So You Want to Buy a Property in Your SMSF

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Buying a property through your Self Managed Super Fund (SMSF) is quite straight forward if you have the money in your fund to purchase it outright, ideally with other diversified assets and some cash left over.  It becomes  a bit more complicated when you want to borrow money to make the purchase.

There are three (3) things SMSF trustees should know before making a decision.  Firstly, not all banks lend to SMSFs.  Secondly, those that do have some strict lending criteria and thirdly, there are some superannuation laws that must be strictly obeyed.  So here are some of the key issues you should be aware of, including basic loan qualification criteria:

  • The borrower must be trustee of your SMSF and it must be a corporate trustee, not the individual members
  • Your SMSF trust deed must allow borrowing for investment
  • You must enter into a strictly controlled Limited Recourse Borrowing Arrangement (LRBA) specifically designed for SMSF borrowing.
  • As part of the LRBA, you must arrange a custodial trust to become the legal owner of the investment property as well as an associated deeds and agreements to satisfy LRBA criteria
  • Be aware that there are strict regulations surrounding the use of borrowed funds under a LRBA arrangement to renovate and improve an investment property
  • For commercial (rental) property, participating banks will only lend up to 70% of the lender’s valuation of the property; and less for rural properties
  • There must be a registered mortgage over the property; the lender has no recourse to assets other than the subject investment property so will generally ask for personal guarantees
  • Your loan serviceability is based (only) on rental income produced by the property and your superannuation contributions over the past 2 years, which are subject to legislated limits
  • You must have other investments in your SMSF besides the real estate, as diversification is one of the key legislative requirements for SMSFs
  • You must have sufficient liquidity (i.e. cash or investment that can be easily converted to cash) in your SMSF to meet fund expenses and support the property if rental income or contributions are interrupted or interest rates rise.
  • Your lender will normally ask your financial adviser to sign off on the fact that you are aware of what you are doing and aware of your responsibilities as a Trustee therefore it is necessary to conduct a full fact finding interview and prepare a step-by-step plan with appropriate recommendations.

One of the biggest risks you face in a SMSF that has a borrowing arrangement in place is where a member dies or becomes permanently incapacitated.  Both events are likely to require the payment of a lump sum benefit to the member concerned or to the member’s nominated beneficiary(s).  In the absence of personal risk insurance owned by the fund trustee and held for the benefit of members, the surviving trustee(s) may be forced to sell fund assets in order to make such a payment.  Loan default can also arise as the result of the fund no longer having sufficient cash flow to be able to continue loan repayments in the case where the loan was approved taking into account the deceased or disabled member’s contributions.  Both circumstances could result in an asset fire sale sell off because there is a strict limit on time taken to pay benefits.  Such a short notice sale will crystallise investment profits / losses and could very well result in unplanned CGT consequences.

Divorce is also another major risk to a SMSF with a borrowing arrangement in place but I will deal with that in another post.

Getting back to the insurance issue, it is almost impossible for SMSF trustees to ignore personal risk insurance (like most people do outside super).  SMSF trustees have a legislative obligation to consider insurance in their annual investment strategies.  It is hard to argue that insurance is unnecessary when the risks added by property gearing are so obvious.  Any auditor worth their salt would note it and report it to the ATO.

If you want to discuss any of this further please contact me.

Cheers

Gary

 

 

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SMSF Investment Strategy – The Jewel In the Crown

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The Investment Strategy is the most important process in running an SMSF. Getting this part right is the difference between limping along on one cylinder and turning your SMSF into a high performance retirement vehicle.

Whilst administration and compliance are important, the real purpose of your SMSF is to maximise and manage your retirement savings. This point is often lost in the noise of compliance.

To put it into perspective, compliance is about operating inside the rules. I say that if you intend playing the game, learn the rules and then focus on the main game of investment management.

The same goes for taxation concessions. Quite apart from the fact that the same tax concessions are available to all superannuation trustees and members, fundamental investment decisions are never made on the basis of taxation alone.

Your Investment Strategy should be treated and respected as the Jewel in the Crown of your SMSF. Here are five (5) good reasons why:

The Investment Strategy is a fundamental document for every SMSF which, from day one stands beside the trust deed as the dual governing documents of your fund. Both govern your actions and put limits on what you can do. For this reason, neither document should be acquired without thought.

