Category: Newspaper/Blog Articles/Hansard

The Australian

19 August 2017

Alan Kohler

The government is thinking about whether, and how, to turn the Future Fund into a national default superannuation fund. They should get on with it — it’s a good idea. Not that it would be simple, or uncontroversial.

For a start the Future Fund doesn’t want to become a national super fund and accept retail money, for fear of losing its status as a sovereign wealth fund and all the immunities that go with that, although it is interested in managing the money.

And the nationalisation of the juiciest part of the superannuation industry (default) would be furiously resisted by all sides, with the semi-socialists in the unions and ALP resisting no less furiously than the finance sector capitalists and the political right.

And yet … Australia’s superannuation system is a gravy train for an army of rent-seekers and a dreadful mess for those it is supposed to serve.

We have a choice of funds, but in reality two-thirds of employees are herded into industry and bank-owned funds based purely on deals between employers and their unions and banks, deals that have nothing to do with the retirement needs of employees.

If it’s a unionised business, the union’s industry fund will usually be mandated in the enterprise bargaining agreement as part of the workplace conditions and therefore compulsory for the workers. If it’s not a unionised workplace, the fund will probably be the bank, using the leverage of the overdraft.

What’s more, every time workers change jobs, they end up in another default fund unless they take action to sidestep the new employer’s union or bank deal and assert super fund choice. Most don’t bother and end up with multiple funds — and fees. The employee gets to find out in 40 years whether the result of a succession of employers’ cosy deals with unions and banks were good ones.

The Productivity Commission recognised in its draft report into the super industry in May that there is “market failure”, caused by “paternalism … and historical overhang”, and proposed four options, all designed to improve transparency and competition. The final report is due soon and presumably will repeat the options.

As I understand it, the government is reluctant to go down this path, either because it fears the hated industry funds will end up winning since their performance is better than the bank-owned ones or, worse still, the banks end up winning because their sales culture is more aggressive, or both.

The fundamental problem is there is too much variety and choice in a service paid for now but delivered in decades. More information and competition won’t help because it is impossible to make any kind of choice about a fund when the funds themselves say that past performance is not a guide to future performance.

Retirement saving is not a financial service like banking, which is paid for and delivered concurrently: you can see immediately whether you are getting a competitive interest rate or good service. With super you don’t know for decades.

In the absence of any basis for making an informed choice on behalf of their workers, employers naturally go with convenience — they slide super into the industrial arrangements or the banking relationship. The question is how to fix this when the usual solution to everything — competition and choice — won’t work. Increasingly, it’s clear the answer might lie with the Future Fund, which   was set up by the Coalition government and is beloved by it. In fact it’s probably the only fund the Coalition does like. It is also one of the nation’s best-performing funds, returning 7.8 per cent a year over the past 10 years, including the global financial crisis. The average balanced superannuation fund return, according to ChantWest, has been 4.8 per cent over the same period. The difference in retirement outcomes is staggering. Someone saving $500 a month for 40 years and earning a return of 4.8 per cent would end up   with $724,360. At a return of 7.8 per cent, the same savings plan delivers $1.6 million.

In other words, as things stand, the average super fund member in Australia still has to rely on the age pension when they retire; if the Future Fund were used instead, and going by past performances, the pension would hardly be needed at all, by anyone. Most peoples’ lives, not to mention the federal budget, would be transformed.

So the urgent question is: how can the Future Fund be used for default superannuation?

Easy. The government should create an agency to collect the money and employ the Future Fund to manage it. The National Superannuation Fund would manage member services, payments and liquidity risk and the Future Fund would be required to manage this money in the same way it manages the government’s money now. The Future Fund itself would retain its all-important    sovereign immunities.

The bigger, more difficult, question is whether the NSF would be the only default fund — a quasi-nationalisation of the default sector — or just another option, a sort of default fund.

I think it would be far better if it were the former. Inserting the Future Fund into the system as yet another choice would just make things worse, and employers under pressure from unions and banks would ignore it. But of course, the outcry if that happened would be something to behold.

Default superannuation is Australia’s great gravy train, one of the greatest in the world, probably in history, at least since the East India Company’s government concession was dissolved in 1874.

And that’s the heart of the problem: it’s a 9.5 per cent personal income tax that’s handed over each month to the private sector. It is time the government kept that money, instead of handing it over to the private sector to be fought over.

