Setting up an SMSF: 10 questions to ask

By Bryan Ashenden, senior technical manager of practice management, BT Financial Group

Self-managed super funds (SMSFs) continue to be the fastest growing area of the superannuation industry. They have shown remarkable resilience, both in the face of what feels like a constantly changing legislative and regulatory environment as well as through the global financial crisis.

With an increasing appetite, many firms – from service providers to large institutions – have either made the SMSF market their sole specialisation or identified it as a key target for future business growth.

But why are so many clients eager to enter this segment of the superannuation market? With the introduction of the “best interests duty” under the Future of Financial Advice reforms, it is important for advisers to the SMSF market to ask the right questions of prospective SMSF trustees/members to ensure setting up a fund is the right thing for them to do.

These are the key questions they should ask:

1. Why are you looking to establish an SMSF?
Historically, many prospective SMSF members have used the terms ‘control’ and ‘choice’ as their reasons to establish a SMSF. But it’s important for them to be aware that the ability to choose underlying investments – often thought of by some as giving control – is a feature that is today available in a number of public offer or retail fund environments.

In general, the only asset classes that SMSF trustees will potentially look to invest in that can’t be achieved through a retail fund are direct property investments and investments in collectibles. Both of these asset classes contain their own set of requirements, so trustees should be aware of the risks and responsibilities involved before setting up an SMSF for these classes.

2. With how much do you plan to start the SMSF?
Of course, the real question – after the ‘why’ above – is where will this initial funding come from? Also, how quickly will the fund grow to a sufficient size – the general industry standard is around $200,000 – so that the costs of running the fund are not prohibitive?

While roll-overs from existing superannuation funds are often the source of initial monies when establishing an SMSF, the trustees (in their capacity as members) need to be aware of the costs of moving monies from one fund to another, such as realising capital gains tax on the sale of existing investments, and time out of the market until investments are re-purchased.

Any potential loss of insurance coverage, as well as the loss of possible benefits from group insurance arrangements, also need to be considered. In some situations, members may be better off delaying the roll-over of existing monies, or delaying the establishment of the SMSF itself.

3. Who will be selected as your trusted partners?
An SMSF should never be looked on as a ‘DIY fund’. It is important that trustees choose experienced service providers to assist with the efficient and compliant running of their fund. These would include administrators or accountants to ensure the accounts are maintained; a lawyer for the appropriate drafting of the terms of the SMSF deed; a tax agent for completion of annual tax returns; and a financial planner to assist with strategy and investment decisions.

Trustees should aim to utilise professionals with experience and expertise in the area of SMSFs, and perhaps with SMSF qualifications or industry recognition, such as the specialist designations issued by the SMSF Professionals Association of Australia.

4. What trustee structure will you use?
Trustees have two choices here – individual or corporate. Historically, a majority of SMSFs have been established with an individual trustee structure, on the basis that initially this structure is cheaper and easier.

While this may be true, the benefits of a corporate structure should not be ignored. No doubt there is an extra cost in setting up a special purpose trustee company, but it does have future benefits for the efficient running of the fund. For example, any direct shareholdings of ann SMSF need to be registered in the name of the trustees.

With individual trustees, when new members are added or removed, changes are required to the share register. If held via a corporate trustee, however, any changes in membership of the fund do not require share registry changes, as it is only the directors of the corporate trustee that will change – not the trustee itself.

5. What will you do if you become incapacitated?
An important consideration for trustees is how will the fund operate if one or more trustees becomes incapacitated (whether permanently or temporarily) and unable to fulfil their trustee responsibilities for a period of time.

Consideration should be given up-front as to whom trustees would like to appoint under a Power of Attorney to assume trustee responsibilities in these situations. The person selected should be someone whom the members trust to make the right decisions by them in the future, and someone willing to take on trustee responsibilities.

6. Have you thought about your investment strategy?
A cornerstone of the operation of an SMSF is to have a sound investment strategy for the fund that complies with the sole purpose test requirements, and assists the members in managing and growing their savings for future retirement needs. This involves considering diversification, risk and return.

It is also important for trustees to be aware that as a result of recent amendments to superannuation law, SMSF trustees are required to review their investment strategy regularly – we would suggest annually – and to consider the insurance needs of the fund.

This doesn’t mean that insurance needs to be taken out if members are adequately covered through other means, but the considerations should be documented for future reference.

7. How will you address the fund’s liquidity needs?
A final requirement when it comes to investment strategy is to consider the liquidity needs of the fund, which may involve making future pension payments when they fall due, meeting ongoing expenses of the fund, or making benefit payments upon the death of a member.

These liquidity requirements become more important when the SMSF holds direct property as, generally, such investments will take time to sell and the remaining members of the fund (in a death benefit situation) may not want the property to be sold. The use of appropriately structured insurance policies may assist in meeting these liquidity concerns.

8. Do you understand your responsibilities?
All new SMSF trustees are required to sign a standard Trustee Declaration issued by the Australian Taxation Office. While this document does a great job of summarising many of the requirements of being a trustee and the responsibilities associated with running an SMSF, it is questionable whether trustees truly understand this or are just signing it to establish the fund.

While ignorance is no excuse for trustees who have signed the form in the event that something goes wrong, it is important for advisers (or anyone recommending to a client that they establish a SMSF) to form a view on whether they believe the client understands what they are getting into.

If an adviser is not convinced that a client will take their responsibilities seriously, then they should consider declining to give the establishment advice. After all, we have a responsibility to act in the best interests of our clients.

9. Have you considered succession planning?
Is the SMSF to be used for the current members only, or will new members (such as the children) be admitted in the future? If children will become trustees in the future then involving them earlier, so they can get an understanding of how the fund is run and its purpose, can only be of benefit.

It also helps educate children around the need for saving for the future and the benefits of the superannuation environment.

10. Have you revisited your entire estate plan?
Superannuation savings are not an estate asset. When clients establish an SMSF, there may be a tendency to put as much savings into the fund as possible. While this may be an ideal outcome, the impact on estate plans, and future estate distributions, should be revisited and carefully planned to ensure the client’s preferred outcomes can still be achieved.

This is not an exhaustive list of questions, and the importance of each question will differ from client to client. However, asking these questions should help to ensure clients have fully considered the implications and consequences of establishing an SMSF to secure their retirement benefits.