Category: Newspaper/Blog Articles/Hansard

Australian Financial Review

June 12, 2018

David Knox

How does Australia fare globally when it comes to retirement incomes?

Our superannuation savings framework is often highlighted as a long-term success of the decisions made in the 1980s and 1990s. Yet the latest OECD numbers show that the system is not delivering an acceptable level of retirement income across all wage earners.

When compared with 10 other countries with similar economies, Australia’s results are skewed.

Odd as it may seem, Australia’s wealthiest and the very poorest are doing well from our compulsory superannuation system. But average wage earners are not. This incongruity means that the system is far from perfect.

So is there a better way, a way that will also result in better outcomes, for even those who expect a very comfortable retirement? Is a universal pension the answer?

First let’s look at the income provided to the poor, when expressed as a percentage of the average wage. The first graphic shows the Australian age pension provides an income that is slightly above the average when compared to the 10 similar countries. So far, so good.

Now let’s consider an individual who receives the average income throughout their career.

Retirement income

The second graphic shows the net replacement rate, assuming they join the workforce at 20 and retire at the future pension age of 67. The net replacement rate, as calculated by the OECD, is the after-tax income received during the retirement years divided by the after-tax income received before retirement.

These net replacement rates range from 29 per cent for the UK to above 100 per cent for the Netherlands with an average of 56 per cent.

Australia is the second-lowest of the 11 countries with a net replacement rate of just over 40 per cent. An important factor driving this relatively poor result is the stronger assets test for the age pension that was introduced from January 1, 2017.

In most countries, the net replacement rate decreases as incomes rise. The reasoning is simple: those with higher incomes do not need the same replacement rate as those on lower incomes. Perversely this does not happen under our current system of the means-tested age pension and compulsory superannuation.

The last chart shows the comparison for an individual who earns 150 per cent of the average wage throughout their career.

Although the net replacement rate in many countries falls as incomes rise, the Australian results are the opposite – with the rate increasing from 40.7 per cent for the average income earner to 43.4 per cent for the 150 per cent earner and then to 44.9 per cent for an individual who earns twice the average wage.

The causes of this outcome are twofold.

First, the superannuation tax system is flat for most income earners, unlike the income tax system which is progressive. This is in contrast to most countries in this comparison where benefits are taxed in a progressive manner. Second, our assets and income tests on the age pension mean that average income earners are expected to receive very little age pension during their retirement years.

Fairer system

The Australian retirement income system has many positive features including coverage of most employees, but the outcomes for the average income worker in respect of retirement incomes needs to be improved.

This would not only improve adequacy but would provide a fairer system. The question is: how can this be done in a simple and sustainable manner?

One way is to follow the Danish system where part of the pension is paid to everyone as taxable income, with the balance paid on an income-tested basis. For example, the current age pension could be divided into two components: a pension equal to 10 per cent of the average wage paid to everyone and an income-tested pension equal to the balance, namely 17.6 per cent of the average wage.

An immediate response could be that Australia, which has an ageing population, can’t afford this.

However, the current and projected Australian government expenditure on the age pension is the lowest of the 10 OECD countries in this comparison. This situation raises the potential to enable pension expenditure to be increased slightly, when expressed as a percentage of GDP, without imposing a significant burden on the federal budget.

The introduction of a universal part-pension has several advantages including the provision of the health card – which would remove the incentive for many retirees to deliberately rearrange their affairs to receive a part-pension and therefore the health card. Such an outcome would encourage all retirees to maximise their assets and income.

A universal pension would improve the retirement income for the average income earner but would have a reduced effect at higher incomes as it would represent a fixed payment in dollar terms. In other words, it would remove the effect that above-average income earners receive a higher net replacement rate.

Clearer incentive

As the income-tested pension would represent less than 18 per cent of the average wage, the income test would cease to have any effect where other income exceeded about 40 per cent of the average wage.

This would provide a much clearer incentive for those with the capacity to save to do so, whereas such behaviour is not always rewarded under the current system. This includes those who may receive a higher income at various stages during their career.

As with all the other countries in this comparison, a single income test should be applied, including deemed income on all assets. This would remove the need for a dual means test which complicates the system. Full-rate pensioners would not be affected.

There would, of course, be an extra expense to the government budget. However, this would be offset, at least to some extent, by additional income tax from those with higher taxable incomes and – possibly – a reduced demand on government services due to the extra income and the changed behaviour as additional saving would be clearly rewarded.

The universal pension could also be seen as an unnecessary gift to the wealthy. However this extra cost could be offset by some adjustments in the total system affecting high income earners, thereby producing a more efficient retirement system without an adverse impact on equity within the overall system.

Dr David Knox is a senior partner at Mercer. These ideas were discussed at the recent Actuaries Institute Financial Services Forum.

By Christian Pakpahan, Lawyer and Daniel Butler, Director, DBA Lawyers

We outline below the key superannuation changes announced in the Federal Budget 2018 on 8 May 2018. Some of the proposed changes will have a substantial impact on SMSFs if they are finalised as law.