Alan Kohler is publisher of The Constant Investor

Comment by Save Our Super:

We wonder how long such a fund would withstand political meddling for ‘visionary’ objectives yielding “inestimable benefits” (Stephen Conroy on the NBN).

The Australian

8 August 2017

Judith Sloan

From the point of view of the economy, there is no doubt that hard work is a good thing. Encouraging work effort means there are more people prepared to take jobs and more people willing to put in and work long hours.

Of course, from the point of view of the individual and family, it is a balancing act: achieving the appropriate work-life balance as well as being rewarded (or not penalised) for working extra hours. But here is the nub of our problem: our income tax system is designed to discourage hard work. In combination with the welfare system and the withdrawal of benefits at certain income points, we have the worst of both worlds: people are discouraged from working harder and/or moving into the next income tax bracket.

It comes as no surprise that the proportion of workers working very long hours, defined as 45 hours or more, has fallen in the past 15 or so years. In 2002, 37 per cent of male workers reported working very long hours; last year, the proportion had fallen to 30 per   cent. (Women workers are much less likely to work very long hours, with the latest recorded proportion being fewer than 10 per cent.)

It should also come as no surprise that people of all political persuasions recognise the strong disincentives in the system. When your pay moves from $18,200 to $18,201 you are up for 19c tax in the extra dollar, although just to complicate matters, if you earn less than $20,542, you are entitled to the Low Income Tax Offset.

Arguably, the worst trap in the system is at annual income of $87,000 when a dollar more leads to 32.5c tax on the extra dollar compared with the previous marginal tax rate of 19c.

And if Labor has its way and the additional Medicare Levy of 0.5 percentage points applies to only those earning more than $87,000, this will add an extra $435 for that extra dollar of earnings. This will set a world-record in term of an effective marginal tax rate.

But it’s not just the tax system that is deterring work effort, it is also the withdrawal of family benefits and, from next July, of childcare fee subsidies as family income rises. And then there are those hardworking small businesses that organise their affairs around a discretionary trust.

Labor wants to increase the tax on the beneficiaries of the trust by at least 50 per cent by imposing a minimum 30 per cent tax on trust distributions. The bottom line is that whoever is the government, there is an urgent need to reconsider the tax and welfare system and the disincentives it throws up for hard work.

The tax-free threshold is too high, the marginal tax rates are too high and the interaction with the welfare system discourages participation of the secondary worker within families. Throw in changed taxation on trusts, a distorted implementation of a higher Medicare Levy under Labor (and don’t even get me on to super) and you have recipe for lower workforce participation, reduced working hours and shorter working lives.

(Emphasis added by Save Our Super)

The  Australian

14 August 2017

Andrew White

The financial watchdog has written to the boards of the nation’s superannuation funds, outlining a range of tough new proposals aimed at lifting governance across the $2.3 trillion sector, including stamping out wasteful spending of members’ retirement savings.

Under the plan — which would become part of the licence condition of the funds — boards may have to demonstrate value for money in sponsorship arrangements, and quasi-political spending by funds has been put into question.

At the same time the new proposals could make it tougher to offer life insurance inside super funds if there is no clear benefit for a fund member.

The Australian Prudential Regulation Authority will also force super funds to bolster strategic objectives and undertake better business planning.

The latest in a series of super fund reforms comes as Industry Funds criticised proposed legislation to improve the accountability and member outcomes of super funds, saying they left out large parts of the industry.

Industry Super Australia said the legislation left the “vast majority” of retail superannuation assets outside a new outcomes test because 83 per cent of that sector’s asset were held outside the low-cost default MySuper fund.

“This is the case notwithstanding that such products on average underperform MySuper products, where the majority of industry fund assets are held,” ISA said in the submission, a copy of which has been obtained by The Australian.

ISA also said new powers for APRA to administer super funds would not apply to bank-owned retail funds, while the power to revoke licences would apply only to MySuper products, rather than all funds.

It also said the reporting requirements for operating expenses had been modelled on “look through” requirements for investment fees that had allowed two-thirds of the funds to disclose “absolutely zero investment fees”.

“The reform package would increase the regulatory burden on industry and other not-for-profit super funds, yet allow bank-owned and other retail funds to resist scrutiny and reform,” ISA said.

“The reform package is an example of both the government’s inability to impose real reform on the big banks, and its determination to shoulder industry and other not-for-profit funds out of their way.

