What is the key to good SMSF advice?

Newly appointed AMP SMSF executive Peter Burgess explains that assessing suitability and explaining the risks is key to good SMSF advice.

In 2012 the Australian Securities and Investments Commission (ASIC) established a self-managed superannuation SMSF taskforce to examine high-risk issues in the SMSF sector.

As its first major project, the taskforce looked at the quality of advice provided to investors, and last month the taskforce handed down its findings in a report titled ‘SMSFs: Improving the quality of advice given to investors'.

In this report, ASIC concluded that the SMSF advice provided to the majority of investors in their review sample was adequate.

The sample chosen by ASIC was not random; instead it targeted investors who, because of the small size of their balance or other factors such as their age, were considered at greatest risk of receiving inappropriate advice.

The result was encouraging for advisers and the SMSF sector.

Since those with higher balances are usually better suited to an SMSF, the Australian Tax Office statistics — which show the average balance of an SMSF has been steadily increasing over time — seems to provide further evidence that those with SMSFs have generally been well advised.

This includes advice in terms of suitability to this structure and the investment strategy to grow their balance.

However, the ASIC report did say there was room for improvement in certain aspects of the SMSF advice-giving process. The investor case-studies in the report provide a good illustration of the type of SMSF advice which was considered by ASIC as good, adequate or poor.

By reviewing these cases, it is possible to identify those aspects of the SMSF advice process which, if done well, were more likely to be considered by ASIC and investors as being good advice and better serving the needs of the customer.

So when providing advice to clients about setting up an SMSF, what should advisers be doing to ensure their advice fits squarely in the ‘good' category rather than poor or just adequate advice?

In a nutshell, ASIC noted that all personal advice graded as ‘good' was clearly scoped, considered all relevant information (including long-term retirement planning objectives) and had a well-structured, easy-to-follow Statement of Advice (SOA). Let's drill down into some aspects of these areas.

Cost considerations

One of the key issues to discuss with clients when assessing the suitability of an SMSF structure is whether or not the client has an appropriate fund balance to justify the cost of establishing and running an SMSF.

This assessment should recognise the client's financial situation, needs and overall objectives in setting up an SMSF and their ability to contribute or transfer additional amounts to the SMSF over time.

Even if the client has a relatively small superannuation balance, an SMSF may still be the right option if the client has the capacity and intention to add to their SMSF balance in the near future, or their needs and objectives are such that an SMSF is justified.

For example, the client may have specific estate planning outcomes that can only be achieved using an SMSF.

In these scenarios, you must be able to demonstrate in your SOA how the SMSF will quickly build to a cost-effective level, or explain why the establishment of an SMSF is necessary given your client's specific needs and objectives.

In the absence of a reasonable explanation for the establishment of an SMSF with a low balance, ASIC expects advisers to refuse to set up the SMSF.

That is not to say that SMSFs are always appropriate for clients with large super balances. For example, a client that is struggling with their personal financial affairs or has low levels of financial literacy may not be an appropriate candidate for an SMSF.

For SMSF client's in the pension phase it's also important to remember that their asset balance will generally reduce as they progress through retirement, and therefore it will be necessary to review the suitability of an SMSF over time.

The ASIC report also makes reference to research undertaken by Rice Warner Actuaries, which when released is likely to reveal that the cost-effectiveness of an SMSF is very much affected by the amount of work the trustee is prepared to do themselves in administering the fund.

It's important to remember that the cost of employing a professional SMSF administrator, rather than the client undertaking their own administration, is an extra expense — but there are some great cost-effective options available these days. In some cases, however, a higher fund balance may be required to justify the cost of establishing and running an SMSF.

Moreover, it is important that a decision to employ or not to employ a professional SMSF administrator is not based on cost alone.

Professional SMSF administrators can play an important role in mitigating some of the risks of non-compliance, which is more important than ever given the introduction of the new ATO penalties from 1 July this year and the Stronger Super SuperStream measures.

It also highlights the importance of choosing a professional SMSF administrator that has the capacity and scale to drive down costs over time and who you and your client can rely on to provide a compliant and reliable SMSF administration service over the longer term.

SMSF succession planning

Another area highlighted in the ASIC report was succession planning and assessing the impact of unexpected events such as a relationship breakdown, illness or death on your client's SMSF.

This is particularly important in situations where there is one trustee more heavily involved in the day-to-day running of an SMSF.

