It's tempting with rates so low but there are extra considerations with a young family, writes John Wasiliev who answers your questions on super.
Q: I’m interested in incorporating a self-managed superannuation fund (SMSF) for my wife and myself so we can refinance our $450,000 mortgage and borrow an extra $100,000 to invest in equities through the SMSF. I’m 46 and work full-time in a good job and she is 38 and working part-time for another year or so, as we have two children under seven. Our current joint super is $120,000 in personal accounts with a retail super administration service. Our annual income is about $200,000. We also have some additional income we could contribute and might receive an inheritance over the next five years we would direct towards super. If we started an SMSF, is the best structure having a corporate trustee or is there an alternative approach? Jason.
A: Your question, Jason, about refinancing your mortgage to borrow money today – $100,000 in your case – at current low interest rates to invest for tomorrow is a strategy that may seem attractive for someone with limited superannuation savings.
But it is one that should not be embarked upon without a great deal of consideration and review, says Peter Crump, private client adviser with AMP Advice in Adelaide.
Borrowing imposes an obligation to make interest payments in the short to medium term, but these funds are being invested into a superannuation system where the money cannot be accessed for another 20 or 30 years at least.
Given you have a young family, there could very well be financial strains over the next five to 10 years of your lives, when additional money in superannuation might be of little value if you need to meet any immediate needs, Crump says.
Although it is true that interest rates are at a very low level, he says, it is quite possible that over time they will rise and the costs of maintaining your sizeable borrowing could increase significantly.
Your proposed extra borrowing is not extreme relative to your well-above-average income, says AMP Capital economist and investment strategist Shane Oliver, given the average mortgage in New South Wales is $450,000 while in Victoria it is $400,000, according to the Australian Bureau of Statistics.
Monitor your mortgage
One option you might consider to address any risk of interest rate rises, says Oliver, is fixing part of your mortgage at rates that are very similar to current levels of just over 3 per cent variable.
With a significant mortgage, you will need to monitor how much of your monthly income goes towards paying off your monthly debts.
Crump advocates an overall more conservative approach of focusing on your mortgage first and getting that into a much more manageable balance before making contributions into superannuation.
While having both members of the couple working helps their income, he warns, family circumstances could change. One member of a couple might have to work reduced hours because of time required at home for one of the children, for example.
In that case, having a buffer of available credit to support your family would be much more beneficial than a higher superannuation balance, he reckons.
As far as establishing an SMSF is concerned: with a balance of $120,000, the maintenance of an SMSF is somewhat problematic, reckons Crump.
At this level, it is questionable whether you have the appropriate balance to justify using an SMSF structure, which has its own costs in expenses, resources and personal time. You will need to research this with SMSF administration services you might consider.
Do you really want DIY?
In addition, establishing an SMSF should only be considered if potential members have sufficient time and expertise to contribute to the operation of a fund. An SMSF should be used where you are unable to achieve similar investment processes in your existing superannuation arrangements.
Have you explored the full range of investment options in your existing superannuation arrangements? he asks. Or do you just believe that moving to an SMSF will give you greater flexibility? You will need to assess this.
If you do choose to add money from a refinanced loan to your super, one strategy you could consider if you expect to have additional income or a future inheritance is using this to get your mortgage down.
When interest rates are low, paying off a mortgage faster than the required terms will reduce the outstanding loan at a faster rate, saving you interest and taking away this risk to family finances.
Another consideration you will need to review is any insurance you have with your present super arrangements and what transferring this to an SMSF might entail in the way of premium costs and contract terms. Having life and disability and even income protection insurance can be very important for couples with young children.
Financial planner Chris Fagan, an insurance specialist with planning firm Scholten Collins McKissock in Melbourne's Surrey Hills, says anyone thinking about moving from one super arrangement to another must review the insurance and be aware there can be a range of options that could be available.
With some super arrangements, the providers have preferred insurers and made special deals with them. What you need to assess is whether it is possible for any existing insurance to be transferred to an SMSF without the need for new underwriting requirements that may result in higher premium costs.
Finally, you ask whether a corporate trustee is better in an SMSF structure.
Establishing an SMSF with the alternative of a personal trustee arrangement is much easier and cheaper because a corporate trustee needs a registered company to act in this role, which comes at an initial cost of about $600 to $800. But the use of a corporate trustee is the significantly preferred option.
Having a corporate trustee will provide greater continuity and clarity of investment ownership of fund assets in the event of the death of one of the members, because of a super requirement that all investments should be in the name of the trustee or trustees.
While the surviving director of a corporate trustee can restructure this into a one-director corporate fund – a simple process – the investments continue to be held in trust by the corporate trustee.
Under a personal trustee arrangement, although the death of one of the trustees can see them replaced by a new trustee who need not be a fund member, the fund administration is more complicated because this change of trustee must be formally registered for all investments the fund owns.
By John Wasiliev - firstname.lastname@example.org.
19 September 2019