“It is unfathomable why the reform package has disregard for improving member outcomes in the poorest performing parts of the industry administered by bank-owned super funds, while imposing further scrutiny largely on not-for profit funds.

“Members are entitled to expect their super savings are being managed transparently and in their best interests regardless of whether they are a MySuper or Choice member.”

The federal government has a suite of reforms for super, including a review by the Productivity Commission into the default system for super fund selection, and governance reforms requiring industry funds to appoint more independent directors.

In a letter to super boards, APRA deputy chairman Helen Rowell said business planning processes of some funds “are based on unrealistic assumptions and lack adequate rigour, including use of poorly constructed indicators or key performance metrics”.

In addition, APRA plans to force funds to act in the “best interest” of members.

“The superannuation industry is going through a period of significant evolution and it is incumbent on licensees to be focused on meeting the best interests of members through delivering high-quality, value for money member outcomes,” Mrs Rowell said.

“This extends to licensees making decisions about the use of members’ money in a manner that provides appropriate transparency and accountability, and is demonstrably in the best interests of members,” she added.

While she declined to be specific, she said some funds were making payments to related parties which had questionable outcomes for members.

“APRA continues to observe instances of poor governance practices by some RSE licensees in relation to decisions regarding the use of member money and fund expenditure, particularly where payments are made to related parties.

“The combination of poor processes and oversight, and failure to take action when issues are identified, can lead to inappropriate costs being incurred that ultimately negatively affect outcomes for beneficiaries.”

In the letter, she also took aim at “business initiatives” where the link to the delivery of quality, value-for-money outcomes for beneficiaries appears limited or is not adequately demonstrated.

She set out plans that would require super funds to regularly assess whether they have provided quality, value-for-money outcomes for all fund members. “The proposed assessment would include consideration of net investment returns, expenses and costs, insurance, and other benefits and services provided,” the letter said.

She said super funds would have until the middle of next month to provide feedback on the planned prudential measures.

While APRA did not name any funds or provide further details in its letter, The Australian revealed in June the regulator had asked the boards of all 15 industry super fund members of peak body Industry Super Australia to explain how the “fox and henhouse” ad campaign was funded.

The employee-and-union-backed super fund group Industry Super Australia launched the TV ad in March to coincide with a Productivity Commission review that is examining breaking open the default model for super, which favours the industry fund sector.

According to a recent report by Rainmaker Information, Australians are charged about $31 billion in fees for the annual management of their super.

The Australian

2 August 2017

James Allan – Garrick professor of law at the University of Queensland

Liberal Party MP Tim Wilson tells us again that he wants to push for a conscience vote on same-sex marriage. And he’s clearly not the only Liberal MP who wants to do this. So what’s wrong with that?

Well, first there is the old-fashioned notion that a political party ought to honour its explicit campaign promises. The Liberals ran at the last election on a straight-out promise to hold a plebiscite on this issue before legislating for same-sex marriage. What does Wilson say about that? He says he has honoured this commitment by voting for the plebiscite and that with its having failed to get through the Senate we can move on to another way to bring in same-sex marriage.

But that is just sophistry, the worst sort of Jesuitical dissembling. No voter understood the Liberals to be promising some version of “‘we’ll try once or twice to have a plebiscite but if we can’t, heck, we’ll have a conscience vote”. That is nothing like what they promised and Wilson and Dean Smith and the other Liberal MPs pushing this know it. Indeed, had the Liberals gone to the election, or the one before it, with such a “we’ll try this for a bit and then go for a conscience vote” they would have lost those elections, and lost badly.

This becomes even more obvious if you try a little thought experiment and imagine that come the next election we still have not held a plebiscite or legislated for same-sex marriage. At that point does anyone want to make a bet on what policy and promise the Liberals will take to that next election? Anyone?

I can tell you right now it will not be to hold a conscience vote. Anything like that would be political suicide for a right-of-centre party that has promised up and down that this would not happen. It would reek of disdain for the voters, and more particularly for the party’s base, and Wilson and Smith know it. That’s why they desperately want to run this backdoor option now while there just may be enough time to hope that right-of-centre voters will have the patience of Mother Teresa and forgive and forget yet another broken Liberal Party promise, joining other express or implied ones such as “we won’t touch superannuation”, “we won’t ever give up on fixing the deficit”, “we’re not for Gonski”, “only Labor would attack the banks” and so on.

