Michael Hutton

The flow of money from self-managed superannuation funds (SMSFs) into residential property suggests many trustees have forgotten that the role of a SMSF is to fund retirement, says Michael Hutton, wealth management partner at HLB Mann Judd Sydney.

“People in retirement should be focussing on income over the medium term with enough capital growth to maintain income levels in the longer term.

“The basic fact is that residential property investment, particularly when the market is close to a peak as it must be now, has to be a long term strategy to get the capital gains sought.  The rental yield on such properties, particularly after expenses, is often very low

“Where gearing is involved, major cashflow problems can occur – particularly for those drawing a pension from their fund or expecting to draw a pension within the next several years.

Mr Hutton said that even younger trustees should consider very carefully whether holding residential property in a SMSF, rather than in their own name, is best for them.

“One of the attractions of property investments is the negative gearing tax provisions which are most beneficial to people on a high rate of tax.  SMSFs are either a low tax or “no tax” environment.

“Anyone still intent on investing in residential property as a way of accumulating wealth through capital gain (which should be the main reason for property investments) must recognise it is a long term investment and consider their own circumstances.

“They should also seek impartial advice and not rely only on the pitch of those interested in making a sale.

“As we’ve said many times before, SMSF trustees must recognise there are weaknesses in placing a large portion of their retirement savings in one asset.

“Property is usually an illiquid asset, which should be a key consideration for retirees funding their own retirement.

“If a significant amount of money is needed at some time in retirement – for instance to pay for a holiday, or to buy a car – people usually need access to cash in their superannuation.

“If they don’t have a mix that includes fairly liquid assets, they may need to sell the residential property owned by their fund, even though they only need a small percentage of its value.

“This can take several months, might not fit in with the trustee’s needs, and it may not be the right market to be selling in.”

Mr Hutton says there are other problems with the trend to gear up within an SMSF to buy residential property.

“Ideally retirees should be debt-free and have assets generating plenty of income to fund their lifestyle.

“Trustees of SMSFs also need to be mindful that upon the death of the last member, the fund must be wound up.  Illiquid assets such as property take time to sell, while transferring a property to beneficiaries in-specie will incur stamp duty and conveyancing costs,” he said. 

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“In its announcement of super reforms, the Government made no comment about whether there would be further changes to superannuation in the Budget, and the reforms recently announced may not be the end of any changes.

“Nonetheless, investors should base their immediate and short-term super planning on the current laws.  Even if any further super changes are included in the Budget, it is very unlikely they will start this financial year, or will be retrospective,” Mr Yee said.

He added that, just to be on the safe side in case there are Budget changes, people could action some of their end of year activities before the Budget is announced.

This could include things such as:

• Ensuring annual concessional (tax deductible) and non-concessional (undeducted or after-tax) super contributions have been maximised.
• Ensuring super contributions are received by the super fund as soon as possible (they must be received prior to 30 June 2013 if they are to be accounted for in this financial year).
• Reviewing all super contributions made, including those by an employer on your behalf, to ensure relevant contributions caps are not breached. Compulsory super guarantee contribution payments made by employers are counted towards concessional contributions caps, as well as any super fund payments such as superannuation-based life insurance premiums.
• Making any planned transfer of assets into or out of SMSFs sooner rather than later.  The government has already announced it proposes to restrict the acquisition and disposal of assets between an SMSF and a related party after 1 July 2013.  For example, after that date, people will not be able to transfer, off-market, personally held listed shares into an SMSF even though the transfer is at market value.
• Anyone who has reached ‘preservation age’ (55 for those born before 1 July 1960) should consider the tax advantages of a transition to retirement strategy, as well as the opportunity to increase their contributions to super while supplementing their reduced take-home pay with a pension.  People can start a superannuation pension and draw a maximum of ten percent of their account balance each year.

Mr Yee commented the Government is unlikely to tinker with this transition to retirement strategy, however it would be prudent to consider starting such a pension prior to the Budget to ensure the opportunity to do so is not lost.

