The final instalment of Tim Mackay’s comprehensive guide to the booming SMSF market.
By independent financial planner Tim Mackay.
As the fastest growing area of superannuation, SMSFs are the vehicle of choice for the wealthiest 945,000 Australians. In this three-part series we’ve armed you with the key information to determine if an SMSF is right for you.
Part one examined how SMSFs can be a profitable vehicle to set yourself up for retirement. Part two took lessons from Michael and Paula’s ‘Never Tear Us Apart’ SMSF.
Eagle-eyed readers will have spotted references to the 80’s rock band INXS in part two. These references were deliberate – Michael Hutchence’s tangled family life, early death and resulting estate leaving nothing to his family is a salient case study in how not to structure your family’s affairs.
In this final part we examine advanced SMSF strategies to build and protect your wealth, to invest in property with gearing, and to pass your wealth to your family in the most effective manner.
Location, location, location
“90 per cent of all millionaires become so through owning real estate.” (Andrew Carnegie)
As a former property analyst, I share Australians’ long held love affair with property. Property is tangible and reasonably easy to buy and manage – it’s not going to disappear like a Babcock and Brown share. Savvy investors are increasingly locating their property investments in their SMSF via a tax effective limited recourse borrowing arrangement (LRBA). We’ve recently advised a number of our SMSF clients through complex LRBA acquisitions ranging from $600,000 investment properties to multi-million dollar exclusive waterfront properties and we share the key lessons.
Before committing, do your research. Understand which lenders will lend to you under a LRBA and obtain a detailed list of their loan criteria. Before lending, they will likely want to see your SMSF and personal financials so make sure your administration is all up to date.
Determine the optimal equity and debt levels to fund your property acquisition. Use of too much equity could reduce diversification in your SMSF (all your eggs in one property basket). Too much debt and you may struggle to meet interest payments, especially if future contribution rules change. Know your expected rental income and other cash flows and be aware that an interest cover ratio of less than one can prove problematic for the serviceability of a LRBA. Know your property investment exit strategy.
Most lenders require a corporate trustee so change from individual trustees if required. You will need to establish a bare trust. Make sure both your trust deed and investment strategy allow you to invest in property and enter into a LRBA – if they don’t, then update them.
These tasks and associated paperwork are complex, easy to get wrong, and can inadvertently lead to double stamp duty costs. Property spruikers are increasingly targeting less informed SMSF investors so seek advice from a recognised SMSF advisor.
Preserving and passing on wealth
“Each generation imagines itself to be more intelligent than the one that went before it, and wiser than the one that comes after it.” (George Orwell) SMSFs are highly effective estate planning and inter-generational vehicles. Where there is a significant age difference between a couple in an SMSF you can optimise your ability to both build and access your family’s wealth, and estate planning can be highly tax effective.
SMSFs also provide security for blended family situations or where you know there will be an unwanted claim from the son-in-law from hell or the like. By tailoring the rules within your SMSFs trust deed to your family’s circumstances, you can better protect your family’s wealth.
Understand the difference between binding and non-binding nominations and determine which is optimal for you. A number of our recent SMSF clients were unaware that their reversionary pension was incorrectly established. This can be solved with a commutation and commencement of a new income stream, so if you’re unsure, check your pension commencement documents.
Other advanced strategies
There are other advanced SMSF strategies that we haven’t had space to cover. The use of reserve accounts (eg for excess contributions and death benefit payments) should only be considered with expert SMSF advice. Likewise, the tailoring of SMSF trust deeds for estate planning and other purposes should only be undertaken with expert legal advice. An SMSF can also provide effective asset protection for business owners or others at risk of litigation and bankruptcy.
The final word
The last word goes to Paul Keating – “When we laid the foundations for the current superannuation system in the 1991 budget, I never expected self managed super funds to become the largest segment of super.” Back then no one did, and today, with their phenomenal growth, perhaps SMSFs should really stand for ‘so many so fast’.