What is an SMSF?

What is an SMSF (self-managed super fund)? 

First, let's cover some basics.

In addition to paying your regular salary and wages, your employer is legally obligated to make regular superannuation contributions on your behalf. Your superannuation accumulates over your working life and is designed to support you financially once you reach retirement, thereby lessening the burden on the government's age pension scheme.

Your super contributions are invested in a superannuation fund, which is overseen by a fund manager, similar to a managed fund. The fund manager decides how your money is invested, intending to grow your wealth over time to maximise your retirement benefit. Hopefully, once you reach retirement age, your super balance will have grown large enough to finance your lifestyle.

An SMSF is really just like any other super fund, only you take on the role of the fund manager yourself. This gives you the freedom to decide exactly how your superannuation contributions are invested.

While an SMSF gives you more financial freedom, managing your super takes time, knowledge, and skill. If you are considering starting an SMSF, always seek professional financial advice so you are fully aware of all the costs, risks, and rules involved.

How does it compare to other superannuation funds?

The obvious difference between an SMSF and other types of super funds is that you manage the investments yourself.

All super funds allow you to decide how your money is invested. For example, you can determine if you'd like to invest in a higher growth option or a more conservative option, depending on your personal risk appetite and investment objectives. However, you still don't get much say regarding which companies or asset classes you invest in.

With an SMSF, you make all those decisions yourself.

Why choose an SMSF?

Gaining the financial freedom to choose exactly how your money is invested is the most compelling reason to set up an SMSF.

Opening an SMSF means you can tailor an investment strategy to suit your specific investing objectives, risk appetite, and personal preferences. You can also invest in asset classes that may not be available in other typical super funds, like commodities, physical real estate, and even artwork.

You can also create a portfolio that aligns with your views on ethical investing. Suppose you are concerned that your current super fund is investing too much in fossil fuels, for example. In that case, you might decide to set up an SMSF to invest only in companies with good environmental, social, and corporate governance (ESG) credentials.

Setting up an SMSF: 10 things you should know before starting

1. You need a fair bit already in super to make it worthwhile

There is no mandated minimum balance to start an SMSF. However, research conducted by the Australian Securities & Investments Commission (ASIC) suggests that an SMSF needs to have a balance of at least $200,000 before it becomes more cost-effective than a typical super fund.

Not only that — you likely need at least $500,000 in your SMSF before it can regularly compete with the average returns earned by regulated retail and industry super funds.¹ This means you should think carefully before opening an SMSF if you have a small amount in super.

2. It's time-consuming

ASIC estimates that running your SMSF takes about 100 hours a year. That's a couple of extra hours you need to find every week to devote to managing your super.

There are many ongoing tasks involved in running your own super fund. For example, you'll need to do all the accounting and administration for the fund, including tax returns.

As a fund manager, you'll also need to find time to research potential investments and keep up to date with all the latest financial news.

3. There are many costs involved

As we've already mentioned, starting an SMSF with less than $200,000 generally isn't viewed as a cost-effective choice, and that is because there are many costs involved in running your own super fund.

Whether legal fees, accounting fees, or other forms of professional advice, the SMSF must pay these. These costs can add up and start eating into your investment returns.

4. You need to be aware of your responsibilities

When deciding to manage your own super, you personally have to take on all the usual responsibilities of the fund manager.

For example, you'll be responsible for preparing and lodging the fund's tax return, ensuring it is compliant with all relevant laws, and maintaining accurate records, among many other duties.

So, before starting an SMSF, make sure you are aware of all your legal, tax, and accounting obligations, as some of these can be pretty complex.

5. Seek professional advice

You should always consult a financial advisor before starting your SMSF, as they can walk you through all the steps required to set up your fund.

Accountants and legal professionals can assist you in administering your fund and ensuring it complies with all rules and regulations. While these services come at additional costs to your SMSF, they can help reduce the stress involved in running your own fund.

6. There are many benefits to starting an SMSF

When you run your SMSF, you make all the decisions about how your super is invested. You devise your own investment strategy and choose where your money goes.