Now to lay my cards on the table: I’ve always been sure I’d vote yes in any such same-sex plebiscite but I have to say that the level of Wilsonian casuistry and (best case view) self-delusion is such that I’m starting to have second thoughts. The political class in this country is shockingly out of touch, not just with the voters but with the core notion of “we promised that this is what we will strive to do, come what may”. Look, if the Liberals wanted to do so they could have a double dissolution on this issue, perhaps tied to emasculating section 18C of the Racial Discrimination Act. It would be a much more substantive double-dissolution call than the one Malcolm Turnbull made in 2016.

And a last point. This tactic by what we may think of as the black-hand wing of the Liberal Party can be stopped in its tracks today. All it takes is any two Liberal Party MPs in the house to hold a press conference and announce that if any such staged and bogus crossing-the-floor conscience vote goes ahead these two MPs will make it the cause of an immediate election as they will vote against the government on all votes, thereby causing an election. If Wilson and Smith want to break the clearest of clear promises to the voters then they can immediately face an election over it. Or if there aren’t two principled Liberal MPs left, which I can’t rule out completely, then the Nationals could make this threat and mean it. If it doesn’t go ahead we know it is because Barnaby Joyce decided it wouldn’t.

Look, the Liberal Party in this country desperately needs to re-establish at least a scintilla of trust with its long-time voting base. Wilson’s suggested dissembling to the voters — no, let’s call it what it is, which is a dressed-up form of lying to the voters — is an awful idea. So on their recent track record it’s got to be a 50-50 call on whether Team Turnbull will be dumb enough to let it happen.

Emphasis added by Save Our Super

Sydney Morning Herald

30 July 2017

Daryl Dixon – Executive Chairman of Dixon Advisory

Recent Australian Services Union-sponsored research to address gender inequalities in the distribution of super account balances, especially of lower income women, does little if anything to improve the current or future financial situation for this group.

The proposal, including increasing compulsory super contributions to 12 per cent of salary and other government and employer top-ups, ignores the basic fact that many lower income taxpayers have an urgent need for more current income to pay their rent or service a mortgage and to fund living expenses.

Forcing them or their employers to pay more into super only increases their financial pressures, especially now that superannuation balances are tied up until at least age 60.

Having money in super provides cold comfort when there are pressing bills to pay or in the all too common event of redundancy or marriage breakdown.

The crucial importance of having money and assets outside super is highlighted in divorce settlements. Intact couples don’t have the option to split super balances between them but in divorce settlements this is an option.

This allows women to negotiate a settlement where they receive half the combined super balances. But in practice, women sensibly trade off super entitlements to obtain equity in the family home, especially when there are children.

For an affordable or comfortable retirement, owning a house places retirees in a much more favourable situation than having a large super balance. The home has no impact on the age pension or other income support entitlement while non-home owners are provided with only a $200,000 special exemption by the assets test, levied at 7.8 per cent.

To the extent that compulsory super reduces the ability to achieve home ownership in working life, the incentive in retirement will be to use all available super to acquire a property or to pay off a mortgage.

The Australian age pension system is unique in providing free to those with little super a generous indexed income stream with an actuarial value of at least $500,000 for single people and $800,000 for couples.

The more favourable asset test treatment for home owners is of vital significance as explained above.

Against this overall background, the benefits of superannuation for both younger and lower income people are greatly overstated at least until home ownership is achieved.

At a personal level, the crucial point to realise is that all super contributions are inaccessible for an extended time. Past government decisions suggest that further rule changes are likely in this area, making the availability of super balances even more distant in time.

The crucial importance of having money and assets outside super is highlighted in divorce settlements.

Daryl Dixon is the executive chairman of Dixon Advisory. You can email him at comments@dixon.com.au.

By Gary Chau (gchau@dbalawyers.com.au), Lawyer, and David Oon (doon@dbalawyers.com.au), Senior Associate, DBA Lawyers

Introduction

The Australian Prudential Regulation Authority (‘APRA’) has just updated its Superannuation Prudential Practice Guide SPG 280 — Payment Standards (‘SPG’) in June 2017. Of interest in the SPG are APRA’s comments on the retirement definition in the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’), in particular it is useful to see APRA’s confirmation that a member that reaches 60 and has two or more employment arrangements will meet the definition of retirement if they ceases one of these employment arrangements. While APRA is not the regulator for SMSFs, its comments and interpretation of legislation are influential, including for the ATO.

