holding real estate inside super can be expensive. Under the rules, the lender must have no recourse to any other assets other than the property.
That means the interest rate on the mortgage is likely to be higher than on a regular, full-recourse, mortgage. Much of the benefit of having geared property in super could disappear among the higher costs of the finance.
And there is another important element of superannuation that SMSFs struggle to compete with - life insurance.
Many SMSF trustees are retaining their large funds for the insurance cover. That is because members of large funds can buy insurance - such as life and total and permanent disability insurance - at cheap "wholesale" rates where no medical examination is required.
SMSF trustees who try to get the same cover have to do so as individuals with likely higher premiums and an examination.
Also, as the case of superannuation fund Trio Capital confirmed, SMSFs are outside the government's compensation scheme for super. Trio collapsed in 2009 with losses of about $180 million.
Under the rules of the compensation 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.
Frequently Asked Questions about this Article…
Why are more Australians choosing a self-managed superannuation fund (SMSF)?
Many people are moving to SMSFs for greater control over investments, the ability to hold business property or use estate-planning strategies, and frustration with the poor performance of some large funds. The article notes SMSFs are especially popular with small-business owners and higher-income earners, and the availability of borrowing to buy property inside super is making SMSFs even more attractive.
How common are SMSFs and how much do they hold in assets?
According to Australian Tax Office data cited in the article, at 30 June 2012 there were about 478,000 SMSFs holding more than $439 billion in assets. That was up from around 443,000 at 30 June 2011 and roughly 15% higher than 30 June 2010.
Who typically sets up an SMSF and why?
The natural constituency for SMSFs tends to be small-business owners and higher-income earners. Many start an SMSF through advice or a relationship with a trusted accountant. Business owners often use SMSFs to hold business property and help with succession and estate planning.
How do SMSF returns compare with large superannuation funds?
Performance varies. The article highlights that many SMSF trustees held higher cash levels and therefore avoided steep sharemarket losses during the global financial crisis, which helped them outperform some large funds. By contrast, SuperRatings data showed the median-performing balanced option returned just 0.3% pa over five years to 31 August, 5.9% pa over ten years, and 6.5% in the most recent year as share markets recovered. Large funds are also improving and adding more investment choices to compete.
Are SMSFs cheaper to run than large super funds?
Not always. Well-run large super funds can have operating expenses around 1%. An SMSF typically needs at least about $300,000 in assets to get operating expenses down to a similar level, the article says. ATO data for 2010–11 showed 22% of SMSFs had assets under $200,000, where per-dollar costs are likely higher.
Can an SMSF borrow to buy property, and what are the downsides?
Yes — SMSFs are now allowed to borrow to buy property, which increases their appeal. However, borrowing in an SMSF usually involves a limited recourse loan where the lender can only claim the property, not other assets. That typically means higher interest rates and fees, so much of the gearing benefit can be eaten by higher finance costs.
How does insurance differ between SMSFs and large super funds?
Large super funds can often provide life and total and permanent disability (TPD) insurance at 'wholesale' rates without medical exams. SMSF members who want comparable cover usually must obtain it individually, which can mean higher premiums and medical checks. For that reason many members keep their accounts in large funds to retain cheap insurance cover.
Are SMSF members protected by the government compensation scheme for super?
No. The article notes SMSFs sit outside the government's compensation scheme for superannuation. It cites the collapse of Trio Capital in 2009, which caused about $180 million in losses, as an example that SMSF members do not benefit from the levy-based compensation arrangements that can apply to members of large funds when losses result from theft or fraud.
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