Nomination of superannuation guarantee (‘SG’) for certain employees with multiple employers

Broadly, members with incomes above $263,157 with multiple employers can decide whether certain employers do not need to provide SG contributions in respect of their wages from 1 July 2018.

This measure may give a solution to those who unintentionally exceed their concessional contributions cap due to multiple compulsory SG contributions. This can give rise to members being liable to pay tax personally (less a 15% tax offset) on their excess concessional contributions to the extent their overall concessional contributions for the financial year (‘FY’) exceeds the $25,000 cap. Moreover, the shortfall interest charge and other amounts can become payable on excess contributions.

Members who are interested in using this measure should consider negotiating with their employers to receive what would otherwise have been provided by way of SG contributions as additional income, which is taxed at the employee’s marginal tax rates plus applicable levies. These negotiations should occur as soon as practicable given this measure is proposed to apply from 1 July 2018.

Work test exemption for the newly retired

For recently retired members between the ages of 65 and 74 with superannuation balances under $300,000 there will be some relaxation from the work test for voluntary contributions to superannuation.

Under current law, a person who attains 65 must generally be gainfully employed for at least 40 hours in a period of not more than 30 consecutive days in that FY before they can contribute to a superannuation fund. A member is ‘gainfully employed’ if they are employed (including self-employed) for gain or reward in any business, trade or profession.

The proposed relaxation is for the first year they do not meet the work test requirements and starts from 1 July 2019. Total superannuation balances will be assessed for eligibility at the beginning of the FY following the year they last satisfied the work test and there is no requirement for members to remain under $300,000 once the member is eligible.

The usual concessional and non-concessional contribution (‘NCC’) caps will continue to apply however members may also be able to apply the concessional contribution cap carry forward rules during the 12 months and contribute more than their annual concessional contribution cap. It should be noted that the NCC bring forward rule is generally not available for members over 65 years of age.

Example:

Malcolm retires from full-time work at the age of 67 on 1 June 2020. As he would not meet the work test in FY2021, Malcolm, under the current law, would be prevented from making any voluntary super contributions after 30 June 2020.

However, under the proposed measure, if Malcolm’s total superannuation balance is $200,000 at the end of FY 2020 he would be eligible to make contributions under the proposed work test exemption from 1 July 2020 to 30 June 2021.

If we further assume that Malcolm had not reached his concessional contribution cap over the past 2 years, having contributed only $10,000 in FY2019 and $15,000 in FY2020, under the existing carry forward arrangements and new work test exemption Malcolm can contribute up to $50,000 at concessional tax rates in FY2021.

As a result of the work test exemption, Malcolm is also able to contribute up to $100,000 in NCCs in FY2021.

Increasing the limit of SMSF members to six

The maximum limit on SMSF members will be increased from four to six from 1 July 2019. This may result in greater savings for families, particularly those with more than two children as more of the family’s overall superannuation money can be managed under one SMSF.

If this measure is finalised as law, SMSF deeds and constitutions (of corporate trustees) will need to be reviewed and in many cases updated. Indeed, this will also be a further reason against having individual trustees due to the costs and complexity of changing individual trustees. Moreover, we generally recommend that careful consideration should be given and appropriate documentation put in place before admitting a child as a member of an SMSF given the difficulty of getting a member out of an SMSF, the divorce/separation aspects relating to superannuation/property splitting and for estate and succession planning purposes.

In particular, there may be more complexity with decision-making and management issues due to the increased number of members that will inevitably lead to more disputes. Accordingly, it will be critical to have an SMSF deed that has robust provisions to manage these issues.

Three-year audit cycle for compliant SMSFs

The compulsory annual audit report for SMSFs will change from 1 July 2019 to a three-yearly requirement for SMSFs with a history of good record-keeping and clear ATO compliance history.

Some commentators have suggested that while this measure may reduce some red tape, certain issues may remain undetected for a much longer period and by that time it may then become more difficult, complex and costly to resolve.

If this measure is finalised as law, auditors will also have to carefully consider how much review they need to undertake on prior years accounts to gain confidence in prior periods.

Personal contribution deductions integrity measures

There will be tighter enforcement of personal contribution tax deductions made by members that will mainly focus on ensuring that the appropriate ‘notice of intent’ documentation is submitted to the ATO when members claim personal deductions.

A tick box will also be added to the personal income tax return form where members will have to confirm whether they have complied with the notice of intent requirements. Currently, according to Treasury, some individuals receive deductions but do not submit a notice of intent, despite being required to do so. This results in their superannuation funds not applying the appropriate 15% tax to their contribution.

This measure will commence from 1 July 2018 and provides greater integrity in view of the more flexible arrangements that now apply following the removal of the prior 10% rule from 1 July 2017 (ie, where broadly a person was denied a deduction for personal superannuation contributions if they received more than 10% of their income from employee activities). That is, broadly, many employees are now eligible to claim superannuation personally even if all of their income is from employee activities.

Reversionary TRISs maintain retirement phase status upon reversion

Broadly when the beneficiary of a transition to retirement income stream (‘TRIS’) satisfies certain conditions of release (such as retirement), the TRIS commences to be in ‘retirement phase’ and the exempt current pension exemption generally applies up to the maximum $1.6m transfer balance cap.