With the introduction of the term ‘retirement phase’ pensions post 1 July 2017, it is now more important than ever to consider whether a member can start an account-based pension (‘ABP’) or convert their existing transition to retirement income stream (‘TRIS’) into an ABP. Only retirement phase pensions, such as ABPs, will be able to claim the pension exemption post 1 July 2017 on investment returns on assets used to support the pension. On the other hand, transition to retirement income streams (‘TRIS’) are not initially classed as retirement phase pensions and therefore cannot claim the pension exemption until they enter retirement phase once an appropriate condition of release is met and the trustee is notified (except for attaining age 65, where no notification is needed).

The definition of retirement

Retirement is a condition of release with a nil cashing restriction and satisfying this definition will allow members to commence an ABP.

The definition of retirement is found under reg 6.01 of the SISR, which provides that retirement can happen under either of the following two limbs:

Limb 1 — for a person who has reached their preservation age, the person is taken to be retired if:

• an arrangement under which the person was gainfully employed has come to an end; and
• the trustee is reasonably satisfied that the person intends never to again become gainfully employed, either on a full-time or a part-time basis; or

Limb 2 — for a person who has reached the age of 60, the person is taken to be retired if an arrangement under which the person was gainfully employed has come to an end, and either:

• the person attained 60 on or before the ending of the employment; or
• the trustee is reasonably satisfied that the person intends never to again become gainfully employed, either on a full-time or a part-time basis.

As you can see above, the definition of retirement is different for people who have reached preservation age but are less than 60 and for those who have attained the age of 60. The requirements under limb 1 require both criteria to be satisfied, whereas limb 2 only needs either of the listed criteria to be satisfied.

Part-time is defined to mean gainfully employed for at least 10 hours, and less than 30 hours, each week (reg 1.03(1) of the SISR).

Working 2 or more jobs

For limb 2 of the definition, those over 60 have some greater flexibility to meet the definition since that limb only requires that ‘an arrangement under which the member was gainfully employed has come to an end’ and that the person attained 60 before the ending of the employment. This will mean that a person who works two genuine jobs can be taken to retire if one job comes to an end after age 60, even if the other job continues. APRA’s SPG confirms this at para 22:

Where a member has reached the age of 60, is in two or more employment arrangements at the same time, and ceases one of these employment arrangements, this is a valid condition of release in respect of all preserved and restricted non-preserved benefits accumulated up until that time. However, it is APRA’s view that this will not change the character of any preserved or restricted non-preserved benefits that accrue after the condition of release has occurred. A member will not be able to cash any further benefits or investment earnings accrued from another existing employment arrangement, or any benefits or investment earnings from a new employment arrangement, until a further condition of release occurs.

What this means is that members could meet the definition of retirement when they cease one role even if the remaining job had the greater number of hours and a higher remuneration. For example, for a person who is over 60 with a full time job and a side job as a genuine self-employed Uber driver can meet the retirement definition by genuinely ceasing only the Uber job.

What is ‘gainful employment’?

It is not possible to meet the retirement definition by simply ceasing any job, work or task. Under both limbs, members must actually cease gainful employment.

The question then becomes, what does it mean to be gainfully employed? Gainfully employed is defined to mean employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment (reg 1.03(1) of the SISR). This definition is narrower than many realise because both requirements ‘employment or self-employment’ and ‘for gain or reward’ are mandatory prerequisites.

To satisfy the definition, the test to determine whether or not there is employment is a multi-factor legal test based on things such as degree of control, who bears the risk of the venture, whether standard working hours exist, etc. Accordingly, not every job, work or task will be regarded as gainful employment. Take for example the following: a director of a small private company is unlikely to be gainfully employed by virtue of holding that role since a being a director alone is not necessarily employment and is not necessarily under any contract of service (see Beljan v Energo Form Act Pty Ltd [2013] ACTMC 21 [22]). On the other hand, a person who is genuinely driving for Uber, as a paid form of self-employment, is likely to satisfy the retirement definition if they were to cease this role.

*        *        *

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2000 (Cth).

Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

© Copyright 2017 DBA LAWYERS

INTHEBLACK

4 July 2017

James Dunn

Superannuation contributions are regarded as a river of gold into Australia’s finance industry, but is that about to change as fund members retire and draw pensions from their fund?

By James Dunn

One of the features of the Australian superannuation system that most impresses foreign watchers – certainly during the global financial crisis (GFC), when virtually no-one else could raise capital – is the streams of cash that flow into it, mostly from the Superannuation Guarantee (SG), but also from voluntary contributions.

