Self-managed superannuation funds

SMSFs have grown rapidly to become a large share of the superannuation sector, in terms of both the number of entities and funds under management.82 The value of assets held in SMSFs is expected to grow further.

Preliminary assessment

Control, choice and competition

A number of submissions highlight the benefits of SMSFs to individuals and the superannuation system. SMSFs deliver members greater flexibility and control, because members can tailor their investments to suit their individual needs. Several stakeholders say this is often the main motivation of people participating in SMSFs.83 Other drivers of the growth in SMSFs include perceived or actual lower fees and better tax outcomes. The growing number of SMSFs may be a positive sign that more Australians are actively engaging with their retirement savings.

Several submissions note that SMSFs provide a source of competition to APRA-regulated funds. Industry and retail funds have expanded their range of products in response to the growth in SMSFs and also provide administrative services to them. Some APRA-regulated funds are trying to match SMSF flexibility by providing more options that allow members to determine their investment allocation.

Cost effectiveness

Investment Trends data suggest that over than a third of SMSFs were set up to reduce the amount members pay in fees.84 However, evidence on the effectiveness of this strategy is mixed. Rice Warner research suggests the average fee rate for SMSFs is lower than the industry average.85 However, SMSFs with low balances are significantly more expensive to run. Several submissions highlight the negative correlation between the average operating expense ratio and the size of the fund (Chart 4.4).86

Chart 4.4: SMSF average operating expense ratio, by fund size (2012)

This chart shows the ratio of SMSF average operating expenses by fund size in 2012. SMSFs with small balances had higher average operating expenses ratios compared to SMSFs with larger balances. For SMSFs with assets more than $500,000, the average fee on APRA-regulated funds, excluding Small APRA Funds, was greater than the average operating expense ratio. In contrast, SMSFs with $500,000  or less in assets had a higher average operating expense ratio than the average fee on APRA-regulated funds, excluding SAFs.

Source: ATO87, Rice Warner.88

Estimates suggest that a SMSF requires a balance between $200,000 and $500,000, depending on how much work trustees outsource, to achieve equivalent costs to APRA-regulated funds.89 Yet, in 2011–12, almost one-quarter of SMSFs had a balance of $200,000 or less.90 Even after being established for three years, 50 per cent of SMSFs had balances under $330,000.91

Benefits of scale

It is more difficult to diversify the asset allocation of a low-balance SMSF, both within and between asset classes, although new financial products are increasingly making this easier. Less diversification can result in SMSF members being subject to higher levels of risk in their portfolio. In addition, low balances may contribute to funds holding a higher proportion of cash due to minimum investment thresholds, which is likely to reduce returns. Exchange-traded funds provide a cost-effective vehicle for SMSFs to access the benefits of pooled and diversified investments.

When they purchase insurance policies, SMSFs are generally unable to realise the same cost economies as larger funds. Life, disability and income protection insurance may therefore be more expensive for individual SMSFs compared to other superannuation funds.

Financial advice

Marketing and financial advice are encouraging individuals to establish SMSFs. According to Investment Trends, major reasons for establishing an SMSF include accountants’ advice (30 per cent of respondents) and financial planners’ advice (20 per cent of respondents).92

However, the quality of advice varies. ASIC’s 2013 review of SMSF advice, as discussed in the Leverage section, found that around 1 per cent of advice provided was considered ‘good’ and around 28 per cent was rated as ‘poor’.93 Concerns about the quality of financial advice are discussed further in the Consumer outcomes chapter, including policy options to raise standards in the financial advice industry. The SMSF Professionals’ Association of Australia notes:

We believe that there could be some improvements to the current financial advice environment to protect consumers and promote high quality, independent financial advice.94

Tax

A number of submissions highlight tax as a driver of the growth in the number of SMSFs. According to Investment Trends, 27 per cent of SMSFs were established because they were “more tax effective”.95 Several submissions argue that SMSFs have tax advantages that APRA-regulated funds do not have. Currently, the tax treatment of all superannuation funds is the same, although in practice SMSFs may achieve better tax outcomes. This is due to more SMSFs being in the retirement phase and to the ability of SMSF trustees to tailor the choice and timing of investment decisions to their individual circumstances.96, 97

The Tax White Paper could examine the tax outcomes of SMSFs and APRA-regulated funds and measures to ensure that setting up an SMSF is not motivated purely by tax outcomes.

The Inquiry seeks further information on the following areas:

  • To what extent should the Inquiry be concerned about the high operating expenses of many SMSFs?
  • Should there be any limitations on the establishment of SMSFs?

82 Australian Prudential Regulation Authority (APRA) 2014, Statistics: quarterly superannuation performance (interim edition), March ed, APRA, Sydney.

83 Switzer Financial Group 2014, First round submission to the Financial System Inquiry, page 2; Association of Superannuation Funds of Australia 2014, First round submission to the Financial System Inquiry, page 11.

84 Investment Trends 2014, SMSF Investor Report, April. Note: Based on a survey of 2,163 SMSF trustees.

85 Rice Warner 2014, FSC Superannuation Fees Report 2013, commissioned by the Financial Services Council.

86 SMSF Owners Alliance 2014, First round submission to the Financial System Inquiry; Industry Super Australia 2014, First round submission to the Financial System Inquiry; Association of Superannuation Funds of Australia 2014, First round submission to the Financial System Inquiry.

87 Australian Taxation Office (ATO) 2013, Self-Managed Super Funds: A statistical overview 2011–2012, Table 22, ATO, Canberra. Care must be taken when using the operating expense ratio figures because comparisons between SMSFs and APRA-regulated funds may not be meaningful. While the methodology used to estimate the operating expense ratio is as close as possible to the method used by APRA, the data collected are not the same.

88 Rice Warner 2014, data provided to the Financial System Inquiry, 24 June 2014.

89 Research by Rice Warner found SMSFs with balances of $200,000 and above can provide the same value as retail or industry funds, provided the trustees do some of the administration. Where balances are $500,000 and above, SMSFs are competitive with industry and retail funds on a full-service basis and may be the cheapest option. Rice Warner 2013, Costs of operating SMSFs, commissioned by ASIC.

90 Australian Taxation Office (ATO) 2014, Self-Managed Super Fund Statistical Report — March 2014, ATO, viewed 25 June 2014.

91 Australian Taxation Office 2014, data provided to Financial System Inquiry, 6 June 2014. This is evident in each of the last three years of data; that is, for SMSFs established in 2007–08, 2008–09 and 2009–10.

92 Investment Trends 2014, SMSF Investor Report, April. Note: Based on a survey of 2,163 SMSF trustees.

93 Australian Securities and Investments Commission (ASIC) 2013, Report 337 — SMSFs: Improving the quality of advice given to investors, ASIC.

94 SMSF Professionals’ Association of Australia 2014, First round submission to the Financial System Inquiry, page 25.

95 Investment Trends 2014, SMSF Investor Report, April. Note: Based on a survey of 2,163 SMSF trustees.

96 Australian Prudential Regulation Authority (APRA) 2014, Statistics: Annual Superannuation Bulletin, June 2013 (revised 5 February 2014), APRA, Sydney.

97 Australian Taxation Office (ATO) 2013, Self-managed superannuation funds: A statistical overview 2011-12, ATO, viewed 25 June 2014.