Under current law, if say a surviving spouse who has not attained his/her preservation age obtains a reversionary TRIS on the death of their spouse, the TRIS can only revert to the nominated dependant if that dependant satisfies one of the relevant conditions of release. In the example just mentioned, since the surviving spouse has not attained preservation age, the TRIS cannot revert and must cease. A lump sum or a new account-based pension (‘ABP’) can be paid as a death benefit to the surviving spouse and if a new ABP is paid, the surviving spouse does not obtain a 12 month deferral to the credit that must be made to their transfer balance account.

However, the proposed new law when enacted will ensure that reversionary TRISs will be deemed to be in retirement phase and can therefore be paid to a reversionary dependant, irrespective of whether they have satisfied a relevant condition of release.

This change will allow a reversionary TRIS to be paid to a dependant, regardless of whether they have satisfied a condition of release, rather than having the TRIS be commuted and a new pension started from the deceased member’s underlying superannuation interests, which would have cost and tax implications.

Retirement strategy for members

Currently, the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’) includes covenants requiring trustees to formulate, review regularly and give effect to an investment strategy. The SISA will be amended to introduce a retirement covenant that will require trustees to formulate a retirement income strategy for members.

The Corporations Act 2001 (Cth) will also be amended to introduce a requirement for superannuation funds and providers of retirement income products to report simplified, standardised metrics in product disclosure to assist decision making.

For completeness, we also mention the following matters that will largely impact large funds.

Super consolidation and limitation of fees

The government announced it will further support the ATO in proactively identifying and consolidating inactive superannuation accounts where balances are below $6,000. The ATO will require that these accounts be transferred to the ATO and upon receipt they will use data matching processes to transfer these funds to the relevant member’s active superannuation accounts.

Additionally the government will introduce an annual cap on passive fees for superannuation accounts with balances below $6,000 of 3% and will ban exit fees on all superannuation accounts.

These measures apply from 1 July 2019. 

Opt-in insurance

Insurance will be offered on an opt-in basis for members with superannuation balances below $6,000, under 25 years of age, or for accounts that have not received a contribution in 13 months. This measure is intended to reduce the erosion of retirement savings due to insurance premiums members do not need or are not aware of.

This measures applies from 1 July 2019 and affected members will have a period of 14 months to decide whether they will opt-in to their existing cover or allow it to switch off.

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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.

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

15 May 2018

Shaun Backhaus (sbackhaus@dbalawyers.com.au), Lawyer and Daniel Butler (dbutler@dbalawyers.com.au), Director, DBA Lawyers

While there are a large number of cryptocurrencies in existence (currently over 1600), this article will focus on Bitcoin for simplicity. Our comments contained here may apply to other cryptocurrencies with the same characteristics as Bitcoin.

What is Bitcoin?

As a very basic explanation, the Bitcoin network is a peer-to-peer payments network that uses public key cryptography to validate transactions involving Bitcoin and to generate new Bitcoins. This network is ‘decentralised’ in that it is not controlled by any government or other central authority.

Bitcoins are created via ‘mining’. This is a process where computer processing power is used to verify Bitcoin transactions and add to the public Bitcoin ledger, known as the block chain. By performing this task the miners may receive new Bitcoin.

Bitcoins in existence may be sent and received via an ‘address’, a unique alphanumeric identifier. A person proves their ownership of a Bitcoin using a public/private key pair. While the public key is known to all and corresponds to a specific Bitcoin, the corresponding private key is kept secret within a digital wallet. The use of the public/private key allows a person to transfer Bitcoin to another address. These transactions are verified by others in the network and added to the public ledger.

Generally, a person would purchase Bitcoin using their own address/wallet privately or via an exchange using a broker (similar to a share trading broker) and if needed transfer the purchased Bitcoin to their own address/wallet.

Can an SMSF invest in Bitcoin?

Any SMSF investment is subject to the regulations under the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’) and the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’). This article does not intend to determine if any specific investment is permissible under superannuation law but generally discusses areas that may need to be considered prior to an investment in Bitcoin. Broadly, there is no specific prohibition on an SMSF investing in Bitcoin but certain factors must be considered.

Investment Strategy

Under s 52B of the SISA and reg 4.09 of the SISR, the trustee of an SMSF is required to formulate, review regularly and give effect to an investment strategy that has regard to the whole of the circumstances of the fund including, but not limited to, the following:

(a)         the risk involved in making, holding and realising, and the likely return from, the fund’s investments, having regard to its objectives and its expected cash flow requirements;

(b)         the composition of the fund’s investments as a whole including the extent to which the investments are diverse or involve the fund in being exposed to risks from inadequate diversification;

(c)         the liquidity of the fund’s investments, having regard to its expected cash flow requirements;

(d)         the ability of the fund to discharge its existing and prospective liabilities; and

(e)         whether the trustees of the fund should hold a contract of insurance that provides insurance cover for one or more members of the fund.

The SISA and SISR do not specify a particular level of risk that is acceptable for a fund’s investment strategy. This would ultimately depend on the risk tolerance of the trustee and members.

