Finance: 7 SMSF Mythbusters
SMSFs and the Ever-Growing Need for Mythbusters
Increasing numbers of people are choosing to own Self Managed Super Funds (SMSFs) in order to make their own investment decisions. As super fund trustee, you are solely responsible and in control of just how your superannuation funds are to be invested. Numerous myths have accumulated around these super funds over the past few years, many of which are not valid and are likely candidates for mythbusters, including the following:
The First SMSF Mythbuster
You are Required to Obtain a Derivatives Risk Statement Prior to Trading SMSFs Involving Derivatives
One popular myth surrounding SMSF trading is that it is absolutely necessary to have a Derivatives Risk Statement when you are trading any variety of derivatives. You may also have been told that when involved in SMSF borrowing, previously referred to as Installment Warrant borrowing, you are required to have a DRS. Consider both of those myths busted, because neither one is, in fact, truthful. The fact is, having a DRS is a requirement whenever you trade a futures contract or an options contract in the event certain collateral in the form of financial assets is offered as a requirement for meeting a margin for initiating the trade. If you are simply trading call or put options, you do not need to acquire a DRS.
The Second SMSF Mythbuster
Any SMSF Management Errors You Make Can Result in an Audit by the ATO and Non-Compliant Status for You
This myth is a good one to bust and beware of, especially since numerous services and products are currently being marketed to aid you in avoiding such a predicament. In reality, fund trustees who commit honest mistakes can often correct their errors with no harsh repercussions or actions from the ATO. Actually, in many such cases the ATO, if appealed to, will aid trustees who made honest errors in managing their SMSFs. Such errors, when made without any intent of wrongdoing on the part of the trustee, are not considered to warrant any adverse charges being made against or restrictions being placed on the trustee by the ATO. If, in fact, you have made a blatant error in including illegal loans or assets within your SMSF, rest assured that by promptly reporting this to the ATO before an audit can take place, you will most likely receive their expert assistance in correcting your mistakes rather than a brand of non-compliance. This myth is definitely busted.
The Third SMSF Mythbuster
Must I Have $200K to Set Up My SMSF?
Another often repeated myth relative to SMSFs is that in order to start a worthwhile SMSF, you must be prepared to invest $200K. This myth is prime bust material simply because super funds which are DIY in terms of administration vary widely in percentage costs of audits and other service fees. Without question, it is definitely not advisable to set up an SMSF with an investment of merely $20,000 or $30,000. If you do, in all likelihood the ATO will be hovering close with grave concerns that your management techniques may indeed breach the non-compliance parameters. However, it is quite possible to responsibly manage a super fund within the range of $75,000 to $85,000.
If you use both a personal accountant and a SMSF financial adviser for administration of your SMSF, annual costs for their services will total approximately $4,000 (2% of a $200,000 SMSF). If your SMSF investment is $75,000, this cost would be only 1.3% of your super fund’s total worth, so this route is feasible for a small SMSF. Especially since many SMSF trustees do not use outside services for administration and auditing of their super funds, the notion that you must invest $200,000 when setting up a super fund is just not valid. Let’s bust this myth, too.
The Fourth SMSF Mythbuster
Is There Such a Thing as a Standard Trust Deed?
Your trust deed essentially defines the rules pertaining to the administration of your SMSF. The only way you can change these rules is by amending your deed. Regardless of what the SIS laws dictate, you must follow the stipulations currently governing your trust deed. For example, if you wish to invest in a particular asset and that action is not allowed by the rules of your trust deed, you can only proceed with the investment after the current deed is upgraded to include this investment. Another example involves super fund member voting. Some trust deeds allot one vote to each trustee or director, while others weigh votes according to member balances or ranking.
A third example is Binding Death Benefit Nominations. According to ATO regulations, super fund trustees are allowed to apply non-lapsing binding death benefit nominations. These death benefit nominations will not lapse after three years. Yet, trust deeds often allow for formation of BDBNs that will, in fact, lapse at the end of three years. In addition, there are trust deeds that designate a death benefit agreement as an SMSF Will, which then is considered a part of the deed. Now we see this as yet another busted myth. For, there really is no one standard SMSF trust deed.
