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2. Why McMaster’s recommends doctors use SMSFs

McMaster’s recommends doctors use self-managed superannuation funds because over the last 20 years we have observed SMSF clients record consistently better investment results, experience lower operation costs and enjoy greater control, information and protection compared to alternative forms of superannuation.

These observations have recently been confirmed in a 2009 government study that found that SMSFs achieve better investment results and have lower costs than both retail superannuation funds and industry superannuation funds.

Any investment will do better in a SMSF

Where the member faces tax of 40% or 46% (which is virtually everyone) any investment will perform better in a SMSF. This is because:

the tax deduction for contributions means up to 31% more cash is available for investment at the beginning of the investment's life (ie 46%, being the member's tax rate, less 15%, being the SMSF’s tax rate);
because more money is invested each year, investment earnings are greater. A head-start is created and this lasts for the life of the investment; and
the fund’s income is taxed at no more 15% and realized capital gains are taxed at 10% (and sometimes 0%), so the after tax rate of return on the investment is always greater than for a 45% taxpayer, meaning there is faster compounding in a SMSF than elsewhere.

This advantage is deliberate government policy. The old age pension is being replaced by a system of private pensions. It is a mathematical certainty that an investment in a super environment will do better than and identical investment in a non-super environment.

Increased information

A SMSF means you don’t have to wait for months after 30 June each year to find out how your investment is performing (or even what it is invested in). The information is always readily available. Most trustees can access information on virtually a daily basis.

The rapid growth in Internet trading is increasing the amount of information. Most e-traders provide free portfolio tracking software, which means clients get immediate reports on the state of their portfolios at any time.

Cheap software packages like Banklink and Praemium make it even simpler for SMSFs to run their own investment portfolios with minimum effort and maximum fun.

Synergy with other investment and business strategies

SMSFs can create synergies with the member’s other investment and business activities. The SMSF's investment strategy should be prepared as part of an overall investment strategy reflecting the member's attitudes and overall financial profile. The member's will and estate planning should be considered as part of this strategy.

It can make sense for a SMSF to minimize property investments if the member’s family trust has invested heavily in property. Overall, the investment portfolio is balanced, even if the SMSF invests solely in shares. It’s hard to see how a managed fund with thousands of members of all ages, from all walks of life and with vastly different financial profiles can be as efficient as a SMSF.

One fund cannot be all things to all people.

Tax free death benefits

In most cases eligible termination payments paid direct to a deceased member’s dependants are tax-free in the dependant’s hands. This applies to all superannuation funds, not just SMSFs. But as SMSFs are usually controlled by the deceased member’s nearest relatives there is more tax planning potential and certainly more control.

Asset protection

SMSF assets are generally protected from bankruptcy. This means a trustee in bankruptcy cannot access the benefits and the benefits are held for the member. Benefits paid out during a bankruptcy, say, on the member reaching a specified age, or before bankruptcy may not be protected.

Capital gains tax efficiencies

Most people know most SMSF income is taxed at 15% and capital gains are taxed at no more than 10%, provided the asset has been held for less than 12 months. This gives SMSFs a significant advantage when it comes to deciding which entity should hold an asset that is expected to increase in value.

Fewer people are aware SMSF income is taxed at nil % if it used to pay a pension, and that capital gains only face tax in the year the gain is realized, not in the year the gain accrues. SMSFs allow you to eliminate CGT by controlling the timing of asset disposals. This means the realization of gains (and, in many cases, other income) can be deferred to a year when the SMSF pays nil tax, ie when the members are being paid pensions from the SMSF. With planning most capital gains can be derived tax-free using this method.

And pensions can start at age 55 without having to stop work.

This significantly increases the after tax rate of capital gain, significantly increasing the return on the investment, just by deferring the disposal of the investment. Try getting a managed fund to do this for you!

Retirement planning for children

SMSFs can be used to obtain retirement benefits for spouses, children and even grand children. SMSFs are a sophisticated method of cross-generational wealth transmission.

Ethical investments

SMSFs can choose to only hold investments they believe are ethical. Trustees can structure the SMSFs’ investment strategy so that no unconscionable investments are held, or so that socially advanced investments are emphasized.