“Those who find themselves no longer needing the income can always turn off the pension at a later date.

“In addition there is no maximum annual limit to account-based pensions, other than for those who are drawing a transition to retirement pension from their super fund, in which case the maximum annual limit is 10 percent.

“Taking an extra sum out of super in pension payments may be a worthwhile strategy for some this financial year.”

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The division will operate under the name HLB Mann Judd (Vic) Wealth Management and will be headed by Mr Lord who has over 15 years experience in financial services.

Mr Lord started his career in funds management and broking before becoming a financial planner in 1997.  He founded his own practice in 2002 which has now merged with HLB Mann Judd Melbourne.

Mark Pizzacalla, managing partner of HLB Mann Judd Melbourne, said the decision to expand into wealth management was one the firm had been reviewing for some time.

“We believe that offering quality financial planning and wealth management advice to clients is an important component of the overall services that we provide and we have therefore been looking for the most suitable partner to join us.”

“Andrew has the experience and skills that we were looking for and that we believe will best serve our existing clients who are seeking wealth management advice,” Mr Pizzacalla said.

Mr Lord said that he had worked with HLB Mann Judd Melbourne in the past and was attracted by their professionalism and quality of service.

“HLB Mann Judd Melbourne was looking to build a more sophisticated client offering in the wealth management area and this fitted perfectly with my own approach and plans.”

“With clients increasingly seeking more holistic services from their advisers, a strategy that brings together the accounting and advice services of HLB Mann Judd, and my own financial planning skills, made sense,” Mr Lord said.

HLB Mann Judd Melbourne is a firm of accountants and business advisers, and part of the HLB Mann Judd Australasian Association.

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However the funds raised were down on previous years, according to the latest HLB Mann Judd Small Cap IPO Watch – click here  to read the report.

A total of 92 small cap companies listed over the 2011 year, up 10 percent on 2010 and 156 percent on 2009.  Small cap listings represented 88 percent of all IPOs during the year (2010: 88 percent, 2009: 92 percent, 2008: 93 percent).

However the total amount raised by small cap companies was down 17 percent on 2010, and the average level of funds raised by small caps was the lowest for five years, even at the height of the global financial crisis.  Small cap companies raised an average of just $6.84 million in 2011, compared to $9.07 million in 2010; $7.47 million in 2009; $7.45 million in 2008 and $8.75 million in 2007.

Mr Geoff Webster, author of the report and corporate finance director at HLB Mann Judd Melbourne, said that the decline in funds raised is a worrying sign of the ongoing challenges for listed companies and for corporate fund-raising generally.

“Coupled with the fact that 29 percent of 2011’s issues were undersubscribed, compared with 22 percent in 2010, it is concerning that the IPO market continues to struggle so badly.

“It is a further example of the difficulties businesses face in raising corporate finance and additional evidence of the challenging operating environment.

He also said that the start of 2012 looks set to continue the lack-lustre performance of the December 2011 quarter.

“The pipeline of upcoming IPOs is down from the same time last year, with only 26 ASX applications lodged seeking to raise a combined $122.2 million, compared to 34 companies seeking $321 million in January 2011.  Significantly, only five companies have a proposed listing date.

“On the other hand, the Australian sharemarket has started 2012 positively, and if this continues it seems likely that more companies will consider an IPO later in the year,” Mr Webster said.

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Unfortunately, if they miss the signal it can make a significant difference to their financial position when they retire, says Mr Jonathan Philpot, wealth management partner at accountants and advisers HLB Mann Judd Sydney.

“Missing out on a couple of years of savings and its compounding effects over ten to twenty years can make a huge difference to the amount they have saved.

“Different people will reach this ‘wealth builder’ stage at different times, so it’s difficult to say precisely what age this is, but for most people it will be some time in their 40s, when their income reaches a peak, their mortgage is down to 50 percent or less of the home’s value, and retirement planning strategies become a focus.

