Former Federal Minister for Superannuation Nick Sherry and ASIC Commissioner Peter Kell have both this year expressed concern that people with low super balances are nevertheless setting up SMSFs – and then borrowing money and investing in real estate.
Sherry pointed to the high administration costs charged on low-balance SMSFs and said that property spruikers were out and about. Kell said it was important the SMSF gatekeepers – predominantly public practitioner accountants – made sure that only those who would benefit from using an SMSF actually set one up.
One of the main arguments presented is that SMSFs are too expensive until they have a certain level of assets. Two hundred thousand dollars is an oft-repeated break-even point.
“There are an awful lot of small SMSFs with less than $200,000,” points out John McIlroy, who recently sold large SMSF administrator Multiport. “You have to have concerns about the viability of many of these funds and the quality of the advice being given to the trustees to set them up.”
According to ATO data, in 2011 SMSFs with less than $50,000 had average operating expenses of more than 8 per cent. In dollar terms, this is a total fee of more than $3,300 for an SMSF with $40,000 in assets. These are the funds that most worry Sherry.
In comparison, SMSFs with more than $2 million in assets had average expenses of 0.23 per cent – or $5,960 for a fund with $2.5 million in assets.
Compare this with investing in a retail super product that might charge you between 1.75 per cent and 3 per cent (between $700 and $1,200 for $40,000) or an industry super fund that charges a low 1 per cent (about $400), and you can easily see the additional fees that low-balance SMSFs are paying.
But the ATO data also shows something else: low-balance SMSFs are shrinking in number year by year, not just as a proportion of all funds but in absolute terms.
In the eight financial years to June 2011, the number of SMSFs grew by 61 per cent – from 534,000 to just over 846,000. During this time, the number of SMSFs with assets under $50,000 fell by 42 per cent. To look at these figures another way, in 2003/04 small SMSFs made up 16 per cent of all SMSFs but by 2011 they only made up 6 per cent of total SMSFs.
On the other hand, the number of funds with more than $1 million in assets over this eight-year period increased by almost 300 per cent – and jumped from 12 per cent to 29 per cent of total SMSFs.
Importantly, this period of time includes the years when the global financial crisis cut into asset values. You also have to factor in that, until recently, SMSFs didn’t have to value assets at net market value.
The ATO figures support the idea that funds start small but grow. Many people seem to be setting these funds up early with the intention of increasing the size of the fund over one or more years. Some of these investors will want to buy assets that aren’t available in retail super funds – for example, artwork and other collectibles or specific real estate investments. In some cases, these people are whizzbang market traders who use their savvy to quickly grow their retirement nest egg by taking big bets on market movements.
Allowing super funds to purchase an asset by borrowing money may have opened up another can of worms that worries Sherry.
The idea is simple enough. Let’s say you have $125,000 in super. You set up an SMSF and transfer this into it. Your SMSF then borrows $120,000 and takes $80,000 of your super assets to purchase a $200,000 investment property. While the loan is outstanding, the asset must be held in a holding trust. Most banks operating in this market seem to be allowing an initial loan-to-value ratio (LVR) of between 50 per cent and 70 per cent. Setting up this transaction will probably cost between $5,000 and $10,000, plus stamp duty.
You then use your employer’s future compulsory super contributions and the rent from the property to repay the loan. There are lots of tricks and traps for the unwary in setting up and running one of these limited recourse borrowing arrangements, as they are officially called.
Given the low LVRs that banks currently allow and the cost of setting up these super gearing arrangements, it’s unlikely that a small-balance SMSF could purchase a property. All this might change if lenders relax their lending criteria and permit much higher LVRs as they did in the years leading up to the GFC, when LVRs of 120 per cent were not uncommon.
But for now, the problem of low-balance SMSFs