If a person suffers loss or damage as a result of a contravention of a covenant imported in an SMSF deed by the SISA, such as the requirement to formulate an investment strategy, they may take action against a person involved in the contravention to recover the amount of the loss or damage. In an SMSF context, it may not be viable for a member to take action against themselves or the corporate trustee. If an adviser assists a client to invest in Bitcoin while the SMSF governing rules do not authorise such an investment and a member suffers loss, the adviser could be exposed to legal liability.

Further, it should be understood that SMSF trustees are in a fiduciary relationship in respect of fund members and any other beneficiaries of the fund. Due to the nature of a fiduciary relationship, SMSF trustees are under the highest of duties to act in the best interests of the SMSF’s beneficiaries. In addition to the various state and territory trustee Act obligations which may apply, s 52B(2)(b) of the SISA places the following covenant on an SMSF trustee:

to exercise, in relation to all matters affecting the fund, the same degree of care, skill and diligence as an ordinary prudent person would exercise in dealing with property of another for whom the person felt morally bound to provide.

The investment strategy for an SMSF must allow for investing in Bitcoin. However, the question of whether such a strategy is prudent for an SMSF will depend on the circumstances of the fund. Considering the volatility of Bitcoin and the fact that it appears (currently) to offer only speculative capital growth opportunities there is clearly a high risk inherent to any Bitcoin investment. On that basis a prudent SMSF trustee may decide that only a small component of a fund’s overall investment portfolio should be made up of Bitcoin or other cryptocurrencies. What is prudent in any situation would depend on the particular circumstances of the fund, such as how close the members are to retirement.

While the DBA Lawyers SMSF deed specifically excludes the rules regarding prudent trustee investment considerations under the various state and territory trustee Acts, not all SMSF deeds will do this. If these provisions haven’t been excluded under a Fund’s deed the Trustee may find them difficult to comply with when investing in Bitcoin.

Governing rules of the fund

As well as the regulations contained in the SISA and the SISR an SMSF trustee will be bound by the governing rules of the fund relating to investment. An SMSF trustee should ensure the governing rules expressly allow them to invest in Bitcoin. As older SMSF deeds are unlikely to provide for this, a variation of the fund’s governing rules may be required prior to such an investment.

Requirement to identify trust assets

A possible issue with SMSFs investing in Bitcoin is the requirement for a trustee to be able to identify the assets of the fund. The Bitcoin market ultimately allows anonymous holdings of Bitcoin. Accordingly, processes should be put in place to ensure that a trustee can evidence any Bitcoin is held as trustee of the SMSF. This could include using the fund’s bank account when purchasing, passing relevant trustee resolutions, ensuring any exchange account is in name of the SMSF trustee acting as trustee, creating a fund-specific email address, completing statutory declarations and otherwise ensuring good documentary evidence exists to satisfy an auditor and the ATO. Prospective advice should be obtained on these requirements prior to investing in Bitcoin.

SMSF trustees should also ensure they take appropriate action to secure the fund’s property. In relation to Bitcoin, this could include ensuring private keys are kept securely.

Acquisitions from a related party

Section 66 of the SISA prohibits an SMSF trustee from acquiring an asset from a related party of the fund. While s 66(2)(a) provides an exemption for the acquisition of a listed security acquired at market value, any Bitcoin holdings will not meet the definition of a listed security in the SISA and so care should be taken to ensure this provision is not contravened.

Further, while ‘acquiring an asset’ does not include accepting money, the ATO has stated that it does not consider Bitcoin to be money nor Australian or foreign currency.

Hedging/Derivatives and Bitcoin

A Bitcoin exchange may allow a user to hedge their Bitcoin against normal currencies or other cryptocurrencies which could involve giving a charge over the Bitcoin holdings. An SMSF trustee is prohibited from giving a charge over the assets of the fund. However, an SMSF is able to give a charge over assets when investing in derivatives if it is in compliance with the SISR. This exemption is only available to SMSFs obtaining derivatives through an ‘approved body’ (subject to a number of other requirements). As no Bitcoin exchange is an ‘approved body’ for the purposes of the SISR, any derivative instrument or hedging that involved a charge over the fund’s assets would be in breach of the SISR.

Valuations and superannuation caps

As has been shown in recent times, the price of Bitcoin can fluctuate widely and rapidly. Trustees and members should be aware of the value of a member’s interest in the fund to ensure relevant superannuation caps aren’t breached. Sharp rises in the value of Bitcoin could result in a member’s total superannuation balance being over the total superannuation balance cap and a member not being eligible to make any further non-concessional contributions to the fund and may affect other caps such as the $500,000 cap for unused concessional contributions (applying from 1 July 2018).

Tax treatment of Bitcoin

This article does not consider the tax treatment of Bitcoin and other cryptocurrencies. The ATO have released a number of tax determinations on the treatment of Bitcoin. Broadly, the ATO’s position is that Bitcoin is a CGT asset for capital gains tax purposes. Specific tax advice should be obtained as part of any investment considerations.

Conclusion

An SMSF trustee is not specifically prohibited from investing in Bitcoin or other cryptocurrencies. However, as reflected above, there are numerous compliance aspects which must be considered. Ultimately, a trustee should act prudently and in accordance with the fund’s governing rules and investment strategy.