“Generally, one of the first signs is that there is more disposable income available in the family and it’s important to recognise this so that a decision can be made to put some of the extra funds into savings rather than spending it all on the family’s lifestyle.

“It’s the first time in our lives when we are in control of our financial situation and can make big decisions about how to manage wealth, and the choices made now can have a significant impact on our financial future.

“For younger people, much of their financial situation is ‘automated’ and inflexible – a set amount goes into superannuation, another set amount goes to pay off the mortgage each month, and there is little opportunity to vary this or put aside enough money to do anything else.

“For those in retirement, there is a good level of flexibility; however there are still rules and regulations governing, for instance, how much you are able to contribute to super, when you are allowed to commence drawing a pension; and a minimum amount that must be drawn down.  There is also the limitation that people in this phase of their life can’t afford to be too aggressive in their investments, and must therefore keep to fairly balanced or simple strategies.

“However in the pre-retiree years there are a number of tax-advantaged strategies that can be adopted – but how these can be applied will depend on how successful wealth accumulation strategies have been.

“It is therefore critical that people who have the opportunity to change gears and focus on building wealth ten to twenty years before retirement, start doing more than just repaying the mortgage and making superannuation guaranteed contributions.

“As it also coincides with the peak income-earning years, there should be additional money available that can be put towards building wealth,” he said.

Mr Philpot added that there are three main strategies that people should focus on when they become wealth builders.  They are: reducing the mortgage; increasing super contributions; and looking at appropriate gearing to diversify their wealth.

Mortgage reduction

Mr Philpot says that people should plan to be mortgage-free by the time they enter retirement.

“Therefore any wealth accumulation strategy should include reducing home mortgages as a priority, especially as the interest on mortgages is not tax-deductible.

“This strategy should start as soon as possible with mortgage holders looking at ways of always paying more than the minimum amount or making mortgage payments more frequently than required.

“Given that we are in a rising interest rate environment, this approach also builds in a buffer against future interest rate hikes.

“However, it should be only part of an overall strategy as your home is a “lifestyle” asset but doesn’t help build your investment wealth, which is what provides future income,” he said.

Super contributions

The simple fact is that people don’t start thinking about their superannuation early enough, according to Mr Philpot.

“It used to be at age 50 that people started worrying about building their super balance, but now, in light of the restrictive superannuation contribution limits, they need to start thinking about it much earlier, when they are still in their 40s.

“A desired retirement income of $50,000 is not extravagant; however it requires around $1 million in superannuation savings, which most people will not be able to achieve without making significant contributions above the superannuation guarantee levels during their 40s and 50s,” he said.

Gearing

Mr Philpot says that gearing can be a useful strategy, as long as it is not just into another residential property, and is not overly aggressive.

“Many people’s wealth is tied up in the value of their home, therefore residential property market moves have a large influence on their future wealth. If the residential property market has a flat period for five years, it follows that most people will see no change in their net wealth.

“Simply buying another residential property for capital gain is therefore a flawed strategy unless there is other diversification.

“Most people have some exposure to the sharemarket through superannuation, but given how low most superannuation balances are, it is relatively small.

“There can be real benefit in borrowing to invest in shares as you will diversify wealth and increase access to more assets.  These are key ingredients to building wealth over the long term,” he said.

However, Mr Philpot cautioned against excessive use of gearing and borrowing against the home to purchase shares.

“Gearing is not for everyone and should be considered very carefully.  It means taking on a much greater level of risk with leverage into shares.

“The borrowing should be interest only, as most of the spare cash flow should be directed towards the mortgage.

“On the positive side, with the dividend yield at close to 5% on Australian shares and interest rates between 7-8%, there is not a large cash shortfall in the cost of holding the shares.  Also, with the Australian equity market still subdued, it is a good time to be buying for long term gain.

“Borrowing against the house to purchase shares has benefits over taking on a margin loan, as borrowers are not subject to margin calls when shares fall in value.

“In addition, the cost of the loan is about two percent cheaper than a margin loan,” Mr Philpot said.

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