What is a self-managed super fund & how does it work?

A self-managed superannuation fund (SMSF) is a private superannuation fund that allows you to control your retirement savings. Unlike retail or industry super funds, SMSF members are also the trustees, meaning you can make decisions about how your fund is managed and how the funds are invested. 

An SMSF can have up to six members who are also trustees (or directors if the fund has a corporate trustee). 

While SMSFs offer significant benefits, including greater control and investment flexibility, they also have risks and responsibilities that must be carefully considered. This guide will cover the key aspects of SMSFs, including:

1. Key features of a self-managed super fund
   
2. Who should consider an SMSF?
   
3. How to set up a self-managed super fund
   
4. Self-managed super fund rules & investment restrictions
   
5. How does a self-managed super fund work?
   
6. Exiting a self-managed super fund
   
7. Risks, considerations & negatives of SMSFs

By the end of this guide, you’ll better understand whether an SMSF is the right choice for your retirement savings.

Key features of a self-managed super fund (SMSF)

As an SMSF trustee, you will have more control over your investment decisions. You will have the flexibility to choose from a wide range of assets, including property, shares, and other income-generating investments, providing a more hands-on approach to building a diversified portfolio that aligns with your personal goals, retirement objectives, and preferences.

However, being an SMSF trustee also comes with a lot of responsibility. You must ensure your fund complies with all self-managed super fund rules and tax obligations. This responsibility is crucial for maintaining compliance and protecting your fund’s tax-advantaged status.

SMSFs can also be cost-effective, particularly for those with larger balances—but overall expenses will vary based on your fund’s structure and whether you opt to outsource administration, compliance, or investment services. 

You will need to assess the potential costs and benefits to determine if an SMSF is the right choice for their financial situation.

Who should consider an SMSF?

Managing an SMSF isn’t for everyone; it involves a higher level of responsibility, risk tolerance, and financial expertise than traditional super funds. Here are a few common types of people who make strong SMSF trustees: 

• Experienced Investors: You have significant experience managing investments and a strong understanding of financial and legal requirements.
  
  
• Those with Larger Balances: Generally, an SMSF is more cost-effective if you have a larger super balance, often recommended to be over $200,000.
  
  
• Individuals Seeking Specific Investments: Those who wish to invest in assets not typically available through traditional super funds, like direct property.
  
  
• People Comfortable with Compliance: Trustees manage compliance and reporting obligations, so this option suits those comfortable with SMSF rules.

How to set up a self-managed super fund

Knowing how to set up a self-managed super fund is crucial if you want to take control of your superannuation. The process involves multiple steps, the most important being noted below: 

1. Step #1—Establish a Trust: An SMSF is a trust structure. You must establish the trust deed, appoint trustees, and determine the members.
   
   
2. Step #2—Obtain a Tax File Number (TFN) and Australian Business Number (ABN): Essential for tax purposes and to identify the fund.
   
   
3. Step #3—Register with the Australian Taxation Office (ATO): The ATO regulates SMSFs and oversees compliance with self-managed super funds rules.
   
   
4. Step #4—Create an Investment Strategy: The trustees must prepare an investment strategy considering the members’ needs.
   
   
5. Step #5—Open a Bank Account: A separate bank account is necessary to manage the SMSF’s cash flow.
   

Of course, this is a streamlined list of instructions—much more thought and planning are required for success. We recommend speaking to an SMSF professional like Elliot Watson Financial Planning for assistance setting up the fund and getting ongoing advice to maximise your investments.

Self-managed super fund rules & investment restrictions

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Running an SMSF comes with a unique set of rules that guide your investment choices and ensure compliance with Australian superannuation law. These rules protect your retirement savings, promote fund integrity, and prevent misuse. 

Before diving into SMSF investments, it’s essential to understand the key regulations that govern them, like: 

• Sole Purpose Test: SMSF rules require that investments be made solely to provide retirement benefits to members.
• In-House Asset Rule: You are restricted from investing more than 5% of the fund’s total assets in in-house assets, such as member loans.
  
• Prohibited Investments: Certain investments, such as collectibles or personal use assets, must adhere to strict self-managed super funds rules, including being stored securely and not used personally by members.
• Diversification: While not compulsory, it’s strongly recommended that you diversify your investments to reduce risk.

Again, this is where speaking to an SMSF professional may be beneficial to ensure you’re set up for success. 

How does a self-managed super fund work?

An SMSF offers the flexibility of personal control over your retirement savings but also requires careful management and adherence to compliance standards. As an SMSF trustee, you are responsible for all aspects of the fund’s operation, from choosing investments to meeting legal requirements.

Here’s how a self-managed super fund works and what to expect regarding roles and responsibilities. 

Investment Decisions and Compliance Management

With an SMSF, you can make your own investment decisions, allowing you to allocate funds into shares, property, and other assets that align with your financial goals. However, this control also brings a responsibility to ensure that all investments comply with SMSF rules set out by the ATO. 

Compliance includes keeping the fund within regulatory boundaries and managing the reporting obligations that keep it in good standing.

