Superannuation Q&A

This week’s questions cover:

• Might self-funding instalment warrants be a good idea in this volatile market?
• Mum’s 67. Should she take a TRIP?
• I’ve got multiple super funds. Should I consider an SMSF?
• Can I rent a residential property from my SMSF?

Self-funding instalment warrants

Could I get your opinion on an investment strategy that includes self-funding instalment warrants within an SMSF given the volatile nature of the present market?

Until recently, self-funding instalment (SFI) warrants were one of the few ways available for trustees to legally gear inside super. Don’t forget that gearing in or outside of super increases the risks and that includes SFI warrants.

SFI warrants are a derivative of a share, based on paying a portion (usually about half) of the share price upfront, with the remainder being wrapped up in what is essentially a loan. The interest is capitalised annually. But over time the loan is (hopefully) reduced by dividends and the benefit of franked dividends. At the end of the term (generally five or 10 years), you have the option to pay out the loan and take delivery of the physical shares.

The new super gearing rules are going to allow for products that will provide serious competition for SFI warrants, which are traditionally inflexible, don’t allow participation in corporate actions (particularly buybacks) and can be expensive to get into and out of because of large buy and sell spreads.

The upside of SFI warrants is that they are close to being a set-and-forget investment. Pick some solid, long-term stocks and a time frame (five or 10 years). You shouldn’t really be looking to trade warrants because of the expense of getting out and then back in again.

Another upside is that the loans in these investments are locked in. Let’s say that when a particular warrant was issued, it was over a $10 stock with a $5 loan, which gives a 50% gearing level. If the underlying share has since fallen to $7, the loan is still $5, but the gearing level has risen considerably.

Because SFI warrants are largely a “set and forget” investment, the current volatility could provide opportunities to pick up some warrants over shares at attractive valuations. But never lose sight of the fact that SFI warrants are geared products and this will multiply your returns, on the downside as well as the upside.

Should Mum take a TRIP?

My 67-year old mother has about $1 million in super. She is contemplating doing a TRIP while she works part-time. What happens if she retires, commences a pension, but then returns to part-time work?

Even after turning 65, there are still good reasons to take a transition to retirement income stream (TRIP).

Your mother is 67 and so has no restriction on access to her super. She can take the whole lot tax-free, if she wants. Any earnings made on the fund from here in will also be tax-free.

The general point of TRIPs is to transition to retirement – to allow those who are still working to cut back on their hours and collect a tax-advantaged pension income stream. However, there are advantages to using them for most people who are working, and work best for those with reasonably large super balances.

She can take a TRIP pension if she so wishes and there would be potential tax benefits from doing so. Depending on how much she earns, the benefits would come from taking a tax-free pension from her super, but then salary-sacrificing a portion of her salary. This has the potential to help her to continue to build her super and save thousands of dollars in combined tax (personal and super) each year.

She would need to see an adviser or her accountant to work through some sums, based on how much income she is likely to make from her part-time work and how to best manage the payment of a pension. If she is going to receive irregular amounts, then some planning with your professional would pay for itself.

She would need to satisfy the work test – working at least 40 hours during a 30-day period – to be able to have someone to contribute for her, or to recontribute herself.

For those aged 65 to 74, the minimum pension you could draw from your fund would be 5% of the balance at the start of the year. For $1 million, that’s a minimum pension of $50,000. If she didn’t need all that, then so long as she satisfies the work test, she will be able to recontribute any excess she wants to (up to $150,000 a year).

Combing the funds into an SMSF

I retired in August, 2001, and have several sources of super, including a $15,000 defined benefit pension. I may go back to work casually. I am thinking about combining my three super funds into an SMSF. I am also wondering about the relevance of the transition to retirement provisions as I will need to access some money soon.

Your super situation sounds quite complex and you really should sit down with a financial adviser to work out a more complete strategy. But I will briefly answer a few of the topics you have raised. Unfortunately, you didn’t give me your age.

TRIP pensions do not allow individuals unrestricted access to their super lump sums. If you are over 60, you might be better off with an account-based pension, which only have minimum annual withdrawals.

If you’re considering setting up an SMSF, here are some starting points to consider. The general consensus is that you should have a minimum of $200,000 to put into the fund. This is because there are many costs that can’t be avoided in SMSFs and $200,000 is the point that many believe it might begin to make financial sense. It sounds like you probably have enough money to cover this aspect.

Are you interested in running your own super fund? Even though you will be getting some advice from an accountant and you should get some other advice from a financial adviser, your responsibilities as a trustee can be quite onerous.

Do you have the skills to do the investing yourself? If you feel knowledgeable enough and comfortable buying and selling shares or managed funds, then this can make a SMSF more economic. If not, then you are going to have to pay for ongoing strategic investment advice. There’s nothing wrong with this, but it probably means you should have more, rather than less, to start your super fund with.

The SMSF as landlord

Can we buy a house in our self-managed superannuation fund and then live in it and pay market rent to the super fund?

That ultimately comes down to this question: Would the house asset be less than 5% of your super fund?

Yes, SMSFs can buy residential property, so long as the purchase is not made from a related party to the super fund.

But the asset has to fit certain criteria for you to be allowed to rent it from your super fund. First, the asset must make up less than 5% of the value of the fund. If the proposed house is worth $400,000, then your fund would need to be at least $8 million. Second, you must, indeed, pay market rates.

Bruce Brammall is a senior financial adviser with Stantins Financial Services.

We can provide general investment advice only. If you’re seeking specific financial advice on your particular circumstances, then you’ll need to make an appointment with a licensed financial adviser.

Do you have a question for Bruce Brammall? Send an email to supersecrets@eurekareport.com.au.