SMSFs invest in income-generating assets mainly to cover running expenses, make pension payments to retired members and manage risk through diversification.
But with interest rates near zero, SMSFs need to look beyond popular income sources to find returns with an acceptable level of risk.
“Often, when people manage their own portfolios, they invest in Australian shares and term deposits. They may include a range of blue-chip shares for diversification,” Creation Wealth financial planner Andrew Zbik says.
This strategy may once have produced a reasonable income stream, but that is no longer the case.
According to Reserve Bank of Australia (RBA) statistics, Australian banks were offering an average of 0.25 per cent on $100,000, one-year term deposits in May. A decade ago, savers could earn 6 per cent or more on deposits of that value with the same maturity period.
Australian shares can produce healthy dividends, but Zbik suggests SMSFs need to remember returns from equities can be volatile.
“You think blue-chip shares are safe, but last year even the bluest of blue chips went down in value,” he notes.
Another asset that attracts SMSFs is direct property. Some property investors in Australia’s capital cities have made substantial capital gains in recent years, but again income returns in this asset class have been weak.
Rental rises have failed to kept pace with increasing property values, meaning lower yields for investors. Gross yields on houses in Sydney and Melbourne were just 2.4 per cent and 2.6 per cent, respectively in April, CoreLogic data reveals.
Fixed income
In Zbik’s experience, fixed income is the asset class most frequently overlooked by SMSFs. Fixed income encompasses a vast range of investments from low-risk, low-return government bonds to higher-risk, higher-return hybrids and junk bonds.
To this end, Zbik recommends clients include assets such as mortgage-backed securities, credit funds and hybrids for income in their portfolios.
Mortgage-backed securities and credit funds invest in loans to homeowners or businesses. They pay a regular income at a higher rate than term deposits, although the risk is also higher, Zbik explains.
“They are mortgage lending to people, so you are relying on security backing those loans and people paying back their loans,” he says.
Hybrid securities can deliver strong income returns with a similar level of risk to shares. Hybrids are issued by corporates or banks and are traded on the Australian Securities Exchange.
“You are relying on the integrity of the issuer and you are ranking just above shareholders in receiving pay,” Zbik points out.
Fixed income investments can be complicated and their relationships with financial markets can be difficult to assess. Zbik recommends SMSFs use exchange-traded funds or managed funds to access fixed income investments or seek professional advice to do so.
Life settlements
SMSFs seeking income that is not linked to financial market returns may find life settlements useful. Life settlement funds buy life insurance policies from US senior citizens, paying the premiums until the policy matures, at which time they receive the death benefit payout.
By including a range of life settlements, the fund receives payouts at varying times, allowing it to consistently pay an income to investors over time. Returns are expected to be in the range of 7 per cent to 11 per cent, according to estimates from investment manager Laureola Advisors, and have no relationship with share market performance.
Annuities
Annuities offer another income option that is unrelated to financial markets. SMSFs whose members have retired can buy these financial products from super funds and life insurance companies, selecting the payment amount and term of the annuity.
The income stream is guaranteed, according to Moneysmart.gov.au, however, payments will be low if the annuity starts in a period with low interest rates. Investors cannot withdraw lump sums after payments have started and payment amounts cannot be changed, although payments can be indexed to inflation or linked to the RBA cash rate.
Zbik emphasises SMSFs seeking income should remember their goals.
“Your ultimate aim for your SMSF is to provide for an account-based pension and not have exposed yourself to unnecessary volatility,” he says.
Including a variety of income-producing investments in addition to assets that will grow in value will help to achieve this aim.