Over the past decade, Australians have contributed A$1.2 trillion into superannuation, of which 52 per cent has been due to the SG, says research firm Rainmaker Group.

In 2015-16 total contributions were A$137 billion – or A$375 million a day. SG contributions were A$77 billion, representing 57 per cent of the total.

That implies that voluntary contributions are also a major growth driver of the system. Rainmaker executive director of research and compliance Alex Dunnin says that while SG contributions are “rock-solid predictable”, voluntary contributions are also remarkably so, albeit slightly more volatile in the long-run trend.

“The two are growing at the same rate,” says Dunnin. “Over the past 20 years, while SG contributions have grown by 4.5 times, non-SG contributions have also grown by 4.5 times.”

It’s been a golden age of endless money for super funds which, along with their investment returns, has doubled the size of the nation’s superannuation kitty since 2008, to A$2.2 trillion.

When do superannuation’s rivers of gold start to dry up?

Shifting demographics will eventually start to threaten these rivers of gold. Sometime in the 2030s, an ageing population is expected to drive the super industry into the net drawdown phase – when more is taken out than goes in.

The system is still growing. Dunnin says Australian super funds paid out A$101 billion in benefits in 2015-16 compared with A$137 billion paid in, so they still had a net inflow of A$36 billion annually, or about A$100 million a day. He says that population factors indicate no projection of super contributions peaking for at least 20 years.

“The long-term projection over the next 20 years is for continued growth,” he says. “That is, the population is growing and the number of working-age Australians is going up too. Yes, the number of retirees is growing, but while they are expected to increase by 2.6 million between 2016 and 2036, the number of working-age Australians is expected to increase by 4.1 million.”

Fewer retirees are taking super lump sums

Besides population, the other major factor Dunnin sees is behavioural: the fact that the proportion of benefits being paid each year as income streams (pensions) rather than lump sums is rising fast, meaning more retirees are keeping more of their money in the system for longer.

“Ten years ago, 59 per cent of benefit payments were paid as lump sums. By 2016 this had plummeted to 36 per cent and by the end of the next decade, our modelling projects it will crash down to 22 per cent,” he says.

“By the end of the following decade it will be just 12 per cent. Interestingly enough, this shift is happening without any compulsory requirements regarding income streams.”

Professional Development: Super advice 2017: featuring a different topic each month, the Super advice webinar series delivers up-to-date knowledge on specialist areas of superannuation and financial planning.

Challenges for super funds in drawdown

Some super funds are already well and truly into net drawdown, because of their structure. This experience holds many lessons for the chief executives and investment heads at other funds, who will face the same circumstances eventually.

“The overriding consideration is that it is difficult to regain any money that we lose,” says John Livanas, chief executive officer at State Super NSW, whose four defined-benefit plans have been cash flow negative since 2004.

“If a positive cash flow fund makes a mistake, a pile of new contributions is coming in tomorrow, but if we make a mistake, the money is gone. It’s the opposite of compounding, it works against you.”

The level of investment skill required in the negative cash flow phase “goes up exponentially,” says Livanas. “Over the years, with positive cash flows, you’ve had a situation where all that a fund has to do is ‘put some growth assets in there and watch them grow’. You can’t do that in a negative cash flow environment.”

Instead, Livanas says State Super has modelled what it thinks the drawdowns are going to be, until the last member is left – which is 2085.

“We create assumptions around what the drawdown is likely to be, which reflects our view around longevity, inflation and drawdown requirements. On that, we overlay what is the type of investment return we’re probably going to need in order to achieve that. We then take that investment return and look to start getting it in particular ways – if volatility takes place in a certain way, even if you get that return, you won’t get the dollars,” he says.

The importance of asset allocation for super funds

Asset allocation becomes the most critical aspect of the investment process, he says. “That’s how you take the risks.”

State Super “actually has to think about running the portfolio like a hedge fund,” says Livanas, focusing on making money when it can, but not losing it when the market goes down.

“The key takeaway is that one can no longer depend on ‘time in the market’. You have to take money out of the market, you have to put in measures to protect the downside, and you have to tilt into the market if you think it’s rising,” he says.

Australian Financial Review

10 July 2017

Ben Smythe

For a number of self-managed superannuation fund (SMSF) members drawing a private pension, July 1 signalled a need to revisit old budget spreadsheets and work out how best to fund ongoing living expenses.