Clients should obtain written advice before investing in Bitcoin to ensure they obtain clearance on all of the compliance aspects.

Naturally, for advisers, the Australian Financial Services Licence obligations under the Corporations Act 2001 (Cth) and tax advice obligations under the Tax Agent Services Act 2009 (Cth) need to be appropriately managed to ensure any advice is appropriately provided.

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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.

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

29 May 2018

Joseph Cheung (jcheung@dbalawyers.com.au), Lawyer and William Fettes (wfettes@dbalawyers.com.au), Senior Associate, DBA Lawyers

An individual’s total superannuation balance (‘TSB’) determines many of their superannuation rights and entitlements, such as eligibility to contribute after-tax amounts into superannuation without an excess arising. Accordingly, there is a strong incentive for individuals to carefully monitor their TSB over time, particularly towards the end of a financial year (‘FY’) when most TSB thresholds are tested. In many cases, actions taken to reduce an individual’s TSB through appropriate planning in a prior FY will provide an individual with greater flexibility in relation to their superannuation.

This article (the first in a series on strategies relating to the TSB) examines the strategy of making pension payments and/or paying lump sums to moderate an individual’s TSB.

(For more detail about the various TSB thresholds, please refer to the following link: https://www.dbalawyers.com.au/contributions/total-superannuation-balance-milestones/.)

Background: Components of TSB

Before considering strategies to reduce an individual’s TSB, it is useful to consider the key elements of the TSB definition.

An individual’s TSB at a particular time is comprised of the following components:

1          the accumulation phase values of their superannuation interests that are not in retirement phase;

2          the amount of their transfer balance or modified transfer balance account — this generally captures the net realisable value of most types of pensions in retirement phase;

3          any roll‑over superannuation benefit that has not already been included under steps 1 and 2; and

4          reductions for any structured settlement contributions.

The above is a broad summary only. A detailed examination of the TSB methodology that is set out in s 307‑230 of the Income Tax Assessment Act 1997 (Cth) is beyond the purpose and scope of this article.

Strategy #1: Make pension payments and/or lump sum payments to an individual

Payments of pensions and lump sum amounts are both outgoings that can reduce an individual’s TSB. Generally, an individual must meet a relevant condition of release before they can receive a payment from their superannuation fund. For example, an individual must attain preservation age (which ranges from 55–60 years old depending on their date of birth) before they are eligible to commence a transition to retirement income stream (‘TRIS’).

Furthermore, once an individual has met a relevant condition of release with a ‘Nil’ cashing restriction, eg, reaching preservation age and retiring or attaining age 65, they can:

• commence an account-based pension (‘ABP’) and start receiving pension payments;
• partially or fully commute any ABP they are receiving and cash the commuted amount outside of the superannuation system; and
• pay a lump sum from their accumulation entitlements to the extent that their benefits comprise unrestricted non-preserved benefits.

Each of the above types of superannuation payments can help to moderate an individual’s TSB, though naturally there are limitations on the potential impact of TRIS payments due to the 10% maximum payment limitation (and commutation restriction) where a full condition of release has not been met.

Additionally, it should be borne in mind that there may be non-TSB considerations that will factor into choosing one type of payment over another. For example, making pension payments above the required pension minimums is not generally advisable due to there being no debit for pension payments under the transfer balance account.

Consider the following example:

EXAMPLE

Benjamin is the sole member of a self managed superannuation fund (‘SMSF’) which is 100% in pension phase. Benjamin is not a member of any other superannuation fund.

Benjamin’s TSB is $1,540,000 just before 1 July 2017 and is broadly based on the net market value of the assets that support his ABP. However, the fund’s assets are performing very well during FY2018 in such a way that there will be overall growth in the fund taking into account all applicable outgoings. Indeed, Benjamin estimates on 10 June 2018 that his TSB will be $1,620,000 just before 1 July 2018

Mindful of this anticipated outcome, Benjamin requests for his ABP to be partially commuted on 15 June 2018 and the commuted amount paid outside the superannuation system as a lump sum. Accordingly, the trustee of Benjamin’s SMSF complies with his request and $50,000 is commuted on 16 June 2018. (For completeness, it should be noted that Benjamin has separately ensured that his minimum pension payment requirements were met with cash transfers as he is aware that the partial commuted lump sum will not count towards his minimums.)

On 15 July 2018, Benjamin’s accountant confirms that Benjamin’s TSB just before 1 July 2018 was $1,580,000. If Benjamin had not partially commuted $50,000, his TSB would have been $1,630,000 just before 1 July 2018 because the performance of the assets exceeded Benjamin’s estimate on 10 June 2018. Fortunately, Benjamin took action to moderate his TSB and included a ‘buffer’ amount in his request for his ABP to be partially commuted and paid outside the superannuation system.

The above example demonstrates how the payment of a lump sum amount can reduce an individual’s TSB.

Conclusion and Part IVA

For individuals who satisfy a relevant condition of release, making pension payments and/or lump sum payments is a readily accessible strategy to reduce their TSB. This strategy can be used in isolation or in various permutations with other strategies (subject to the below commentary about pt IVA of the Income Tax Assessment Act 1936 (Cth) (‘ITAA 1936’)).

