Don't fall for self-managed super sales pitch

When property prices are hot, as they are now, it can be tempting to jump into the market to get a slice of the action using a do-it-yourself super fund.

But just because you can do something, it doesn't mean you should.

The golden rule of investing applies: don't put all your eggs in the one basket, especially when it comes to a self-managed super fund (SMSF).

Laura Menschik, a director of WLM Financial, says property is an illiquid asset and trustees need to allow for sufficient liquidity and cash flow to fund pensions in retirement.

If it's the only or main asset of the self-managed super fund, problems can arise.

"You may not have enough diversification in your super fund over time to achieve your objective of meeting the SMSF's income requirement rules in the pension phase," she says. "If you've got a $500,000 property and only a small amount in cash, how are you going to make your minimum pension payments if the rent stops coming in?

"If the money isn't there, the fund becomes non-complying and it can be taxed at the highest marginal tax rate on the assets. You can't claim ignorance when this happens."

Menschik says rental income can be unpredictable.

"Properties can be untenanted for long periods. It's not an asset you can sell tomorrow and get your money in. It's not like selling shares and three days later the money is in your bank account."

"A residential property can be a death sentence for an SMSF when the fund is in pension phase," says self-managed super specialist and partner in accounting practice TaxBiz, Max Newnham.

"With most residential property you are lucky if you get 3% net return on the value. If most of the SMSF is made up of residential property and you're in pension phase - and you must take a minimum 5% - you can't start taking bricks or tiles out of the house to help meet your minimum pension requirements." Under these circumstances you may be forced to sell and make a loss, Newnham says.

"Putting it another way, people forget the importance of diversifying."

Both experts say property can make sense if it's part of a bigger portfolio and that holding business premises in an SMSF can be particularly attractive for owners.

"The beauty of business property is their normal return is 8% to 10%," says Newnham. "It also means from a tax planning point of view you have owners that are paying the rent to their super fund rather than to someone else."

Small business owners can transfer business premises into their SMSF free of capital gains tax. Menschik says it can be a good strategy.

"They know they will be making super contributions over time and getting their rental income coming in over time," she says. "That money can then be invested in other assets like shares, managed funds, term deposits - whatever is appropriate.

"When they retire, they've eventually accumulated, say, $1 million. They've got a property worth [say] $400,000, generating income, and another $600,000 in other investments - enough to meet their minimum pension.

"If they find over time, as they are getting older and drawing down more, they might need to sell the property, it will be capital gains tax free in the pension phase."

Dud investments

The Australian Securities and Investments Commission (ASIC) is concerned at the sharp rise in promoters who recommend investors either set up a self-managed super fund or use their existing SMSF to gear into property.

ASIC says developers are working with groups of "advisers" and they recommend each other's services in order to sell overvalued properties to investors.

"People pay inflated prices, and borrowing inside a super fund is a lot more expensive, so buyers who started with a reasonable amount of super end up with little or nothing because the investment is a dud," says TaxBiz's Max Newnham.

Negative gearing's tax benefits are better outside super. "Given that a super fund has a tax rate of 15%, the benefit pales into insignificance when compared to a gearing strategy outside super, where the lowest tax rate is 21% [incl. Medicare] and for most people 34.5%," he says.

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