An SMSF allows you to build an investment portfolio tailored to your personal financial situation, investment objectives, and ethics. This sense of financial independence can be incredibly valuable to people.

7. SMSFs are becoming more popular

No wonder, then, that more people are opening SMSFs than ever before. According to the Australian Taxation Office (ATO), there are currently more than 600,000 SMSFs in Australia. Together, they control almost $900 billion in assets. This means nearly a third of all money invested in super across the entire superannuation industry is in SMSFs.

8. Just about anyone can start one

As long as you have a firm grasp of all the responsibilities involved in running your SMSF, you are free to create one.

However, keep in mind what we've already mentioned in this article. Running an SMSF takes time and dedication, and you'll need a large super balance to make it a more cost-effective option than leaving your money in a professional fund.

9. You need an investment strategy

When you run an SMSF, you need to make all the decisions about how your super is invested. This means developing an investment strategy that aligns with your investment objectives, risk appetite, and financial situation.

A solid investment strategy is vital to a successful SMSF, but it can take time and research to get it right. Make sure you have yours worked out before setting up your SMSF.

10. An SMSF puts you in control of your investments

An SMSF allows you to be the fund manager. While this comes with many added responsibilities, full control over your super can give you a true sense of financial independence.

Benefits of self-managed super funds

As we keep saying, the primary benefit of running your SMSF is that you can control how your money is invested.

For most people, their super is likely to be their most significant asset – apart from their home — and so having personal control over it can be pretty important. You might even think you have the skills required to outperform the professionals!

Having complete control over your investments also means you can choose to only invest in companies that support causes you believe in. For example, you may want to ensure that none of your money is invested in the gambling industry.

One way to do this is to take control over your super and open an SMSF.

And the disadvantages?

Running an SMSF can be expensive, and it can also take up a lot of your personal time. Once you take on the responsibilities of running your SMSF, the buck stops with you. You must ensure your SMSF complies with all relevant rules and regulations and that all tax and other legal obligations are met.

You are also responsible for coming up with the fund's investment strategy. While this is one of the main benefits of running your own SMSF, it can also be one of its key challenges, especially if you're unprepared for the time commitment involved.

As the fund manager, you will need to research potential new investments for your fund and monitor the financial markets for emerging risks.

Alternatives to self-managed super funds

A recent development in the superannuation industry has been the Direct Investment Option (DIO). A growing number of super funds now offer this option to their members.

In a DIO, you get to play an active role in managing your super. You can choose which shares, funds and other products your super is invested in. This means a DIO provides many benefits of an SMSF but is far easier to set up and manage.

When you open a DIO, you transfer a portion of your existing super balance into a cash account. Once your balance is deposited in this account, you can use it to execute trades through your super's trading platform. This works much like a regular broker account, with any gains on investments you make deposited back into this account and any transaction fees deducted from it. 

A DIO doesn't give you quite as much freedom as an SMSF. For example, you can only select investments from a pre-approved list, and you'll often need to leave a portion of your super in one of your fund's professionally-managed investment options. 

Different super funds have different investments on their pre-approved lists, so it's wise to always check what your fund offers as part of its DIO before setting one up. And depending on your super fund, other restrictions may be placed upon your investments. For example, you may be unable to invest more than 20% of your portfolio in any share. 

Also, ensure you understand all the fees involved in a DIO. You will often have to pay administration and other account fees, as well as brokerage fees, on each trade. These costs – particularly the brokerage fees – can add up quickly.

The bottom line

Running your SMSF can be challenging and costly, but it comes with the benefit of gaining full control over how your super is invested. Judging by the sheer number of SMSFs in Australia, many people think that benefit is well worth the cost.

If you are thinking of starting your own SMSF, the best first step you can take is to seek professional financial advice. An accountant or financial advisor can help you determine whether an SMSF is the right choice for you. 

A DIO is a relatively new super product that provides many of the same benefits as an SMSF, but is far easier to set up and manage. Many retail and industry super funds now offer DIOs. However, always check the terms and conditions of your fund's DIO before opening one — and ensure you fully understand all the costs involved.