While it is very difficult to rule out the application of the general anti-avoidance provisions in pt IVA of the ITAA 1936 to the strategy of using benefit payments (ie, making pension payments and/or lump sum payments) to moderate an individual’s TSB, we are not aware of the ATO publicly expressing a view that such a strategy constitutes a ‘tax benefit’ and circumvention of the new rules. Additionally, we consider that paying benefits where a relevant condition of release has been met is, by itself, so common that it would be difficult to see the ATO applying enforcement scrutiny to this strategy in relation to pt IVA of the ITAA 1936 apart from blatant or contrived cases.

However, it is worth highlighting the following example from the Superannuation Taxation Integrity Measures consultation paper released by Treasury in relation to proposed laws to capture outstanding loan balances for limited recourse borrowing arrangements (‘LRBAs’) in an individual’s TSB.

Example 1 [Treasury’s example]

Laura is the sole member of her SMSF, which holds $2 million in accumulation phase.

• Laura takes a lump sum of $500,000 from the SMSF, on 1 June 2019 which reduces her TSB as at 30 June 2019 to $1.5 million;
• On 30 June 2019, Laura lends the $500,000 on commercial terms back to her SMSF under an LRBA;
• The  SMSF  uses  $1  million  of  its  existing  assets  and  the  borrowed  $500,000  to  acquire  a  $1.5 million investment property.

Current law

Laura’s  TSB  as  at  30  June  2019  is  $1.5  million,  comprising  the  net  value  of  the  property  of  $1 million ($1.5 million purchase price less the $500,000 LRBA) as well as the other assets valued at $500,000.

As  her  TSB  is  below  $1.6  million,  Laura  can  make  further  non-concessional  contributions  of  up  to  $100,000  in  the year ending 30 June 2020.

As  the  SMSF  repays  the  LRBA,  the  net  value  of  the  fund  will  increase  and  Laura’s  TSB  will  approach  the  $1.6  million threshold. However just prior to reaching the $1.6 million threshold, she could withdraw another lump sum and enter into a new LRBA to acquire another income-producing asset. This would reduce her TSB again, allowing more contributions to be made to the SMSF.

The above example illustrates that Treasury regards using benefit payments together with related party loans to moderate an individual’s TSB (and as a result of that enable additional non-concessional contributions) is a potential threat to the integrity of the new superannuation reforms.

Naturally, it should be borne in mind that Treasury does not necessarily represent the ATO’s view as the regulator of SMSFs, and not everything that is (arguably) a threat to the integrity of the new laws will strictly fall foul of the general anti-avoidance provisions in pt IVA of the ITAA 1936.

However, conservatively, taxpayers should be mindful that where they are contemplating using a benefit payment strategy to moderate their TSB, the risk of pt IVA being enlivened might conceivably be magnified if this strategy is used together with other actions, such a entering into an LRBA with a related party loan, or paying a small benefit and making a large contribution in a tight timeframe.

The law in relation to TSB is a complex area of law and where in doubt, expert advice should be obtained. Naturally, for advisers, the Australian Financial Services Licence under the Corporations Act 2001 (Cth) and tax advice obligations under the Tax Agent Services Act 2009 (Cth) need to be appropriately managed to ensure advice is legally provided.

In Part 2 of our series, we highlight another strategy that can be used to reduce an individual’s TSB.

DBA Lawyers offers a range of consulting services in relation to TSB issues. DBA Lawyers also offers a wide range of document services.

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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.

30 May 2018

The Australian

9 June 2018

James Kirby – Wealth Editor

Will it ever come to pass? Already powerful forces in superannuation, such as the Financial Services Council, are lobbying against it. They say having a set of funds pinpointed as the very best would cause all sorts of problems. I guess so, especially for the funds that don’t make it to the top!

Being realistic, it might be a long wait for this “best in show” concept to get going. But, as someone once said, you can’t stop the power of a good idea.

There are a variety of lists of the top funds in Australia, but let’s go with a benchmark list as defined by the Australian Prudential Regulation Agency. To find, say, the top five publicly accessible funds is not that hard; you just have to ignore the “staff-only” funds, such as the Goldman Sachs Staff fund or the CBA Group super fund. And to be sure none of these funds have been just lucky over a short time­frame, let’s also focus on the 10-year figures that include how they performed during the GFC. Here’s the list:

UniSuper

One of the biggest and certainly one of the most influential funds, UniSuper is a $63 billion fund with a 10-year return of 5.8 per cent. Unlike the rest of the toppers on the APRA list (mostly industry funds) UniSuper is not strictly a “public offer fund”. It might be described as semipublic in that you can join if you work in higher education or you have a relative among its 421,000 members.

Care Super

This is a typical public offer industry fund that covers general workers in just about every industry. It is one of the smaller funds in the top league with $16bn under management (compared with $123bn at the King Kong of industry funds, AustralianSuper). A quiet achiever, Care Super has about quarter of a million members and a 10-year return of 5.5 per cent.

