One of the most important things to understand about any superannuation fund is that it is not an investment, like property, shares or cash. A superannuation fund is actually a trust, which is an entity that can buy, hold and sell those investments.
Like any trust, it must have trustees and beneficiaries, (in this case called members), and a trust deed that sets out how it must be operated.
However, a superannuation fund is a particular type of trust that was set up under government legislation to provide an incentive for people to provide for their own retirement income needs, so that they would not be so reliant on the Government Age Pension when they finished their working lives.
The incentives that were put in place are concessional rates of tax that apply to funds held in superannuation, and to personal and employer contributions. In return for these concessions, there are restrictions on access to these funds until the member reaches retirement age.
A superannuation fund provides a low tax environment for accumulating assets for retirement, which becomes more attractive the closer a member is to retirement age.
Australian workers can consider a number of different types of superannuation funds suited to their financial situation and goals.
The most common type of superannuation fund is a not-for-profit, or industry fund, which charges minimal monthly fees to manage funds on behalf of their members. They also offer life insurance cover at very competitive rates through group buying schemes.
There are also retail superannuation funds, which are offered by the major banks and fund managers and charge asset-based fees of between 1and 2 per cent on each member’s account balance, and can be substantial for large account balances.
One option for people who have the time and interest is to take full responsibility of their superannuation benefits by setting up their own Self Managed Superannuation Fund (SMSF).
A SMSF still comes under the superannuation legislation, but is restricted to four members, who must also be the fund’s trustees, and must ensure the fund complies with the legislative requirements.
To set up a SMSF, there are initial costs of around $2,000, and annual running costs of around the same, depending on what your accountant charges.
For a fund with a starting balance of $100,000 these fees would represent setup and ongoing costs of 4 per cent of the fund balance in the first year, and 2 per cent per annum after that. For smaller balances, these fees would represent a bigger percentage of the fund balance.
However, having a SMSF provides greater flexibility and choice in what the fund can invest in, with most people choosing to invest in direct shares, business and residential property, and cash.
There is an additional benefit for a SMSF to invest in shares in Australian companies that pay dividends out of profits, which are taxed at the company tax rate of 30 per cent.
Because a SMSF in accumulation mode is taxed at only 15 per cent, franking credits attached to dividends can totally offset the fund’s tax liability. Even better, if the fund is in pension mode, the franking credits are paid as a tax refund.
A SMSF with a balance of $100,000 fully invested in Australian shares with a dividend yield of 5 per cent would provide an income of $5,000 plus franking credits of up to $2,143 that would easily cover the first year’s setup and running costs.
There are a number of additional incentives to contributing to super, including the government’s co-contribution scheme, the spouse tax offset, and concessions that allow those who are self-employed to contribute up to $50,000 and claim it as a tax deduction against assessable income.
However, because of the complexities of superannuation, and the potential penalties for breaching compliance requirements, professional tax and financial planning advice should always be sought before embarking on any of these strategies.