It’s a pleasure: SMSFs as a enjoyable way to spend your time

Each year we give this heading more and more weight. Most people who run SMSFs do so because they enjoy it. They like the control and they are genuinely interested in investing. They enjoy learning about investment opportunities.

Most people who run SMSFs enjoy it. SMSFs do not have to take up a great deal of time. Some people get by with just a few hours a year. They only buy quality blue chip shares or other conservative investments, such as an index fund, and never sell. This strategy has worked well in recent years and has the added benefit of lower administration costs since there are fewer transactions to record and monitor. This strategy is common with younger people with smaller funds and/or larger work and family commitments.

Other people enjoy spending a few hours a week or in some cases even a few hours a day attending to their SMSF investments. They believe they can add to its performance by paying closer attention and investing. Older people who are retired from full time practice are more inclined to do this. With the low cost of e-trading, and the huge amount of information available on the Internet, we are seeing a new class of investor who works his or her SMSF hard to make extra profits.

Whether one method is better than the other is not clear. And it really depends on the ultimate choice of investments. But for many clients spending a few hours on their investments beats playing bowls. As Barbara Smith and Austin Donnelly say in “Do It Yourself Superannuation” under the heading “Psychological Benefits”:

“Other benefits enjoyed by some trustee members are the interest and satisfaction from buying shares or property and watching market developments closely, particularly in relation to the share market. This process is an absorbing interest for some people.”

Running a SMSF is a valid and interesting occupation: ten years ago many managed funds did not have as much in them as some SMSFs do today. Their size and cash flow means the trustees enjoy the time spent on SMSF activities.

Tax deductible life insurance premiums

Life insurance premiums paid through a SMSF can be tax deductible. This can halve the cost of the cover and is the cheapest way to arrange insurance. Often the tax benefit of deductible premiums more than covers the cost of running the SMSF.

Any insurance benefits paid will be included in the SMSF’s assessable income. Whether there is a tax charge or not will depend on the fund’s tax profile: the worst case is a tax charge of 15%, and the best case is a tax charge of 0%, which will apply if the SMSF is paying an allocated pension at the time of the member’s death.

Roll-over of taxable capital gains

Small businesses, including businesses run through companies and trusts, can roll over taxable capital gains on the sale of their businesses into their SMSF. This special rule acknowledges that businesses are often the main retirement asset for many people. Conditions apply and expert advice should always be obtained.

Reversibility

If for any reason you decide a SMSF is not for you, it’s the easiest thing to reverse the decision. This can be done by paying your-self an ETP, paying tax, and then reinvesting in a non-superannuation environment or by rolling over to a managed fund. Unlike managed funds, this reversal is simple and cheap to complete, and you have not wasted thousands on entry fees and even more thousands on exit fees!

Other reasons

Other reasons for SMSFs are:

increased information: you don’t have to wait for months after 30 June each year to find out how your investment is performing. The information is always at hand. Most trustees can access information on a daily basis, and low cost portfolio administration software such as Praemium allow the information to be collated and collected and presented in real time in diagrammatic form;
synergies with the member’s business activities (eg ownership of business premises) or other investment activities. This means the SMSF's investment strategy makes sense as part of an overall investment strategy. For example, it can make good sense for a SMSF to minimize property investments if the member’s family trust has invested heavily in property;
control over the investment. This is perhaps the most important advantage. Control and security appeal to self-employed or professional people;
tax-free death benefits. Benefits paid to a deceased member’s dependants are usually tax free in the dependant’s hands even if the member is not 60 years old;
SMSF assets are protected from bankruptcy;
control over the timing of income: capital gains and, in many cases, other types of income, can be deferred to a year when the SMSF pays nil tax;
retirement benefits for spouses and children. SMSFs can be even used to create retirement funds for spouses and children. They can be used to help grand-children: SMSFs as a sophisticated method of cross-generational wealth creation and transmission is a growth area at the moment;
tax-effective savings. The deduction for contributions and the low rate of tax (15%, 10% or nil %) means virtually any investment will do better in a superannuation fund; and
access to unrestricted non-preserved amounts at any time without having to retire, in the same way a member can access benefits held in an ADF. In some cases a SMSF can be used as a low tax rate (or even nil tax rate) bank account.