“If I could make a wish I think I’d pass
Can’t think of anything I need”
— Simply Red, “Air that I breathe”
In the current environment, it’s easy to understand the appeal of self-managed superannuation funds.
Self-managed Super Funds offer the promise of better returns, an increased level of control over the investments and investment decisions, lower costs, greater transparency and access to direct property.
Self-managed Super Funds currently account for approximately one third of superannuation assets in Australia and despite the added complexity, responsibility and costs, their popularity continues to grow. Many see the opportunity for investment in direct property, whilst others would like more control over their investments and investment decisions.
Unfortunately, they don’t always deliver and, according to ASIC, the vast majority of SMSF advice is poor, sub-optimal or, in some cases, even detrimental to those that act on the advice.
“Around 90% of financial advice on setting up a self-managed super fund (SMSF) did not comply with relevant laws”
— ASIC Media Release 18-192MR “SMSF advice needs significant improvement”, Thursday 28 June 2018
We review a lot of advice. While our experience with SMSF doesn’t entirely accord with ASIC’s, we have noticed some common issues in the advice we have reviewed. I don’t intend to deep dive into SMSF advice but I will provide you with five elements you need to address to ensure that your SMSF advice doesn’t “suck”.
- Roles and Responsibilities
“Decisions about super are some of the most important a person can make. However, ASIC found there is a lack of basic knowledge of the legal obligations in setting up or running an SMSF. It is also concerning many people with an SMSF have not understood the importance of diversification, which puts their financial future at risk.”
— Peter Kell (Previous ASIC Deputy Chairman)
If you’re recommending SMSF to retail clients, you need to both ensure and demonstrate that your clients’ understand:
- their duties and obligations as Trustees;
- the laws and rules governing SMSF;
- the consequences and implications of contraventions.
Establishing a Self-Managed Super Fund can be exciting and one of the biggest decisions your client will make regarding their superannuation funds and the added and ongoing responsibilities and obligations will increase significantly (whether they outsource or not).
ASIC, in their report 576, expressed their concerns that not all of the relevant areas are being adequately. For example:
- One in three trustees did not know that an SMSF must have a documented investment strategy;
- Many trustees did not realise that they could not live in the property within the SMSF.
- Provide a clear explanation to your clients in the initial meetings. Document and confirm these conversations;
- Talk to your clients about Trustee obligations (solvency, capacity and character) and requirements before making any recommendation;
- Direct your clients to the relevant ATO web pages or provide copies of the relevant publications;
- Ensure your clients complete the ATO’s Trustee declaration (within 21 days of becoming a trustee); and
- If you don’t have the specialist knowledge, or don’t have experience with SMSF, don’t provide the advice (and refer the clients to a SMSF expert).
As we’ve long argued, and as the Royal Commission observed, “disclosure is a poor substitute for good judgement, un-conflicted advice and informed consent”. The problem underpinning most ‘poor’ SMSF advice is the fact that advisers too often rely on boilerplate disclosures in their SOA and avoid a clear and relevant statement of risks. This is an inadequate response for a professional adviser.
Some avoid clear and relevant discussions of ‘obvious’ matters because they’re well understood. Others rely on the Licensees’ approved text as the solution for every client need. Others avoid it from a fear that, if a client really understood the risks, costs and obligations of a SMSF, they would explore alternatives.
It’s often this failure that undermines the quality of the advice.
For example, ASIC’s consumer research found that 29% of trustees wrongly thought they were entitled to compensation for theft and fraud within the SMSF. It’s alarming that almost one in three trustees were not aware of this aspect.
Ensure that your clients know and understand that
- They have no access to a statutory compensation scheme for theft or fraud;
- They have reduced access to dispute resolution bodies;
- Individual and corporate Trustees have different roles and responsibilities;
- They need to consider, before implementation, issues around succession planning and dealing with relationship breakdowns; and
- They need to contemplate and arrange appropriate insurance coverage.
“Self-managed superannuation funds with less than $500,000 perform “significantly worse” on average than regular funds, the Productivity Commission says.”
— Joanna Mather, “Productivity Commission super report: SMSFs with less than $500,000 perform poorly”, AFR 10 January 2019
As a general principle, low-balance SMSF are not viable. While the minimum balance will depend on the clients’ context and circumstances, it is, in my opinion, imprudent to consider establishing an SMSF with a balance less than $300,000.
I appreciate that, historically, ASIC have recommended a minimum balance of $200,000, but we, at Assured Support, think this is actually insufficient to satisfy the best interest duty. It seems others agree. While we considered the Productivity Commission’s original suggestion of a minimum of $1,000,000 we understand why their final position was half that.