Your Investment Strategy is the driving force behind your fund. Without one, your SMSF is like a ship without a rudder. It exists but floats around aimlessly. Where you go is anyone’s guess.

While the existence of an Investment Strategy document is mandatory, it is actually your considered and deliberate processes behind the document that are of critical importance.

The Investment Strategy document itself is the written manifestation of the planning you do for your SMSF. So if the plan isn’t written by you or you don’t buy into it, then the document itself however compliant, is a waste.

Your Investment strategy need not be a lengthy or complicated plan. It must take into account the needs and circumstances of each member; and the overall liquidity of the fund. Further to that, it documents (under a few simple sub-headings) your decisions about how to invest the fund’s assets to achieve the fund’s objectives; which in turn reflect the objectives and risk profiles of each member.

Whenever I see a problematic SMSF, I usually find the investment strategy is either missing, out of date, or it has been trivialised to the bare minimum necessary to pass an audit. It appears to me to be one of the least respected and least effective SMSF documents. In reality, it represents the heartbeat of your fund and it should be treated that way.

This is general advice only. The purpose of this article is to provide you with education in SMSF investment, which is a complex area. As a licenced financial advisor, I strongly urge you to seek personal advice based on your individual goals, needs and circumstances, before making any decision about a self-managed superannuation.

 

Three (3) Areas Of SMSF Investment Poorly Done

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Whenever I review the investment section of a problematic SMSF, the areas I find that are commonly poorly done are:

The Investment Strategy

Appreciation of risk

Asset allocation

Inadequate Investment Strategy

More often than not, I find the investment strategy is either missing, out of date, or it has been trivialised to the bare minimum necessary to pass an audit. It appears to me to be one of the least respected documents in the SMSF suite.

I find that the investment strategy is rarely the driving force it should be, which is a shame because it represents such a great opportunity to set up the fund for success. Whilst administration and compliance are necessary priorities, it is ultimately the investment strategy that will achieve your retirement goals.

Lack of appreciation of risk

It is common to see an SMSF investment portfolio that is not consistent with the innate risk tolerances of its members. If the trustees have moved away from cash, it is common to see investments that are way too risky for the members. If the members do have an appreciation for the underlying risk, it can mean many sleepless nights worrying about it.

Trustees typically do not fully understand risk, for example:

The risk of not understanding individual comfort zones and tolerances

Risks associated with speculating rather than investing

The risks of holding too much of one asset type, including cash

Risk by not understanding investment correlations

Risk by not understanding the role of insurance in managing investor risk.

So the aim of your Investment Strategy is to pull together investments that work well for you; that are inside the comfort zones of members, without raising stress levels. Paying attention to protection is critical.

Poor asset allocation

From what I see, there is a major gap in know-how when it comes to choosing assets to invest in within the SMSF environment. With no training and little previous experience, trustees find themselves suddenly charged with the responsibility for investing hundreds and thousands of dollars, or even a million or more.

It is little wonder that people tend to hold a lot of money in cash. Trustees I talk to simply don’t know what to do. This is ironic because one of the widely promoted advantages of an SMSF is the wide range of investment possibilities.

How to research, what to invest in, identifying and managing risk are the biggest challenges that SMSF trustees face. However, the trustees who solve the investment conundrum are the ones most likely to achieve their financial retirement goals.

So it is a matter of experience and getting the balance right; a balance that I should point out is different for every SMSF, and varies among members of the same SMSF.

This is general advice only. The purpose of this article is to provide you with education in SMSF investment, which is a difficult area. As a licenced financial advisor, I strongly urge you to seek personal advice based on your individual goals, needs and circumstances, before making any decision about self-managed superannuation.

 

Set Up An SMSF … Now What?

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People I see leaving the mainstream superannuation system to an SMSF environment are usually disillusioned in some way. Either they have had poor advice in the past, or suffered loss in the GFC, or they want to stop money leaking out of their fund by way of advisor commissions. Of course, some make the move because they see a property opportunity.

But regardless of the reason for moving to an SMSF, clients often say that their first priority is to have safe custody of their own money.