REST

With a 2 million membership base, REST is among the biggest funds. Such a major presence and $47bn in assets under management can restrict performance, but REST has impressed with an ability to still top the performance tables year after year — it has a 10-year average return of 5.5 per cent.

Cbus

With its constant advertising and previous public endorsement by a former RBA chief, Bernie Fraser, Cbus is perhaps the best known of the industry funds. As with any industry fund, there is union links, including with the CFMEU, which is a “sponsoring organisation”. The fund has $40bn under management and returned a 10-year average return to its 750,000 members of 5.4 per cent.

BUSSQ

This relatively small fund punches above its weight. It has emerged from the building industry but with just 85,000 members it could almost be described as a boutique operation. Nevertheless, it has been very successful in investing the $4bn or so under management with a 10-year average return of 5.2 per cent.

So there’s the top five — the best in show — according to APRA. The issue, of course, is what defines the best in show; those numbers will change in the future. The best funds of the past may not be the best funds of the ­future.

What’s more, some people will want more than raw numbers, they may want a fund that follows their principles closely — that might mean the fund is actively investing in renewables, or it might mean the fund should have no links to trade unions, it might just mean that the fund plays fair and by the rules. Retail funds from the big banks and insurers might tick the boxes on independent directors, but it’s not much consolation if they have higher fees and get beaten endlessly in terms of returns from industry fund rivals.

If you want to draw up your own list of “best in show” options for making the right choice in super I’d suggest picking from one of these choices.

Big funds: The APRA top five (UniSuper, Care Super, REST, Cbus and BUSSQ) along with perennial outperformers AustralianSuper, HostPlus and Sunsuper.

Big retail funds: If you insist on a fund that is not linked with ­unions then among the top retail funds (over 10 years, according to Superratings) you would have AMG Super-Corporate Super, smartMonday PRIME, Macquarie Super Options-Super Plan, Colonial First State (First Choice Wholesale Personal Super) and Mercer Super Trust — Corporate Superannuation Division)

Specialist funds — ethical and environmental: It’s your money and you may want to do more with it than hand it over to whoever tops the charts. Australian Ethical is the best known of the specialist funds group, while Future Super is also a key player. According to super ratings the top five sustainable balanced funds over 10 years are: Hesta’s Eco Pool, AustralianSuper’s Socially Aware option, VicSuper FutureSaver-Socially Conscious Option, Care Super-Sustainable Balanced UniSuper Accum (1) Sustainable Balanced.

Roboadvisers: ING Living super, SixPark, Stockspot, Ignition. If the remarkable success of passive investing in the wider funds management industry is anything to go by, then the biggest threat to the current power structure in super are the new digital operators designed from the ground up to keep fees low and to create funds that match the market. The roboadvisers are still too new to offer 10-year track records.

SMSFs: If you really want to run your own super then an SMSF is the best way possible to do it. There has been some negative publicity around SMSFs, but the SMSF system remains very attractive. The Productivity Commission suggests you need $1 million to succeed with an SMSF, but industry experts and active investors disagree with this estimate. A starting point of $200,000 is entirely feasible.

The Australian
June 2, 2018
Alan Kohler

The word “inequality” hardly figures in the Productivity Commission’s draft report on superannuation, but that’s what it’s really about: some people get poor retirement outcomes as a result of decisions made for them by others.

It’s the fundamental problem with the system, apart from the government’s unremitting effort to politicise and muck it up, of course.

At least the commission has finally called out the Coalition on its nonsense this week.
The commission’s research has established conclusively that bank-owned retail funds charge twice the fees and produce 28 per cent lower returns than industry funds, leaving their unsuspecting members worse off when they retire. We already knew that, but the PC has proved it, so you might think it will put an end to the Coalition’s dishonest attacks on industry funds.

Alas, no. In every interview this week about the report, Financial Services Minister Kelly O’Dwyer first tried to blame Bill Shorten and then forgot to mention the huge difference in outcomes ­between retail funds and industry funds.

Let’s measure it: according to my savings calculator, the difference between saving 9.5 per cent of current average weekly earnings for 40 years at the retail funds’ average return of 4.9 per cent and the industry funds’ average return of 6.8 per cent is, as it happens, $666,000 ($996,000 versus $1,662,000).
The fact that the government has not denounced this and given the banks a deadline for fixing the problem can only be explained by the Coalition’s absurd bias against industry funds because union officials sit on their boards, as opposed to those pillars of rectitude and good governance — bank directors.

But while the Productivity Commission’s draft report is a fine, exhaustive piece of work, it has also fallen short, in my view.

Its recommendation that default super funds be chosen from the top 10 performing funds sounds good on the surface and is definitely better than the current mess and, as the saying goes, we shouldn’t let the perfect be the enemy of the good. But it’s definitely not perfect.

The commission says the median annual return of the top 10 funds in the decade prior to 2017 was 5.7 per cent, 1.1 per cent below the average return of the industry funds. That produces an average difference in retirement outcome for the worker on average weekly earnings saving for 40 years of $432,000 ($1.23m versus $1.62m).

Last year I wrote that a single national default fund should be established that would be run by the Future Fund and would ensure that everyone got the same good result — no choice or competition, but at least no inequality. The idea was later supported by the chairman of the Future Fund, Peter Costello (unsurprisingly), but was specifically rejected by the PC this week.

