The truth about SMSFs

Robert MC Brown says advisers must resist the temptation to push the boundaries of risk with self-managed super funds.

Self-managed superannuation funds (SMSFs) have long been targeted by funds managers, financial planners and industry superannuation funds. Their main criticisms are that SMSFs are poorly run, far too conservatively invested and inherently risky.

Therefore, the critics argue, it is in the public interest to bring SMSFs under the stringent compliance regulations imposed on other sectors of the superannuation industry.

Of course, the truth has far less to do with the public interest, and rather more to do with uncomfortable commercial realities. The real problem for the critics is that SMSFs are too successful and must be brought to heel, preferably by their extinction (most unlikely) or by making them more complex and expensive to run. Recently, a different approach to SMSFs was proposed by the Commonwealth Bank in its “if you can’t beat them, join them” purchase of Count. That seems to be far more sensible than seeking to extinguish a sector whose imminent demise has been predicted regularly since its inception in the 1970s.

Consider these statistics. There are about 200,000 qualified accountants in Australia. Approximately 5000 of them (2.5 per cent) are financial planners with their own AFSL or a representative’s licence. Most of those write very little business because they don’t like the unprofessional taint and conflicts of interest involved in selling products.

The vast majority of accountants in professional practices are self-employed small business people whose clients are SMEs and individuals. As a general rule, they have a deeply ingrained distrust of large financial institutions (a challenge for the CBA/Count alliance) due to anecdotes and personal experiences of high fees, poor service and inadequate investment performance.

Therefore, the principal reason that accountants promote SMSFs is to get away from control by the “big end of town”. This desire by clients to exercise personal control over their superannuation is a very powerful motive and (based on my considerable experience as a practising chartered accountant) needs little encouragement from professional advisers.

As for the critics who disapprovingly point to a lack of government regulation of the SMSF sector, it should be remembered that the original thinking behind SMSFs (in the 1980s with the Occupational Superannuation Standards Act) was to allow small businesses and individuals to establish, control and invest their own superannuation funds with a minimum of bureaucracy. The view of government at that time was that provided membership of SMSFs was restricted to Mum, Dad and the family, the risks of losses and political fallout were minimal. Regular claims that there’s a lot of rorting and poor administration taking place in the SMSF sector are commercially motivated cheap shots that are never backed up with facts.

The recently reported comment by an industry superannuation fund spokesperson that no one looks at these funds except “every 52 years” is wrong. A qualified auditor must sign off each and every year. The vast majority of auditors take their responsibilities seriously because to do otherwise would lead to a loss of livelihood.

SMSFs are not a high-risk sector of the industry from a political and regulatory point of view. That’s simply because there are so many of them (more than 420,000). Most are controlled by fiercely independent people making their own investment decisions. Therefore, the risk of failure of a large number of them at the same time is minimal, if not non-existent.

However, there is a dark cloud on the SMSF horizon. Superannuation has always been viewed as a safe harbour in which aspiring retirees could accumulate money without the risk that would otherwise be created by borrowing against the assets in their self-managed superannuation funds. In fact, this substantially risk-free approach to investment was legislatively codified for many years. Borrowing (and lending) by SMSF trustees was a serious breach of the law, often leading to loss of tax concessions and substantial fines.

At least that was the case until the Coalition Government decided to offload a major portion of its telecommunications monopoly by way of a float known as Telstra 2. Much of the selling activity took place in the form of warrants.

All was well until it was suggested that the use of warrants was technically in breach of the law against borrowing by superannuation fund trustees. Not to be thwarted, the Government promptly introduced amendments to the Superannuation Industry (Supervision) Act to allow the use of warrants in these circumstances.

However, the new law went a lot further than expected. Surprisingly (and much to the joy of the real estate industry) it opened up the possibility of borrowing by SMSF trustees to purchase direct property investments. Even more surprisingly, the legislation contained no limit to borrowing by trustees, so that theoretically a loan of at least 100 per cent was (and still is) possible; although anecdotal evidence suggests that most loans are limited to 70 per cent of valuation.

The latest twist to the tale is that it is apparently against the law for SMSF trustees to use a fund’s monetary resources (where the fund is geared) to improve its real estate holdings. Putting aside the disasters that will undoubtedly occur because superannuation funds are now allowed to borrow money, an inability to make improvements after the purchase has been made does seem to be rather absurd.