Think outside the SMSF square

Summary: Asset allocation became a whole-of-wealth game on July 1. Have you put enough thought into it?

Key take-out: Members should review their asset allocations, specifically, what investment vehicles will work to their greatest advantage. A SMSF is just one investment vehicle, and with the new rules coming into effect, some assets might be best kept outside of this.

The new rules for super came in three months ago, on July 1. So, have you changed anything since then?

For most, the answer will be “no”, or “not a lot”. If you have an “average-sized” self-managed super fund, you're probably doing what you always have, trying to make contribution and investment decisions to grow your balance as much as you can.

Those with larger balances might have started to think a little more outside their super funds. If they haven't, then they've been wasting time.

But thinking outside the SMSF square should also apply to those who are reasonably confident that they will trip the $1.6 million transfer balance cap at some stage.

SMSFs will lose their place on the investment mantelpiece of some members. In the future, their SMSF won't be the keeper of all their wealth.

The $1.6 million pension transfer balance cap (PTBC) is one reason. Stuffing money into super gets difficult after that. Smaller limits for concessional contributions (of $25,000) and non-concessional contributions (of $100,000, with limits on how much you can put in once your super fund reaches $1.4m) have left many more with spare capacity, or no choice, to grow wealth outside of super.

There are many options, including insurance bonds, trusts, direct property and self-managed accounts. (But they are for another day.)

What I want you to think about today is your overall asset allocation, taking into account your SMSF.

Increasingly, because of the PTBC, the wealthy need to consider their wealth holistically. Not just their SMSF, but what they hold outside in several different buckets, each with different tax arrangements.

A SMSF is an investment vehicle. It's taxed at a low rate (for complying super funds) of a maximum of 15 per cent. For pension funds, the tax rate is 0 per cent.

What if you have substantial assets inside your SMSF, and outside, in your personal name, within a family trust, or a company?

Let's say you have overall wealth of somewhere between $3m and $5m. What sort of decisions do you need to make?

It will often be complicated. But here is a starting list. And it will help to start considering these issues at the point of purchase. Because changing ownership mid-way through an investing life will have capital gains tax and potentially stamp duty implications.

Assets with CGT implications

What assets are you likely to sell (at some stage) and thereby incur CGT?

A SMSF in pension phase (or at least a portion of) won't incur CGT on the sale of assets. Property is a big, chunky asset that often comes with big capital gains that can't be managed on the way out.

That is, you generally can't sell a portion of a property. The entire capital gain will be caught in one financial year. Gains made in property, therefore, can be good to hold in a CGT-free environment, such as a pension fund.

This is the opposite of shares, obviously, which can be sold down in parcels of various sizes, with the CGT managed over time. You can sell a portion of a shareholding in one financial year, another portion the following year, and more the year after that.

Shares might, therefore, be assets more suited to non-super holdings. For many, they belong in personal names or trusts.

Some assets are never likely to be sold, for a range of reasons. If they're never likely to be sold, then these could be assets to sit outside of super.

Alternatively, you might feel that they are assets that are not going to be sold by you. If you're happy for future generations to sell them – and pay whatever CGT bill comes with that – then those assets might also be best held outside of super.

Income-generating assets

Some assets are more about income generation. These will predominantly be cash and fixed interest, but can also include some types of property and shares.

As I discussed a little while back as the 'three pots strategy' in Your best super moves for 2017, while pension funds are tax free, individuals also have the benefit of receiving the first $18,200 a year tax free (potentially more with other tax breaks and concessions). After that, the next marginal tax bracket is 19 per cent (and 21 per cent, including the Medicare Levy).

This means that an amount of assets, particularly income-producing ones, should be held outside of super (for those over the $1.6m PTBC limit). Holding $500,000 outside of super, earning 3.5 per cent, will net you $17,500 and will be tax free.

Holding a half-million dollar property yielding 4.5 per cent will also probably be tax free (after costs, including insurance, agent fees, rates and general maintenance).

Shares with fully-franked dividends (don't forget to gross up the franking) can also have this sort of taxation advantage.

Property comes with the CGT issue outlined above. If you have a big capital gain, you're going to incur it in a single tax year. With shares, you can sell down over time.

For those with a mortgage, of course, nothing beats an offset account for holding cash. If you still have a mortgage of, say, $700,000 and you're holding $700,000 in your offset account, you're ‘saving' interest payments at probably 4 per cent, but it's not declarable income, so won't even count towards your first $18,200.

Sit down for proper advice

Advice is going to become complex again. It was the first thing that became obvious to anyone offering financial advice when the changes were announced in the May 2016 Federal Budget.

The old ‘reasonable benefits limits', that were flicked in 2007, have essentially come back. And it's going to take some work to make sure you don't overpay on tax and structure your finances in a way to not donate more than is necessary.

More of you are going to need good advice to weigh through the options. There are good fee-for-service advisers out there. If you need help weighing through options that are specific to you, pay for their time and get that advice.

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The information contained in this column should be treated as general advice only. It has not taken anyone's specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.