This article appeared in the June 2012 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Learn why Self-Managed Super Funds have become so popular.
By Grant Abbott, chairman, Australian SMSF Members Association
Self-managed superannuation funds (SMSFs) are nearing their 18th birthday and what an amazing ride they have had. About 470,000 funds hold in excess of $416 billion in investments, with an average fund size around $900,000.
Those in a fund for 18 years have been able to earn high growth with shares until 2007 and now pay no tax on lump sums or pensions paid from the fund after age 60, while being able to control investments in it.
The May Budget brought changes to superannuation tax concessions. The Government reduced the concessional contributions cap of $50,000 for over-50s to $25,000, a reduction of 75 per cent since the 2007 Better Super reforms when $100,000 of concessional or tax-deductible contributions could be made to a fund.
It is this whittling away of SMSF tax concessions that led to the setting up of the Australian SMSF Members Association (ASMA), giving members a voice. Membership is free for all ASX newsletter recipients who are SMSF trustees. Register for the free newsletter.
The early history
By the time the Superannuation Industry Supervision Act 1993 (SISA) came into effect in July 1994, the number of small superannuation funds had dwindled to fewer than 70,000.
For many years, accountants had largely recommended clients to wind them up and transfer members’ benefits into a retail superannuation fund. But they still retained an important place in the superannuation landscape and, in recognition, the government introduced specific rules into SISA for SMSFs.
Suddenly, SMSFs had legislative validity and accountants began recommending clients go back into them. This is illustrated in Table 1, which shows the growth in the number of funds from 1994 to 2012. Over these 18 years, the number of funds increased by 668 per cent, and their popularity shows in the assets SMSFs hold - an increase of more than 4000 per cent.
It is not only the war generation and Baby Boomers getting into SMSFs; the fastest-growing population group is Generation X (born between 1965 and 1980.
Table 1: The growth of SMSFs in Australia since June 1994*
|Number of funds ('000)||70.1||147.9||212.4||262.1||327.5||397.7||468.1|
|Assets ($ billion)||12.1||36.1||75.1||109.2||214.8||323.7||416.3|
Why SMSFs became popular
There have been four key elements of SISA and the Income Tax Assessment Act 1997 that have driven the growth of the SMSF market.
(1) Legislative recognition of small funds
For the first time, SISA recognised that small superannuation funds were different from their bigger brothers. The Act established a name and definition for these funds in Section 10(1). This required the fund to have fewer than five members. More importantly, as funds were mainly for family members they did not need all the sophisticated prudential legislation required by the employer, industry-based and commercial funds.
There were also a number of other benefits of being an SMSF, including that its trustee could acquire business real property from a member of the fund provided it made up no more than 40 per cent of the fund’s assets. (The 40 per cent rule was dropped from August 1999 and replaced with the 100 per cent rule.) Non-SMSFs cannot, under any circumstances, acquire any property (business or otherwise) from members.
(2) Retirees allowed to use SMSFs
Mum-and-dad superannuation funds only had a finite life under the superannuation laws before SISA. For example, when a member of a fund retired, the superannuation laws at that time required the trustee to transfer their superannuation benefits to a rollover fund. Unfortunately, they could not stay in the existing fund. That meant a retired person you could no longer be a member of a superannuation fund.
For a mum-and-dad fund this was a disaster because, for the most part, when the man retired, the fund had to be wound up. SISA changed that by allowing retiree members to stay in the fund until they died, provided they commenced a pension in their SMSF no later than age 65, or age 75 if they were still working full-time. This was changed in 2007 with no compulsory requirement for the trustee to pay a member’s benefits except on their death.
This has opened up a new market for SMSFs - couples in retirement or semi-retirement. Given all the tax, estate planning, investment and other family benefits of a SMSF, it is surprising that any retiree couple with more than $300,000 in superannuation would consider any vehicle other than a SMSF for the rest of their retirement days.
(3) SMSFs are multi-generational and last forever
It is crucial for trustees and their members to focus on the long term. Believe it or not, when it comes to an SMSF, the long term is a period of 60+ years or more. As such, the fund must be established with an eye on future generations.
However, at general law, there is a rule that prevents a trust (an SMSF being a trust-based structure) from extending beyond 80 years. This is called the law against perpetuities and was put in place by Henry VIII to prevent the escape by wealthy landowners in England from estate taxes on the demise of the landowner. The law still applies today.
Where does an SMSF stand with this? SISA Section 343 provides that "the rules of law relating to perpetuities do not apply, and are taken to never have applied, to the trusts of any superannuation entity". As such, SMSFs have an infinite life.
Well, at least until a decision is made to wind up the fund. This means the passing of retirement wealth and estate assets from generation to generation is as strong as ever in an SMSF. This cannot be guaranteed: we have seen so many changes to superannuation laws that assets in SMSFs may not always be secure.
(4) Better Super changes in 2007
There were a wide range of changes to superannuation laws in 2007. Most still apply and have led to a significant change in the size of SMSFs and the number of funds (see Table 1):
- No tax on income, or lump sums taken from a complying superannuation fund after age 60.
- When a person 60 or older has all, or a significant majority, of their income-producing investments in a superannuation fund, and their taxable income is less than $6000 per annum, they do not need to lodge an income tax return. The nil tax threshold is to change from $6000 to $18000 from July 1, 2012.
- A member of a fund age 55 and born before 1960 can access their super benefits as a low-taxed transition-to-retirement income stream, even while working full or part-time. There is a 10 per cent maximum limit on the amount of income the working member can take each year while working. Once they retire there is no limit on the amount of withdrawals.
- Contributions can be made up to age 65 for any person and to age 75 for a person who is part-time gainfully employed.
- No tax penalties or limits on the amount of super benefits that can be withdrawn by members or their dependants and/or legal estate, in the event of the member’s death.
- Warehousing of super fund investments for the benefit of the next generation, with the abolition of the requirement for superannuation benefits to be taken as a lump-sum or pension at age 65.
- Relaxation of the assets test thresholds for Social Security purposes so a home-owning couple may be able to access a part-pension while holding a significant parcel of assets.
- Most superannuation fund members over the age of 60 will be able to access the Health Care card, and telephone and electricity allowances, at their pension age, regardless of the amount of superannuation benefits they have in their fund.
- Members can exchange investments between their income stream and lump-sum benefit accounts at any time they wish, to meet their specific income needs.
- Insurance premiums in the fund for death, permanent and temporary disability of fund members are tax-deductible.
- Death and permanent disability benefits paid during the working life of a member are
proportionally tax-deductible to the fund.
Choice of investments
One of the key drivers to establish an SMSF is the ability to choose investments. This includes ASX-listed shares and listed investment companies (LICs), and, as can be seen in Table 2, at March 2012 there were $154.4 billion in ASX-listed investments. With the current market capitalisation of ASX being $1,261 billion, SMSFs control 12.2 per cent of the Australian sharemarket.
Table 2: Investments in SMSFs - $bn
|SMSFs March 2012|
|Cash, securities and term deposits||119.9|
|Life insurance policies||0.2|
|Other managed investments||20.1|
About the author
Grant Abbott is chairman of the Australian SMSF Members Association, and founder of SMSF Strategies. To see a video or ask him a question, visit their website.
For membership of ASMA - free for all ASX newsletter recipients who are SMSF trustees, simply go to ASMA to register.
SMSFs provides useful information about the basics of establishing a fund. The page also features an ASX video on SMSFs, in which the television presenter Anne Fulwood interviews Graham O’Brien of ASX business development
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