The Fifth SMSF Mythbuster
Am I Prohibited from Staying in Any Residential Real Estate Owned by My SMSF?
Can I be charged with violating the sole purpose test if I stay in a residential property that my SMSF owns? Is this prohibited? While doing so is generally deemed against SMSF administration rules and policies, there are some exceptions, according to SMSF Ruling SMSFR 2008/2 by the ATO. For example, if trustees of an SMSF own a vacation lodge in a ski resort, they may not inhabit this residence as vacationers or house guests. However, they may stay in the lodge as short-term guests during off-season for the purpose of performing or overseeing repairs or maintenance on the property, provided they pay the fund normal lodging fees for their accommodations.
If and SMSF already owns short-term rental property in an area where a trustee is currently travelling, is it acceptable for this trustee to stay in the property and pay the going rate for occupancy. In this instance, the sole purpose test is not broken since the property was not purchased by the super fund so that the trustee would have a place to stay while in transit. It was owned by the SMSF prior to the trustee needing a place to stay in the vicinity and therefore is only of incidental benefit to the trustee. Now we can call this myth a busted one, as well.
The Sixth SMSF Mythbuster
Can I Borrow Money in an SMSF?
In earlier years, a core principle of SMSF administration was that trustees were prohibited from borrowing money in the super fund. Now, however, under the regulations of limited recourse borrowing arrangements (LRBAs) borrowing is allowed under specific circumstances, including:
- to facilitate member benefit payments up to 10% of SMSF total worth, for up to 90 days;
- in order to pay for security transactions up to 10% of SMSF total worth, for up to seven days;
- to acquire a singular asset or a group of identical assets having equal market value, known as the “acquirable asset(s)”, and such asset(s) must be acceptable for SMSF acquisition;
- to pay acquisition costs such as loan rates, stamp duty or asset maintenance costs;
- to refurbish or make improvements to an asset that is acquirable without making major alterations to the asset;
- to pay only acquisition costs for a specific asset, excluding any added charges.
Only when such stringent restrictions are met can trustees arrange to borrow money in an SMSF. We see that the old myth that borrowing money from your SMSF is strictly prohibited is now passé, and therefore busted.
The Seventh SMSF Mythbuster
Is It True That All Retirees Are Irresponsible Financially?
There is a popular myth that all retirees, especially Baby Boomers, tend to spend the total sum of the super money in their SMSFs and then attempt to live on their pensions. In other words, rumor has it that retirees waste their super money foolishly and then have to live a modest lifestyle lacking in quality and creature comforts. Thankfully, for all those planning to retire in the near future, this widely spread rumor is also a myth to be proven busted. According to the majority of financial advisors and accountants working with SMSF trustees, people approaching retirement age are usually well focused on increasing the value of their super funds as much as possible in order to have sizable tax free investment funds that they can continue to administer and add to when retired.
Although some accountants have reported that some new retirees were using super funds to eliminate debt, leaving mainly their pensions to live on subsequently, this unwise practice is most assuredly not the norm. In general, retired people are acutely aware of the funds they have on which to live when their working years are over. They are constantly seeking new ways of adding money to their current investments, and especially to their tax-free SMSFs in order to enjoy a good quality of life throughout retirement. We can definitely call this a well-busted myth that is thankfully losing its luster and clout rapidly.
Aaron Long has been a financial advisor since 1992. He says, without question, there are many popular myths pertaining to SMSFs and the habits and practices of their trustees. Yet, it is encouraging to know that most of the myths that detract from the value and advantages of owning an SMSF are, quite simply, untrue. With the aid of powerful mythbusters in the form of valid facts about SMSF structure and administration, we can be assured of the real importance and unique benefits of these highly rated self-managed superannuation funds.