Self-Managed Super Fund (SMSF) – The right thing for you?
Chances are most of you reading this either know someone who has an SMSF or have even considered opening one yourself.
It is important to not follow the crowd when making this decision and to spend the time needed to critically analyse one question: is a SMSF the right thing for you?
I have had a lot of conversations of late with people who have floated the idea of opening an SMSF for themselves and their partner. Almost every time the main reason for wanting to do this is to be able to invest directly in residential property. However, there is more to consider.
It goes without saying that there are benefits of using a SMSF. Common ones are complete investment control and the ability to invest in direct property (commercial and residential).
Consider the following scenario we often see:
Jack and Jill own and operate a Mechanic business. For the most part, Jack runs the workshop and Jill runs the office. Jack and Jill have a SMSF which owns the commercial shed their business runs out of. The business pays rent to occupy the shed, effectively meaning the business is the tenant and the SMSF the landlord.
The ways Jack and Jill benefit from this arrangement is that the business has long-term security that it will have a commercial shed to operate from, the SMSF will also have a long-term tenant that pays rent on time and the capital value of the shed should appreciate in value over time. Also, the business needs to pay rent at commercial rates rather than Jack and Jill deciding to let the shed out for free, however, the added benefit is that the SMSF will only pay tax on the rent at 15%. As Jack and Jill control the business and the SMSF, the rent flows from the business to the SMSF as income and incurs the 15% tax, rather than it being paid to another landlord and being lost completely.
In this situation Jack and Jill’s total portfolio is connected and can benefit strongly through commercial transactions occurring, therefore it is clear that the SMSF is the right thing for them considering their circumstances. Jack and Jill also have additional investments inside their fund that provide them with solid diversification and liquidity, which spreads their overall risk and should help their long-term return.
However, an SMSF can also be inappropriate.
A key reason there has been an influx in enquiries about owning property inside an SMSF is due to the affect COVID-19 has had on regional property prices. The idea of owning a property inside your SMSF and watching its price continue to go up and up is hugely appealing and worth considering. What people tend not to think about are the risks and costs involved and the minimum balance they should have to make it worthwhile. Not to mention the administration and legal responsibilities.
The main purpose of superannuation is to provide income in your retirement. Therefore, investing all of your super into one asset increases your risk. What happens if there is a large downturn in the property market? What happens if your tenants do not pay rent on time? What happens if your tenants don’t maintain the property? Even if your tenants do pay on time and look after it, there are going to be periods where the house is empty and the dishwasher and hot water service are going to need replacing at some point. Your property manager will ask for a fee and you will need to pay certain rates and insurances. Further, if you are required to borrow funds for the project, the rates on loans inside an SMSF are more expensive than you may think.
It pays to do your research and focus on areas that have higher rental yields to ensure your costs are going to be covered; you do not want the balance of your SMSF going backwards. An inexperienced property investor may be best served waiting until they have some decent understanding of what being a landlord is like before opening an SMSF for this purpose.
After taking into account the potential pros and cons, it is important to know that not everybody’s situation and circumstances are the same, therefore their financial plan and strategy shouldn’t be either. Having your assets allocated appropriately is key to long-term wealth creation; superannuation is merely a vehicle people use.
If you have been thinking of opening an SMSF to invest in property, precious metals, shares or even artwork, reach out to an adviser at Mulcahy & Co today so we can help determine if one is, in fact, the right thing for you.
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