You may recall that in 2012, Rice Warner Actuaries were commissioned to identify the point where an SMSF is cost-effective against an APRA regulated fund. Their report can be accessed here.
In a nutshell, Rice Warner found:
- SMSF balances of $200,000 or more can provide equivalent value when compared to industry and retail funds (if the trustee takes on some of the administrative functions); and
- SMSF balances of $500,000 or more can provide equivalent value when compared to industry and retail funds (if the trustee outsources all administration aspects of the fund).
- Identify and assess your client’s financial literacy, skill level, time and willingness to act as a Trustee. In the right circumstances, it may be appropriate to commence with a lower balance but this will depend on your client’s circumstances that assist the fund’s ability to increase in the short-term and become viable.
- Obsessively explore (and document) your client’s financial situation, needs and objectives (including why they want or need SMSF);
- Record your client’s ability to transfer and contribute additional money into the fund;
- Test your client’s ability and willingness to take on some administrative functions;
- Consider whether a low-cost investment strategy is being implemented; and
- Address the comparatively higher costs of SMSF and alternatives.
“SMSFs are not a universal solution for everyone but have provided a healthy competitive balance to large APRA-regulated funds (a view endorsed by the Federal Treasury) where despite the massive growth in assets and scale benefits, lower fees have barely been passed on to members.”
— SMSF Media Release, 14 June 2016
SMSF’s appeal is based, at least in part, on the presumption that they’ll deliver better returns through either better investments or a better investment strategy. Certainly, the popularity of SMSF is built on the flexibility provided to Trustees to invest in direct property. While property prices may be depressed (for some time), there’s an almost religious conviction in the value of direct property in wealth building.
Poor SMSF advice often reflects the Trustee’s aspirations, biases and beliefs (or those of their advisers) but fails to incorporate these in a considered investment strategy. In some cases there is no Investment Strategy. In others, the adviser has never seen it. In a smaller number of cases, the adviser has considered neither the Investment Strategy nor the Trust Deed.
The SMSF must have a documented Investment Strategy. The Investment Strategy must be regularly reviewed by the Trustees and their Advisers. However, ASIC’s Report 576 observed that one in three Trustees didn’t know that their fund needed an SMSF investment strategy.
Another key aspect of this requirement and process is diversification and the risks of inadequate diversification. (Incidentally, this seems to be one of the reasons for ASIC’s concerns about the preponderance of property in SMSF). This should be adequately explained to your clients during the initial advice process but the consideration of adequate diversification is an ongoing obligation; particularly when markets are volatile or where the investments held expose the fund to greater risks.
SMSFs with investments in a single asset class (shares), or single asset (real property) are exposed to increased risks. Clients need to be unambiguously warned of the risks and likely returns, and if these are unacceptable, then alternatives should be considered.
The Trustee has a role to ensure that the funds within the SMSF are invested appropriately with the purpose of saving for retirement and the investment strategy should take into account the needs of all members of the fund. Remember that the members’ needs will change over time.
Make sure that your written advice adequately considers
- Age and retirement needs;
- Diversification level;
- Risks and likely returns from the investments;
- Liquidity of the assets to meet expenses and benefit payments (where applicable); and
- Capital growth required.
5. Red Flags
“The job of financial advisers is to help their clients by providing professional advice that leaves their clients in a better position, not to merely execute their client’s wishes, especially when those wishes are going to leave their clients in a worse position.”
— Peter Kell, Former ASIC Deputy Chairman
Since their introduction in 1999, the popularity of the SMSF has remained relatively constant despite the ups and downs experienced within the share market, housing market and industry.
As a compliance business we see a lot of SMSF advice and this varies in quality between each adviser significantly. All too often, we see advice which appears to be primarily driven by the client and which frames the adviser as an ‘order taker’ instead of an advice professional acting in the best interests of their clients.
In addition to the previous tips, we’d recommend that you remain alert for the following ‘red flags’. If you see them, think very carefully about whether you’d like to proceed.
- Low fund balance with limited ability for additional funds or contributions;
- Client with cash-flow issues or ‘worrying’ debt;
- Singular focus on property (including a preference for a particular property or developer);
- Clients with unrealistic expectations of returns;
- Referred clients that simply want you to execute their instructions and establish the fund;
- SMSF clients that are not ‘price sensitive’;
- Referred clients with similar preferences, instructions or circumstances to other clients from the same referral source;
- Goals and objectives which refer to a ‘simple’, ‘low-touch’ or ‘easy to manage’ superannuation solution;
- Potential Trustees with no desire to become actively involved in their investments;
- SMSF advocates that want to leave the decisions to someone else;
- Clients that have no time to devote to the running of the fund;
- Undischarged bankrupts or has been prohibited persons; and
- Clients with low levels of financial literacy.
If you liked this you might enjoy