However, that in itself doesn’t lead me to the conclusion that they are risk averse. Although it can look that way when there is so much money sitting in cash, I think it is more about not knowing what to do next.

If you set up an SMSF and hand off the administration to an external service, it is not a job done. It’s far from finished. All you’ve done is to have acquired a superannuation vehicle and a service contract.

The missing key is that there’s no one in the driver’s seat! Addressing this anomaly is critical to the success of most SMSFs because there is usually a marked lack of in-house expertise.

The areas I see that are typically poorly understood are:

Investment, in particular documentation, risk and asset allocation

Risk management strategies, in particular structural and insurance protection

Estate planning across a wide range of issues

Effective use of the Transition To Retirement strategy

Meeting the requirements of Exempt Current Pension Income

Property purchase issues, particularly when borrowing is involved.

I find that these are the areas where trustee support is needed most. This is where an experienced SMSF financial advisor can work beside you as a technical advisor, mentor and educator to help you achieve the retirement you want.

At Gary Weigh & Associates, this is our specialty.

Adopting a team approach enables you as trustee to bridge the expertise gap and effectively manage your new _retirement investment business. _You can feel confident jumping into the driver’s seat and embracing all of the opportunities offered by the SMSF concept.

Of course, the other major aspect of managing an SMSF is being able to interact confidently with all of the external professions relevant to running an SMSF, including:

Accountant

Auditor

Solicitor

Share broker

Estate agent

Property manager.

Once again, we are very used to meeting with these professionals and instructing them on our clients’ behalf. We would be pleased to extend the same service to you.

With Gary Weigh & Associates on your management team, you will have the leverage in both knowledge and expertise to be able to manage all the functions of your SMSF, particularly the high payoff activities that turn an empty vehicle into a retirement performance machine.

This is general advice only. The purpose of this article is to provide you with education in SMSF management, which includes many difficult areas. As a licenced financial advisor, I strongly urge you to seek personal advice based on your individual goals, needs and circumstances, before making any decision about self-managed superannuation.

 

Be Sure Of Your Purpose Before Moving To An SMSF

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You might wonder why it is important to set clear goals and be certain about your reasons for leaving the mainstream superannuation system to start your own SMSF.

I have had two instances recently, where SMSF trustee groups came to me AFTER they’d already moved from mainstream super to the SMSF environment, saying that they now weren’t sure if they’d made the right decision.

I found that in both cases, they were encouraged to set up their own SMSFs for what appeared to be good reasons at the time, only to find soon after, that circumstances had changed and the original purpose had not come to fruition.

Case 1

The original purpose was to buy business real property (that is, premises for their business to be owned by the SMSF). In this case, the client subsequently struck a great lease deal with their current landlord and the original need for their SMSF disappeared, at least for a few years.

Case 2

The original purpose was to minimise capital gains tax on the sale of a privately owned property. In this case, had the clients received advice from a competent tax advisor before moving to an SMSF it is likely that the purpose would have been revealed as invalid in the first place.

So why is being sure of your purpose so important? What difference does it make whether these people are in SMSFs or not?

From where I see things, it matters a lot because in both cases, once the original purpose had evaporated, the parties involved lost interest in their respective SMSFs. Because they had come from retail super, they immediately slipped back into a ‘set and forget’ frame of mind.

In the SMSF environment, this attitude rings alarm bells very loudly to me!

Why? Because client disinterest means that I am likely to find inattention to compliance, record keeping and annual reporting. And in both cases, that is exactly what I found in the course of gathering information.

Even though outstanding matters were brought up to date very quickly, inattention to these matters can result in adverse outcomes ranging from late lodgement to contravention, depending on the period and extent of the inattention.

In both cases, the clients indicated that the move to SMSF was at the suggestion of other professionals. Whilst it may have been well-meaning, it became clear to me that these clients had not fully understood the responsibilities and implications of being a superannuation trustee. When I explained it to them, it came as a complete surprise.

This is not the first time I have seen time-poor business owners pushed towards an SMSF with no idea of what it actually means to be a trustee of a superannuation fund. It is easy to say that all SMSF members must be trustees, or directors of the trustee company, and bear 100% of the responsibility but living it is a completely different reality if people aren’t ready for it.

