Start here. I gave Part 1 a trim so it’s now easier to read. If you fell asleep last time, give it another go. Circled in orange is what we’re gonna cover in this post.
We’re gonna look at what a super managed super fund (SMSF) is, why it’s awesome and how it works. If this is something you’ve been interested in but couldn’t muster enough care factor to get going, I’m here to help you take that first step.
First up, let’s re-stress the importance of compounding.
- Assume Charlie, Alan and Kutcher are all 25, each earning $80,000 a year and each adding $7,600 (or 9.5%) to their super each year.
- Charlie is a “winner” so naturally he earns a superior return of 15% year after year while his brother Alan manages a measly 5%.
- By the time they’re 65, not having “earned” a cent more, Charlie will be worth ~3x his brother. That’s winning.
- If you’re young, you’ve got time on your side. Play it smart and put every dollar you save today to work.
Ok got it. So what’s a SMSF?
Rather than having someone else look after your retirement money, SMSF is when you manage it yourself. If you wonna be a home owner in Australia, the allowance of SMSF to borrow money to purchase property is arguably the best tax incentive for property investing since the introduction of the tax perks associated with negative gearing.
Why is it awesome?
- SMSF income is taxed at 15% or less, just like normal super. So if you purchase a property through SMSF, the maximum tax rate on your rental income is 15%.
- Any expenses such as interest, council rates, insurance and maintenance are tax deductible and paid by the fund, meaning you’re not out of pocket in the same way you would be with a directly owned investment property.
- Even if you sell your property before you retire, capital gains tax (CGT) is calculated at a discounted rate of 10-15% (see here). This is a significant tax benefit vs. paying CGT based on your income (see here).
- Negative gearing is available to reduce tax paid on earnings and potentially reduce tax paid on the fund to zero, just like a normal property purchase.
- Borrowing money via SMSF to buy a property is through a limited recourse loan, which means you won’t lose all your money if the loan blows up.
How much money do I need to start one?
The magic number is different depending on who you speak to. Commsec suggests $200,000, a very conservative man once told me $500,000 while some have started on as little as $100,000 provided you play your cards right and have foresight of decent super contributions coming in. Just keep in mind it can be costly and cumbersome to run your SMSF so you’ll need a good amount of money to make it worthwhile.
Ok, so what’s the catch?
You must always meet the sole purpose test. That is, you gotta be generating “retirement benefits” to either yourself and/or other fund members. There are limitations on where you can put your money as a consequence.
It’s also a bit of work. You gotta consider start-up, ongoing and wind-up fees and time required to put together an investment strategy and run your SMSF. You can get others to manage it for you but this means more fees.
Can I buy a residential property with SMSF?
Yes, you can but it must be an investment (i.e. something that makes you money). Therefore, you can’t buy your family home through your SMSF or rent the place you bought through SMSF to yourself. You can’t buy a holiday home either, even if you agree to live it in one day a year. Bummer.
But if you’re like me and don’t care for owning your own home, this may work well for you (e.g. you can live overseas for a while and enjoy good returns and tax benefits on your SMSF property).
Can I buy a business with SMSF?
Yes, you can. You can even buy your own business (e.g. buy an office and lease it back to yourself). The catch is that you must meet the business real test, which means the place must be for business use. The transaction must be done at an arm’s length, which in English means you gotta treat it as if you were dealing with a complete stranger. This means paying market value for the property and following market practices (e.g. charge market rent, can’t skip paying rent etc).
Nonetheless, if a billionaire can manage to sleep in an office with his brother, shower at the local YMCA and live on a dollar a day, then perhaps not all hope is lost for first home buyers. If the world goes to shits, at least I’ll have myself an office and a good supply of mee goreng and OJs.
To put it all in perspective
- When you’re young, time is your friend. Be conscious of that and put every dollar you save to work.
- SMSF is a great investment option, it affords you the freedom to invest in shares, properties or business in a tax-effective manner
- To get started in SMSF you need a decent amount of super and a basic level of financial literacy. You won’t find all the answers here so as you embark on your journey, don’t be discouraged and take it slow (I knew nothing about SMSF a week ago).
On a more philosophical level, we don’t have to conform to conventional ways of money management and the same speaks true for our lives. We live in an age unlike any other and are afforded access to infinite opportunities. There are no rules confining us to live in any one place, stick with any one job or commit to a single lifestyle choice. So if there’s one thing I’d like you to take away from the Super series it is this: