Weighing the pros and cons of SMSFs as you plan for retirement: Michael Yardney

I recently read an article suggesting that financial planners often recommend that, based on current average annual returns, a couple would need close to $1 million in superannuation when they retire to live modestly.

In my opinion that would only give them a very modest lifestyle since they would, in general, live off the $40,000 or so interest they receive on this, or on dividends from the shares in the super fund.

Apparently, a single person would need about $800,000, once again to live modestly.

By the way; I think you will need much, much more than this to fund a comfortable retirement.

Either way, this means millions of Australians will struggle in retirement because only 10% of Australians have more than $100,000 in their super accounts. 

A report from last year by the Association of Superannuation Funds of Australia says:

“On the basis of the current average superannuation balance and average income of those aged 35 to 44 and the assumption of only compulsory superannuation contributions being made, the average retirement superannuation payout at age 60 for a male currently aged 35 to 44 would be $183,000, while for a female it would only be $93,000.”

That’s scary stuff…  

Most Gen X-ers will fall far short of being able to retire on their superannuation.  

Little wonder that more and more Australians are looking at taking control of their financial future and setting up self-managed super funds (SMSF).  

With 5.3 million Baby Boomers transitioning into retirement over the next 15 years or so, I see properties bought in a SMSF as a major driver of property values over the next decade.

How much super is enough?

So, the big question is how much money do you really need for your retirement?

Well, lifestyle is a very personal thing – luxury living for one person is a modest existence for someone else.

While you’re in your working years, choosing a lifestyle is simple – most of us live the life we can afford. If we want a fancier lifestyle, we need to earn more, win the lottery, marry someone rich or inherit money from a rich relative.

However, if you want a comfortable life in retirement, then you better start working on your financial independence now. Super alone is unlikely to get you there, but growing a substantial property portfolio just may.

The 4-step formula to financial independence

Here are four timeless rules for achieving financial freedom. Please don’t dismiss them because they sound so simple:

1. Spend less than you earn

This maxim may seem obvious, but many people have difficulty following it. If you're spending more than you earn, you will never become financially independent. You will be paying money to others for the rest of your life. The earlier you start living by this rule, the better. It is never too late to start.

2. Invest the difference wisely

It may surprise you, but the average Australian earning between $50,000 and $60,000 a year for 40 years will earn somewhere between $2-3 million during their working life. Yet most of them will retire poor. Clearly, the level of your income has no bearing on the level of wealth you achieve; what is critical is the amount you save and invest wisely.

3. Reinvest your investment income so you get compounding growth

As you are beginning to understand, you will never become financially independent on your earnings alone. You need to keep reinvesting. In fact, by the time you become financially free almost all your assets will have come from compounding capital growth, not from your income, your savings or your rent.

4. Keep doing steps 1 and 2 until your asset base reaches a critical mass so that you have the cash machine that gives you the income you desire.

If you’ve been following my blogs you’d know I advocate growing a multi-million dollar property portfolio as your cash machine. In fact, I’ve written a best selling book on that topic, How to Grow a Multi-million Dollar Property Portfolio. This book is about helping you build your own cash machine.

So how many properties do you need to retire?

Do you know? Well, it’s a trick question.

It’s not really how many properties you own that’s important. I’d rather own one Westfield shopping centre than 35 small regional properties.

In other words, what’s really important is the size of the asset base you build – the size of your cash machine. And this probably needs to be a lot bigger than you think.

Over the last few years, more and more property investors are considering setting up a self-managed superannuation fund (SMSF) as a vehicle to buy their properties and increase their asset base.

So what are the main advantages and disadvantages of taking this tack when it comes to building your own retirement nest egg?

The good

> Control – You have control over your SMSF rather than entrusting your future financial wellbeing to a complete stranger, who will take your hard-earned cash and invest it in shares and managed funds that may or may not perform.  

> Leverage – You can make the money in your SMSF work harder by using it as a deposit and borrowing to buy investment properties that grow in value.  

>Tax savings – In the past, those who bought a property in their fund until they retired were exempt from paying either capital gains tax if you sell the investment, or income tax on any rental income should you decide to hang onto it. Before they retired, any capital gains or rental income generated by your SMSF was taxed at a rate of 15% and 10% Capital Gains Tax was applicable if they sold the property after holding on to it for over a year.

Recent changes to the tax law means that in the future these concessional tax rates will change, but owning property in super may still be tax effective for you.  

>You will have a diversified super portfolio that is not reliant on just one investment vehicle, meaning you will have better financial security for the future.  

The bad

>The cost! This usually involves thousands of dollars in establishment costs and sometimes there will be higher fees involved in borrowing to buy property through your SMSF.  

>The confusion – There’s no denying that managing your own super fund can be a minefield of complicated rules and regulations. Get something wrong and you could end up paying hefty penalties. Of course, you can pay a professional to manage it on your behalf and this is something I would strongly advise anyone with a SMSF to do – whether they’re buying real estate or not!  

>You have to have the cash to do it. This is not a strategy for someone with a small amount of cash in his or her super fund. Basically, unless you have over $150,000 of available funds in your SMSF and are still contributing to your SMSF, the banks may not be willing to lend money for you to buy property in your SMSF.

If you’re at all concerned about financial independence in retirement, put some plans in place, review your finances, do something now and don’t leave it until it’s too late.

Be careful  

Of course, before you go down the route of setting up your own SMSF, it is critical to seek independent advice from a properly qualified financial planner to ensure that it is appropriate for your circumstances, and that you set up things correctly and don’t fall foul of the tax man.  

Michael Yardney is a director of Metropole Property Strategists who create wealth for their clients through independent, unbiased property advice and advocacy. Subscribe to his Property Update blog.