With a $1.6 million cap on a tax-free super pension, some might find that their pension income falls from last year’s levels and they will need to consider assets in an accumulation account or in their personal name to make up the shortfall.

It is important that members revisit any pre-existing automatic pension payments now as they may no longer wish to keep drawing the same amount. Given that many SMSF pensions will have been reduced to meet the $1.6 million pension limit, the pension minimum will also need to be reduced.

To fund any income shortfall from the tax-free pension, there are three main options. Retirees can draw a higher amount from their super pension, take lump sums from the accumulation account or use personal assets – or a combination of all three.

By Gary Chau (gchau@dbalawyers.com.au), Lawyer, and Daniel Butler (dbutler@dbalawyers.com.au), Director, DBA Lawyers

Introduction

We have had numerous queries about the proportioning rule over recent times. A common query is how does the proportioning rule apply and how do you calculate the tax free and taxable components in a superannuation benefit. This article is to assist you understand the fundamentals of this rule.

As a starting point, think of the proportioning rule as a sort of integrity measure that prevents the ‘cherry picking’ of the tax free and taxable components when a payment is made from superannuation. At its core, the proportioning rule provides that the tax free and taxable components of a benefit are taken to be paid in the same proportion as the tax free and taxable components of the member’s interest from which the benefit came (s 307-125(2) of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’)).

Terminology — key definitions

To be able to fully understand the proportioning rule, you first need to know the meaning of the following terms that are used in s 307-125 of the ITAA 1997: ‘superannuation income stream’, ‘superannuation interest’, ‘superannuation benefit’, ‘tax free component’ and ‘taxable component’.

Please note these terms can have different meanings in other legislation. We have primarily focused on the definitions of the terms used in s 307-125 of the ITAA 1997 from a taxation perspective and where relevant, we will also discuss each term’s meaning in superannuation law.

Superannuation income stream

Broadly, the term ‘superannuation income stream’ in the ITAA 1997 means ‘a pension for the purposes of the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’) in accordance with subregulation 1.06(1) of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’)’. For ease of reference, we will use the term pension under the SISA to also refer to ‘superannuation income streams’.

Superannuation interest

The term ‘superannuation interest’ is a tax concept in the ITAA 1997 and essentially refers to either a member’s accumulation or pension interests. More technically, the ITAA 1997 provides that ‘every amount, benefit or entitlement that a member holds in a self-managed superannuation fund is to be treated as 1 superannuation interest in the superannuation fund’ (reg 307‑200.02 of the Income Tax Assessment Regulations 1997 (Cth) (‘ITAR’)). For reference, most SMSF members only have one interest in an SMSF, ie, their accumulation interest. However, this definition can get tricky when you consider the superannuation definition. For instance, the SISR provides that an amount that supports a pension is treated as a separate superannuation interest — meaning each pension gives rise to a separate superannuation interest. Another way to explain it is as follows, each SMSF member will have one interest per pension and one accumulation interest.

Superannuation benefit

The term ‘superannuation benefit’ means a payment from a superannuation fund to a member (eg, broadly this refers to payments from a superannuation fund to the member in the form of a lump sum or pension payments) (s 307‑5 of the ITAA 1997).

Generally, each superannuation interest of a member in a superannuation fund consists of the ‘tax free’ and ‘taxable’ components (although in some cases, the proportioning rules do not apply where one component may be nil and the other 100%).

Tax free component

The ‘tax free component’ includes the contributions segment and the crystallised segment. The contributions segment generally includes all contributions made after 30 June 2007 that have not been, and will not be, included in your fund’s assessable income. The contributions segment is made up of what is commonly known as non‑concessional contributions (and also includes the CGT exempt component, superannuation co-contribution benefits, and contribution splitting benefits). Whereas, the crystallised segment broadly includes numerous tax free components that existed prior to 30 June 2007 and are becoming increasingly uncommon.

Taxable component

The ‘taxable component’ is broadly the total value of the member’s superannution interest less the value of the tax free component. Contributions that would form part of the taxable component are generally amounts included in the assessable income of the fund. Broadly, the taxable component consists of concessional contributions and earnings and capital appreciation from investments in the fund.

When do you calculate the tax free and taxable components?