In these scenarios, your SOA should consider and plan what the less active trustee will do if the controlling trustee becomes unable or unwilling to manage the SMSF.

If the fund membership comprises business partners, unrelated couples, friends or even adult siblings, you may need to spend more time discussing the risks of relationship breakdown and explaining in your SOA how those risks can be best mitigated, managed or avoided.

Corporate trustees v individual trustees

Despite the benefits of a corporate trustee versus an individual trustee structure for an SMSF, the ASIC report noted that very few SMSFs are established with a corporate trustee.

In ASIC's advice file reviews, they found little evidence that the issue of corporate versus individual trustees was discussed with clients.

The ATO has previously published information on this issue and, at the very least, this information should be brought to the attention of your client as part of your advice-giving process.

Compensation options and dispute resolution

It is also necessary to explain to your client that SMSF investors are not entitled to receive compensation under the SIS Act in the event of theft or fraud, and that they do not have access to the Superannuation Complaints Tribunal if issues or disagreements arise about how the SMSF is being managed.

Your SOA should clearly explain the limitations of SMSF compensation arrangements and the reduced access to dispute resolution bodies.

Insurance needs

ASIC also found examples of advisers identifying an insurance need but inappropriately excluding insurance from the scope of advice.

As insurance considerations may affect your client's decision to set up an SMSF, you should deal with the client's insurance need before setting up an SMSF.

It's important to make sure the client is aware they may be uninsured by switching from an APRA-regulated fund to an SMSF and will often have no access to group policies or discounts.

ASIC says if you don't have the necessary expertise or authorisations to provide advice about insurance issues, you should notify your client and refer them to an insurance specialist, and then wait until your client has received the insurance advice before setting up an SMSF.

It's also important to note from 7 August 2012 SMSF trustees were required to consider insurance for fund members as part of the fund's investment strategy.

Alternatives and replacement product obligations

If you recommend that your client replace their APRA-regulated fund with an SMSF, it is important that your advice complies with the replacement product obligations set out in the Corporations Act.

This obligation requires you to provide information to your client about the consequences of transferring their superannuation from one fund to another.

The lack of adequate disclosure about product replacement was a significant factor that contributed to advice being downgraded in the ASIC report.

Related to this is the need for you to properly consider alternative superannuation structures. Your SOA should include a discussion about potential alternative superannuation structures and the advantages and disadvantages of each.

Role and obligations of SMSF trustees

Once you have assessed the suitability of an SMSF for your client and you are satisfied that it is the right option, you should explain the roles and responsibilities of being an SMSF trustee.

The ATO provides a number of useful publications on its website about the obligations and duties of an SMSF trustee, and it is good practice to provide copies of key ATO publications with your SOA.

One of the more important responsibilities of SMSF trustees is the requirement to formulate and implement an appropriate investment strategy for their fund.

When providing advice to client's about investment strategies it is important to ensure the fund's investments will be diversified across a number of asset classes whilst demonstrating appropriate liquidity and the ability to pay benefits.

The ASIC report states that if an investor specifically requests advice on a single asset class, the advisers should provide a clear and unambiguous warning to the client about the risks associated with an undiversified portfolio.

Furthermore, where the advice on a single asset class would be inappropriate for the client, the adviser should refrain from providing that advice .

Although not specifically mentioned in the ASIC report, when assessing the suitability of an SMSF a good rule of thumb is to assume an SMSF is not the right structure for your client and then look for the special circumstances which may warrant the use of an SMSF.

For example, the client may have access to a unique investment opportunity which is not available in other superannuation structures, and their other needs and objectives are such that the establishment of an SMSF is justified.

This approach, together with close attention to the issues raised by ASIC in their report, will introduce a discipline which makes identifying the special or unique circumstances — which warrant your client taking on the role and obligations of an SMSF trustee — a critical step in the advice-giving process. It will also ensure the use of an SMSF is not ignored in situations where it is in the best interest of the client.

ASIC has indicated its immediate focus in the SMSF space will centre on unlicensed advice and misleading or deceptive advertising. On 15 May, ASIC issued its first banning order for unlicensed SMSF advice.

SMSFs are a great option for some clients but they are not for everyone. It's important that those looking to set up and manage an SMSF receive quality advice, so this presents a great opportunity for advisers who have the appropriate SMSF qualifications and training.

Peter Burgess is AMP SMSF head of policy and technical.