This is general advice only. The purpose of this article is to provide you with practical examples as a means of education in a difficult area. As a licenced financial advisor, I strongly urge you to seek personal advice based on your individual needs and circumstances, before making any decision about self-managed superannuation.

 

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Two Clients Reach Different Decisions About SMSF

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These two client stories provide some insight into the process of weighing up the pros and cons of an SMSF. You will read in the first client story why Veronica and John decided to proceed to an SMSF and in the second, why Patricia and Alfred decided against it.

Client Story 1 – Veronica and John

“Our superannuation was with a company that evolved from one of the old life assurance companies. Our former adviser did set us on the path to retirement savings by encouraging us to contribute as much as we could afford each year. So we saved a lot over two decades.

However, as time went on our access to him became very restricted. By choice, all of our money was in cash so we thought that the fees we were paying were excessive as we weren’t getting the access we needed or the retirement advice we were seeking.

We called [Gary Weigh & Associates](http://www.garyweigh.com/) because that’s the organisation my sister was using to solve her SMSF problems at the time. Gary explained a wide range of superannuation alternatives to us but we had our hearts set on SMSF. Despite that, he still took the time to fully explain the pros and cons, and he showed us a costed comparison with a viable retail alternative.

Because my husband and I run a business, I feel comfortable in the trustee role. It just feels like running another small business. We now have good advice and great service. I feel in control.”

Client Story 2 – Patricia and Alfred

“We reached a crossroads when we sold a block of land at the back of our property. We wanted to put the proceeds into super as an after-tax contribution. When we asked our former advisor to arrange it for us, he said that it would cost us several thousand dollars because of the contribution fee that existed on our super account.

It was then we realised that we had been losing part of everything we put into super up to that point. That was on top of administration fees, investment fees and ongoing advisor commission. We didn’t know much about super and, at first, assumed this was normal practice.

A friend suggested that we get a second opinion. We were referred to [Gary Weigh & Associates](http://www.garyweigh.com/). Gary came to see us and explained other superannuation options to us including SMSF, and told us that advice fees didn’t depend on which type of fund we chose. It was the same fee, whatever we did.

We considered an SMSF but we really didn’t want to be bothered with the hassle of running it ourselves. Too busy in retirement for all that stress and paperwork! So Gary recommended personal super with investments that we feel comfortable with, and they have really gone ahead for the past two years. Importantly, we receive retirement advice as we need it, which is what we wanted in the first place.”

Of course, the moral of both stories is seek personal advice; talk all of the issues through with a licenced financial advisor, and decide on a form of superannuation that best suits your individual needs.

 

SMSF Putting The Certainty Back Into Superannuation

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If you like the safe feeling of keeping your retirement nest-egg close to you, then you are not alone. There are many people who also want to control their own wealth in their own way.

Some like the feel of cash, while others prefer to invest in tangible bricks and mortar. Then there are those who are avid DIY share market enthusiasts.

People are heading towards Self-Managed Superannuation in numbers. With the scars of the global financial crisis (GFC) still fresh, there is a growing desire to become ‘Master of own Destiny’ when it comes to wealth and retirement building.

For many, it is a comforting and safe feeling to have superannuation under close control, even if it stays in cash. I don’t think many would seriously argue that they are better investment managers than the professionals, but then nobody has the same level of care and invested emotion in one person’s retirement as the individual retiree in question does.

For several people, switching to SMSF is also the opportunity to leave managed funds behind, together with inherent investment risk and the association with advisor commissions. And I can understand why.

Managed funds are at the heart of the Australian superannuation system. In a system where so many people had their superannuation savings brutalised through the GFC, it is no surprise that managed funds are widely associated with eventual loss.

After many discussions with clients, I would rank the following as their most common perceptions of managed fund-based super:

You start a new job and get what you’re given.

Often, there is only a limited number of one-fund investment choices.

They are often accessed through platforms with confusing layers of fees.

The options available are rarely capital guaranteed and therefore carry risk.

There is widespread unawareness of the risks until it is too late.

Unseen faces are ultimately in control of members’ retirement benefits.

There is a strong association with advisor commissions even through a downturn. Even after recent banning, grandfathering provisions mean that there are a lot of funds still paying commissions to advisors.

