A Self Managed Super Fund, or SMSF is a legally sanctioned, stringently regulated, tax-advantaged structure for accumulating wealth during your working life to either fund or assist in funding, your retirement.
Currently, in Australia, there are approximately 600,000 SMSF’s with almost 1.1M members. SMSFs control assets of close to $750B, or nearly a third of all superannuation assets.
Contributing to or holding assets in an SMSF affords the investor favourable tax treatment, but the tradeoff is strict compliance responsibilities and individual liability for the member trustees.
An SMSF can have up to 4 members, and all are equally responsible for making sure that the fund complies with superannuation and tax legislation. The Australian Tax Office imposes harsh penalties for stepping outside the guidelines.
Australia’s ageing population makes the welfare burden unsustainable. Compulsory super contributions are an investment for the future and a deliberate measure to ease the strain on the government’s purse strings.
How those contributions, compulsory or voluntary, are invested depends on whether you choose an industry or retail fund or undertake to do it yourself by setting up and running an SMSF.
SMSFs are established for the sole purpose of providing financial benefits to members in retirement and their beneficiaries. They have a Tax File Number (TFN), Australian Business Number (ABN) and transaction account, for contributions and rollovers to be paid into, to make investments and disburse funds to beneficiaries.
It’s important to understand that an SMSF has strict controls and high compliance costs in terms of effort and expense. For a short overview, take a look at this video from the ATO and seek professional advice!
ATO – What’s involved with an SMSF?
SMSF legislation allows non-recourse borrowing by an SMSF for a property.
‘Non-recourse’ refers to the fact that if the borrower (the separate entity, the SMSF) defaults the lender can only seize the assets held as collateral for the loan (the property). The lender cannot seek any compensation from the personal assets of the fund members.
Legislation allowing SMSFs to purchase a property under these provisions is a strong vote of confidence in the asset class’s relative predictability and the security of retirement funds.
One of the principal features of a trust structure is asset protection from creditors in the event of bankruptcy or legal action involving one of the beneficiaries.
They also provide clarity as to what happens should one of the beneficiaries die, and the beneficiary of a will owes no duties.
As attractive as a trust structure sounds, there is no opportunity to benefit from negative gearing should the property incur a capital or rental loss. Trust members cannot offset that loss against their tax liability for the year.
A discretionary trust has the freedom to decide which members (if any) will benefit from the trust’s income or capital growth from year to year. The trustee can consider each beneficiary’s tax position for the financial year and distribute benefits in the most tax-effective way. Family trusts are very often discretionary trusts.
A unit trust, on the other hand, is less flexible in terms of determining who receives the benefit. Units (or shares) in the trust are in a fixed ratio, and benefits are distributed accordingly. This form of trust is less tax effective but offers predictability for the unitholders.
Given the flexibility and opportunity that trusts afford investors to manipulate tax liabilities, the compliance and regulatory burden imposed by the authorities are more rigorous than for any other structure.
Personal ownership is the simplest and straightforward way of purchasing an investment property. Many people will proceed on this basis as the majority of strategies will be a ‘buy and hold’ approach. The idea is to enjoy the tax benefits now and long term capital gain in the future.
Personal ownership can either be as an individual (sole) or held by two or more people (Joint).
Joint tenants mean those on the title (can be more than two people) own the property jointly and are responsible equally. The property can only be disposed of wholly, not in parts and on death, ownership of the property passes to the surviving owner. Most committed couples would elect to have this setup.
Tenants in common means each of those on title own a share (50/50, 75/25, etc.) of the property and can dispose of their share if they choose to. On death, the will of the deceased determines the outcome of the deceased’s share in the property.
Capital gains tax applies but is discounted after the asset is held for at least 12 months. (discourages speculation)
The setup costs are modest, and lenders are comfortable with high loan to value ratios, especially when the equity in other property secures the purchase.
It is possible to apportion ownership between purchasers to maximize tax benefits now and or to minimize capital gains tax obligations in the future.
The downside of this arrangement is its lack of flexibility – there is no opportunity to distribute gains or losses according to marginal rates of tax or variable annual earnings.
Also, once an ownership split is chosen at contract signing, the set up remains in force for the life of the investment, so should circumstances change the ownership proportions cannot be amended.
There is no asset protection, and in the event of the property eventually becoming positively geared, the additional income will be taxed at the individual owner’s marginal rate.