Annual Audits, Reporting, and Record Keeping

SMSFs undergo annual audits, file tax returns, and report to the ATO to remain compliant. Accurate record-keeping is essential; trustees must document decisions, transactions, and financial statements and retain these records for at least five years. Maintaining detailed and accessible records meets legal requirements and supports transparent fund management.

Insurance Considerations

As part of an SMSF’s investment strategy, you must also consider insurance options for your members. This adds an additional layer of financial protection, underscoring your responsibility to act in the best interests of the fund’s members.

Taxation

Operating under a concessional tax rate, SMSFs enjoy financial advantages that can boost retirement savings through reduced tax obligations. For example, SMSFs are taxed at a concessional rate of 15% on income, covering contributions and investment earnings. This lower tax rate can be especially advantageous for higher-income earners facing higher tax rates outside superannuation.

SMSFs benefit from favourable tax treatment for capital gains. Capital gains are generally taxed at 15%, but this can be reduced to 10% if the fund holds an asset for over 12 months. This long-term holding incentive encourages stable investment strategies and can significantly reduce the tax burden on capital growth over time.

SMSFs can also claim deductions on fund-related expenses, such as management fees, administration costs, and insurance premiums. These deductible expenses can offset the fund’s taxable income, further enhancing the tax efficiency of managing an SMSF.

Exiting a self-managed super fund

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While an SMSF offers control and flexibility, there may come a time when it’s no longer your best option. You must have exit strategies available to ensure a smooth transition if required.

Winding up the fund

In cases where an SMSF becomes less cost-effective, or your financial or personal circumstances change, you may choose to wind up the fund. This process involves selling the fund’s assets, paying any outstanding tax obligations, and finalising the fund’s affairs with the ATO. 

Properly winding up the fund ensures compliance and protects members’ retirement savings.

Rolling over to another super fund

If managing an SMSF becomes unmanageable or undesirable, you can roll over the SMSF balance to a traditional super fund. This option is particularly helpful if you want to reduce administrative responsibilities while preserving your super balance. 

Paying out benefits 

When members retire or reach a condition of release, the SMSF can pay them benefits either as a lump sum or as a regular income stream. This flexibility allows retirees to structure their withdrawals to suit their retirement lifestyle and financial needs, providing immediate and ongoing financial security.

Risks, considerations & negatives of SMSFs

Managing an SMSF involves specific risks and responsibilities that trustees should fully understand before proceeding. For example, you must adhere to the ATO’s strict rules and regulations. Failing to meet compliance standards can result in substantial penalties, emphasising the need for a thorough understanding and ongoing monitoring of SMSF regulations.

Other negatives include: 

• Investment Risks: Like any investment portfolio, an SMSF is exposed to market fluctuations and the possibility of capital loss. Trustees bear the full responsibility for investment decisions, making it essential to consider market volatility, diversification, and overall investment strategy to manage risk effectively.
• Time Commitment: Managing an SMSF is time-intensive, requiring consistent involvement in investment decisions, administrative tasks, tax regulations, and compliance. Those without sufficient time or expertise may find it challenging to manage an SMSF effectively.
  
  
• Potentially High Costs for Smaller Balances: SMSFs may not be cost-effective for smaller balances, as the expenses associated with setup and ongoing administration can erode returns. Industry or retail funds often provide better cost efficiency for those with lower superannuation balances.
• Investment Responsibility and Risks: As the trustee, you are responsible for the fund’s investments. Poor investment choices, inadequate diversification, or high-risk assets can negatively impact your retirement savings, amplifying the potential for financial loss.
• Limited Access to Professional Management: You have to rely on personal expertise or pay for external financial advice. This can be challenging for those lacking extensive investment knowledge, potentially impacting fund performance without professional management.
• Liquidity Concerns: SMSFs invested heavily in illiquid assets like property may struggle to provide cash flow when required, which can present challenges in paying pensions or winding up the fund.
• Loss of Consumer Protections: Unlike industry or retail super fund members, SMSF members are not eligible for compensation in the event of theft or fraud, increasing the risk associated with fund security.
• Impact on Personal Relationships: Decisions within an SMSF require consensus among all trustees, often family members or close associates. Disagreements over investments or fund management can lead to conflicts and potentially strain personal relationships.

Considering these risks and drawbacks is essential in determining whether an SMSF aligns with your financial goals, expertise, and willingness to take on administrative and investment responsibilities.

Seek professional SMSF advice from Elliot Watson Financial Planning today

Given the complexities of managing an SMSF, we recommend seeking professional advice before taking the plunge into self-management. Our financial planners and SMSF specialists can help set up a self-managed super fund, manage compliance, and advise on the best investment strategies for your personal goals.

Contact us to book a consultation and discuss the best superannuation option for your financial future. We will provide tailored advice and assistance in understanding the complexities of SMSFs. 

Disclaimer

Elliot Watson Financial Planning Pty Ltd is a Corporate Authorised Representative of RI Advice Group Pty Ltd, ABN 23 001 774 125 AFSL 238429.

The information (including taxation) in this website does not consider your personal circumstances and is of a general nature only – unless otherwise stated. You should not act on the information provided without first obtaining professional advice specific to your circumstances.