Personally, I am a fan of managed funds because I know them and understand them. Even so, there is still widespread exposure to risk and, in my experience the majority of people in or near retirement are generally risk-averse. They simply can’t afford to lose their capital because, after ceasing work, they have no means to replace it.

Older Australians I speak to generally want safety and certainty when it comes to their retirement savings. The mainstream superannuation system is not set up to deliver that, so risk-averse people feel they are left with little choice but to take matters into their own hands.

Very few make the move to an SMSF because they have a burning desire to be a superannuation trustee. They view that responsibility as the price to be paid for total control over their own money.

Most retirees I talk to agree that they need some growth in the capital base that underlies their super and pension, but they don’t necessarily see managed funds as the way to achieve it.

So I think this is an insight into why we see so many SMSFs where members hold the majority of their funds in cash and term deposits and purchase a relatively small number of direct shares. It’s all about safety, certainty and control.

 

SMSF Exit Triggers in Retirement

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Without putting too fine a point on it, retirement is a journey from ceasing work to the end of life, and it is far from a homogeneous experience. Circumstances change and sometimes change suddenly. At Gary Weigh & Associates, we see retirees going through three broad phases.

Settling in Phase

This period is different for everyone. Some people struggle with the lifestyle change while others take to retirement like a duck to water.

Enjoyment and Purpose Phase

The ‘golden years’ period everyone dreams about – travelling, doting over grandchildren, enjoying family and indulging in favourite pastimes. Lifestyle and quality of life through this period depends on how well the balance of health, money, relationships and purpose is managed.

Getting Old and Needing Help Phase

Unfortunately, age eventually brings health problems, both physical and mental. Like it or not, there is ultimately a slowing down, leading to restrictions in lifestyle choices and the need for assistance.

So how does this relate to SMSF trustees?

SMSF trustees retire just like everyone else. While everyone’s retirement experience is different, all retirees go through the broad phases listed above. So while an SMSF can be an appropriate retirement vehicle through the accumulation and transition to retirement years, there is likely to be a time on the retirement journey where trustee circumstances trigger the need for change.

SMSF Exit Triggers

The first is lack of interest, and it is more common than you might think. What was important during the working years can become unimportant in the ‘enjoyment and purpose’ phase as priorities change. And there is nothing like the feeling of time running short to refocus priorities.

Of course illness or decreasing cognitive ability can trigger an SMSF exit. Physical or mental health may deteriorate to the point where it may no longer be possible to perform the trustee role. The loss of mental capacity can not only disqualify a trustee but it is risky, given the degree of legal responsibility.

The loss of a partner can trigger an exit from an SMSF. When a partner dies, particularly if it’s the dominant trustee, the surviving partner often lacks the motivation to carry on the SMSF, even if he or she can legally continue as a sole director of the corporate trustee.

A change of asset allocation can trigger an exit. It is a common strategy to sell down assets in the pension phase to achieve a favourable CGT outcome. Without property and shares for example, the reason for maintaining an SMSF may no longer exist.

And finally, regardless of interest, capability, health or investment mix, there are some good reasons to exit an SMSF and move back to personal super. These advantages are discussed on Gary Weigh & Associates’ website in the article http://garyweigh.com/smsf-investment-it-pays-to-do-your-homework/

Review Outsourcing Arrangements

It can be risky for an incapacitated or disinterested trustee to continue to rely on an SMSF administration service. It is important to realise that an administration service is only an outsourced provider. At no point does such a service bear the onerous responsibility of the trustee. That’s why it is important to review regularly and consider other options that may be a lot safer.

 

This is general advice only. The purpose of this article is to provide you with information and education in a difficult area. As a licensed financial adviser, I strongly urge you to seek personal advice based on your individual needs and circumstances, before making any decision about self-managed superannuation.

 

Three Essential Reasons To Have An SMSF Corporate Trustee

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There is no doubt that setting up an SMSF with individual trustees continues to be the most popular choice. It is cheaper and less effort but it has the potential to set up the trustees for unnecessary risk, unwanted hassle and avoidable stress if / when an unfortunate event occurs. And such an event could occur two decades later, at a time when the clients are well into retirement.

It is encouraging to see the tide turning as the regulators appear to be taking a more active role in discouraging this practice. As an advisor, I strongly encourage clients to use or continue to use the corporate trustee structure. It’s a small price to pay for ongoing protection and peace of mind.