The value of the superannuation interest and the amount of tax free and taxable components of the member’s interest is determined as follows:

1. Determine whether the benefit is a lump sum or a pension.
2. Work out the total value of the superannuation interest and the proportion of tax free and taxable components as at the applicable time, which means:
3. if the benefit is a lump sum — just before the benefit is paid; or
4. if the benefit is a pension — on the date the pension commences. (In other words, you lock in the proportion of the tax free and taxable components on the date the pension commences, and future growth and earnings are shared proportionally between these components.)
5. Apply the same proportions to the amount of benefit paid (this part is the essence of the proportioning rule).

Consequences of the proportioning rule

Proportioning rule when a pension is commenced

In an accumulation interest, the tax free component is normally comprised of a static amount (ie, the crystallised segment and the contributions segment). Whereas, the taxable component can change every day as the investments supporting the superannuation interest fluctuate with investment markets and earnings (or losses) accrue in some cases on a daily basis.

However, when a pension is commenced with a certain proportion of a tax free component and the pension assets increase over time, the tax free component will effectively grow. This is because at the time of paying pension benefits, the proportioning rule will use the same proportion of tax free component that was locked in at the commencement of that pension.

To illustrate how the proportioning rule works, in practice, in respect of pensions, look at the following example:

In January 2017, Christopher is 66 years old, still working and is a member of an SMSF. In his SMSF, Christopher’s superannuation interest consists of a tax free component of $300,000 and a taxable component of $200,000. His total superannuation balance is $500,000. This means the proportion of his superannuation interest that consists of the tax free component is 60% and the taxable component is 40%.

Christopher commences an account-based pension with just $250,000 of his total superannuation interest. At the commencement of this pension, the tax free component is $150,000 (or 60%) and the taxable component is $100,000 (or 40%) since his total superannuation interest before commencing the pension was 60% tax free component and 40% taxable component.

If the value of the assets supporting the pension were to rise, the percentages representing the tax free and taxable components do not change. Thus if Christopher’s pension balance, which started at $250,000, were to rise to $400,000 after three years due to his savvy investment decisions, his tax free and taxable components would retain the same proportion as at the pension’s commencement and will be as follows: a tax free component of $240,000 (or 60%) and a taxable component of $160,000 (or 40%).

Of course, if the value of the assets supporting the pension were to fall to say $100,000, then the proportion of the tax free and taxable components will still remain the same as at commencement (ie, $60,000 tax free and $40,000 taxable).

Accordingly, the following general rules should be noted:

• Where assets are going to increase in value, the tax free component is maximised by commencing a pension sooner rather than later (locking in the tax free component to grow proportionately).
• Where assets are going to decrease in value, the tax free component is maximised by commencing a pension later rather than sooner (allowing the decrease in assets to erode the taxable component).

Proportioning rule with an accumulation interest

To illustrate further the above general rules about the proportioning rule, consider the following:

Again, same facts as above, in January 2017, Christopher is 66 years old, is working and is a member of an SMSF. In his SMSF, Christopher’s superannuation interest consists of a tax free component of $300,000 and a taxable component of $200,000. His total superannuation balance is $500,000. This means the percentages representing the proportion of his superannuation interest that consists of 60% tax free component and 40% taxable component.

Let’s focus on his accumulation interest this time. Recall, Christopher commenced his pension with $250,000 of his total superannuation interest, he therefore has $250,000 remaining in his accumulation interest. That $250,000 in accumulation would comprise of a tax free component of $150,000 (or 60%) and the taxable component is $100,000 (or 40%). Like his pension interest, the value of his accumulation interest rises to $400,000 after three years due to his savvy investment decisions. Unlike his pension interest, his tax free component remains static and the proportion of his taxable component increases. Christopher’s tax free and taxable components in respect of his accumulation interest is now as follows: a tax free component of $150,000 (or 37.5%) and a taxable component of $250,000 (or 62.5%).

As the above example shows, there is no change to the tax free component if investments in the accumulation interest increase in value. Hence, the decision to commence a pension with some or all of a member’s benefits at the right time can make a significant difference to a member’s interest over the course of time.

Conclusion

A sound understanding of the proportioning rule is important as it is forms the basis of many strategies that leverage off it. For example, where there is a significant tax free component, the pension should generally be commenced as soon as practicable for a member where the fund expects to see some growth in the value of its assets. Further, when a member is contributing or rolling back a pension into accumulation, stay alert to the effect on what will happen to the tax free and taxable components — since these two components cannot be separated to maximise each client’s position once these amounts are mixed together.

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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2000 (Cth).

Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.

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