Why these two factors are crucial in SMSFs

Paying excessive fees will harm your retirement balance, as will failing to take a portfolio approach when it comes to income.

What does it cost to run a self-managed superannuation fund? In October 2019, the Australian Securities and Investments Commission released a fact sheet for SMSFs noting that it cost on average $13,900 a year to run an SMSF, and that establishing an SMSF with a balance below $500,000 was not recommended.

This fact sheet caused quite a stir in the SMSF industry, and recently ASIC conceded that it might now be “stale”, as updated Tax Office statistics point to much lower average annual fees for SMSFs.

When considering whether an SMSF is right for you from a stand-alone cost perspective, there are several things you need to consider. First, establishment costs average about $2000 if you are also starting a corporate trustee entity at the same time.

In terms of continuing costs, you need to determine whether your SMSF will be truly “self-managed” or whether you will be use professionals to assist in this. As the trustee of your SMSF, your basic annual requirements include the lodgement of an annual return with the Tax Office, and the completion of an annual audit.

If you are confident in maintaining the SMSF financial records and lodging the annual return without the help of a tax agent, the annual audit requirements could cost you only $500 on average. The annual $259 ATO levy for an SMSF will be charged to your fund when you lodge your return. So all up, you can run your SMSF for less than $1000 per annum.

If you seek professional help via a tax agent or specialist SMSF administrator in preparing the financial records and reporting, you will be looking at about $2300 a year for the lodgement of your SMSF annual return, including the annual audit and ATO levy costs. This figure will vary depending on the complexity of your SMSF – ie, whether you are in pension or accumulation, and the types of investments held in your fund.

The next thing is investment costs. If you manage the investments yourself, the only costs will be your transaction fees – ie, brokerage costs for shares. If you are looking at a property purchase, with or without debt, the establishment and holding costs can be an expensive exercise inside an SMSF.

If you work with an investment professional, you will be charged their costs, which could be a fixed fee or a percentage of the assets in the SMSF they are managing. There will also be investment costs based on the recommended investment portfolio, which may include fund manager costs for managed funds, brokerage costs for listed securities and administration platform/reporting costs.

Where the total cost to run an SMSF equates to more than 2 per cent of the value of your SMSF, you would question whether the benefits outweigh the costs. Paying excessive fees will harm your retirement balance, and for those running or contemplating establishing an SMSF, a comprehensive understanding of the total costs is strongly recommended.

Payout pain

As SMSF bank accounts are now hit by significantly reduced dividends, there is a sense of nervousness as to how members will meet their minimum pension payments this year without dipping into their capital. How did we end up focusing on income returns in isolation rather than the total return of an investment portfolio?

Australian companies have always had a history of high dividend payout ratios, particularly when compared with their international compatriots. This is often one argument for a “home bias” when investing, in that the dividend yield for Australian shares is a lot higher.

It is suggested that the prevalence of high dividend yields is correlated to the introduction of the dividend imputation system, and the added value to a shareholder of receiving a fully franked dividend. With the introduction of dividend imputation, we saw a cycle of high dividend-paying companies being targeted by retirees or those seeking passive income, which drove up their share prices and incentivised boards to keep paying out high dividends.

Managed funds with marketing titles such as “yield chaser” or “dividend harvester” also sought the attention of investors seeking income returns for their portfolio. Investors have become obsessed with income returns in isolation, and have considered the drawing of capital in retirement to fund living expenses as a failure of the investment portfolio.

As dividend yields decrease with falling profits (particularly banks and financial shares), and with cash and term deposit rates at historically low levels, it is time to adjust your mindset when investing to focus on the total return of your investment portfolio.

This approach is not new but does involve a change in mindset by considering your portfolio from the “top down”, rather than a basket of isolated parts. In other words, you build your portfolio around a diversified asset class framework rather than picking individual investments.

The key advantage of diversification is that the various asset classes in the portfolio will behave differently at different times, offering the opportunity to take profits when certain asset classes are doing well, and to top up other asset classes that have been underperforming.

Using this framework, your cash flow requirements then come from the total return of the portfolio, and are not confined to the interest, dividend or rental income stream.

Sometimes this means the cash flow is coming from a mixture of income and capital, and this is OK – so long as the total portfolio return is exceeding the cash-flow draw.

A total return and top-down diversification approach will also unlock a wider range of traditional investments for portfolio inclusion, such as lower-yielding bonds and international shares, as well as Australian shares with low or no dividend yields. These assets can add meaningful diversification benefits and offer the potential for higher capital growth.

With investment income levels falling for Australian shares, other alternatives to a total return mindset include cutting expenditure to match your income or seeking out investments that promise higher yields. These approaches do not sound appealing when you consider they could lead to a diminished standard of living and higher risk outcomes.