Whilst there other advantages, I have highlighted the three (3) that, given the right circumstances, have the potential to unleash financial disaster.

Limited liability for trustee directors

The last thing you want is your personal assets (for example, your house) at risk when you are retired. When an individual acts as an SMSF trustee in his or her own name, it is akin to running a business as a sole trader. All of the individual’s personal assets are on the line. Also, in certain circumstances SMSF trustees can be sued. This risk is higher when the fund owns property or takes on debt.

Using a company as the trustee of an SMSF, where all members are company directors, means an added layer of protection for the individuals personally. Any legal stoush will be generally limited to the fund’s assets and, unless personal guarantees are in place, is unlikely to involve members’ personal assets.

Certainty of trustee succession

I’ll explain using a common example. In the event of a member’s death (and everyone dies eventually) where only one individual trustee remains, the SMSF can’t carry on. A second trustee must be appointed.

Depending on who this person is, there is a risk that the ‘shared vision’ decision-making process that typically prevails up to the day of death could change dramatically. How could this happen?

Just think about lack of proper estate planning combined with divorce, remarriage, a blended family, a nasty in-law, a spendthrift child or a child with a gambling or drug addiction! You can see how your lifetime of work could be misdirected.

On the other hand, a sole director of a corporate trustee can carry on alone in the event of a member’s death with continuing certainty in decision making for the surviving spouse.

Definitive separation of SMSF assets

Again, this is a risk issue. It lessens the risks associated with mixing SMSF assets with personal and business assets. A corporate trustee structure provides a clear line of separation between SMSF assets and members’ personal assets. It also demonstrates this separation to regulators. It is also a practical protection in the event of personal bankruptcy of a member. The corporate trustee structure can help protect fund assets from receivers.

If you can’t afford a company to act as the trustee of your SMSF, I would question whether you should be taking on the trustee role at all. After all, it is your responsibility to think beyond your own needs and consider the needs of other members (your family) and to act prudently to protect them.

 

If Investing in SMSF, Create a Vision

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In my experience as Principal Advisor at Gary Weigh & Associates, many people don’t have a clear vision for their SMSF before jumping in. The overriding need for control over superannuation is not enough. It is important to understand why the need for an SMSF exists.

As an experienced financial advisor, I can tell you that in some cases the need exists because an accountant or financial planner suggests it does. It depends on the advice provider’s motivation because an SMSF recommendation can also mean years of ongoing SMSF service work which can be very profitable for the advice provider.

But regardless, I encourage anyone heading down the SMSF track to do their homework and satisfy themselves that significant need exists that an SMSF will satisfy where no other form of superannuation can.

Start by asking the following questions of yourself and / or the person who recommended an SMSF:

1. Do you have a special skill as a trustee, administrator or investor?

2. Is the prime purpose to acquire your business premises?

3. Is the prime purpose to purchase residential real estate?

4. Is the prime purpose to invest in Collectables (e.g. collections of art, wine, coins, stamps etc.)?

5. Are you aware of the SMSF rules pertaining to real estate acquisition, limited recourse borrowing, collectables and restrictions on investment?

If your answer is NO to all of these questions, I can’t see a strong need for self-managed super and you may be better off staying out of an SMSF and choosing another form of superannuation.

So for example, “If the purpose of your SMSF is to invest in listed shares, term deposits or managed funds, you don’t need an SMSF to do that. It can be achieved with a superannuation wrap”.

Furthermore, even if you answered YES above, and do intend to invest in mortgaged real estate property, ask yourself the question, “Is it really worth taking on trustee responsibility, setting up three separate entities, incurring additional legal costs, and years of ongoing admin and compliance, with no ability to improve the property, just to acquire a real estate investment that may be eligible for a tax break?”

The majority of people are not expert property investors and simply want to have enough money for a comfortable retirement. So I encourage prospective SMSF trustees to have another look at personal superannuation.

From experience, I can confidently say that with good investment advice and a reasonably priced administration platform, personal super can deliver investment performance and control at a reasonable cost is very achievable without all the work and hassle of an SMSF.

For more information about SMSF and other retirement services visit http://garyweigh.com/advice/