The Future Fund’s 10-year return to March 31, 2018, was 8.5 per cent. Putting that number into the savings calculator produces a retirement sum for the average weekly earnings saver after 40 years of $2.7m, $1.5m more than from the average of the top 10 super funds.

And apart from the averages, a choice from a menu of 10, even if they are the “top 10”, would inevitably produce inequalities, most of all between the best and the 10th best. And will they still be the best and 10th best in 20 years? Or will those positions reverse?

And how does a 25-year-old make the choice from that drop-down menu? The only thing that matters is the maximum compound interest over the long term, so why have numbers two to 10 at all?

Why would the Productivity Commission recommend a system that, based on past performance, is going to produce, on average, a $1.5m lower retirement sum than the Future Fund would, and continue to result in at least some inequality and unfairness?

Because while the Coalition is ideologically biased against industry funds, the PC is ideologically biased in favour of competition: it’s the answer to every question that is put to it.

And it is true that competition with informed choice is the answer to most, if not all, questions about the efficient functioning of markets, the problem with superannuation is that it’s not a normal market. The choice is about the future, and therefore can’t be “informed” because the future is unknowable.

Competition in banking, for example, works fine because you know the interest rates on offer. Same with most other products.

But with superannuation the product is money in 30-40 years’ time, and depends on future ­returns that can’t be known.

With super, you can only know past performance and current fees, and intangibles like governance. Fees are important but not decisive in retirement outcome — it’s all about performance, and past results are an imperfect guide to the future.

And governance? Well, give me a group of trustees who represent workers and employees over bank directors any day.

The PC rightly says that super is an unfair lottery with too many losers, especially those in retail funds, so consolidation through the removal of underperforming funds and accounts with small balances is long overdue.

Basing the fix on competition, just less of it, won’t work, but nobody in politics or the industry wants to create a new monopoly, especially after the NBN debacle — although it’s clearly the right thing to do — so it won’t happen.

The Australian

June 2, 2018

Paul Kelly

Fundamental reform of Australia’s unique $2.6 trillion superannuation industry is essential following the devastating Productivity Commission analysis this week — but the stage is now set for a titanic struggle over the design and dynamics of reform.

Superannuation in Australia is not just a retirement policy that shapes the living standards of older people. It is a compulsory system still tied to industrial awards and agreements that delivers a guaranteed flow of savings into funds, creating a huge financial edifice projected to be worth $9.5 trillion in less than 20 years, with the trade union movement a critical stakeholder via the successful industry funds.

Super is driven by two sometimes conflicting forces: the public or member interest and the vested interests of the big players. How this shake-out occurs will be decisive in future financial and political power in this country and living standards in retirement. The politics of super are complex, brutal and often in the shadows.

Consider the deliberations of senior cabinet ministers over the recent 2018-19 budget when Revenue and Financial Services Minister Kelly O’Dwyer brought forward a proposal — previously advocated by Peter Costello — for a universal based not-for-profit government agency to manage and invest default super.

This would have been a radical game-changer. It would have constituted the biggest reform to the super system since its inception by the Labor Party nearly three decades ago. O’Dwyer is close to Costello. She worked for him as an adviser when Costello was treasurer. She took up the idea that Costello, chairman of the nation’s sovereign wealth fund, the Future Fund, had put into the public ­marketplace in late 2017, speaking in a private capacity.

Members who decline to choose a fund — an extraordinary two-thirds of people — are placed into a default (MySuper) product, a result often dictated by awards or agreements. Total assets from ­default in the system are just under $600 billion and heading towards one trillion, testifying to the pivotal power of this policy for the funds. A cabinet minister called the system “one of the great sweetheart deals”.

Costello, champion of free markets, favoured a government agency fund to handle default, believing this was a superior model and replicated overseas experience in countries such as Canada.

But O’Dwyer’s proposal was ­rejected by Scott Morrison and ­Finance Minister Mathias Cormann, who were concerned about the downside of such a government-run agency operating as a superannuation national safety system. The Productivity Commission considered and rejected the Costello model in its report.

The report documents the failure of the super system for about a third of its members, the centrality of the default model as a problem and recommends reforms that, in their own right, amount to the biggest remake of the system.

While opposition Treasury spokesman Chris Bowen has kept open Labor’s options on the Productivity Commission report, the ACTU, the industry funds and board trustees are determined to fight for a core principle — keeping the super system tied to the ­industrial relations system. This is the heart of the issue.

The pivotal strategic aim of all key Coalition figures is to break this link — and the Productivity Commission report said it must be terminated in the interest of members since the labour market had changed so much over the past three decades.

O’Dwyer has embraced the ­report, given her defeat in the budget deliberations on the Costello model. She says: “This report shows the super system has not been working as effectively as it should for millions of Australians. The default arrangements are broken for those people who don’t choose where to put their money.”

The pre-budget debate among senior cabinet ministers reveals the extent of concern within government and by O’Dwyer, as relevant minister, at the under­performance of a third of the system, the financial leverage for the trade union movement via ­industry funds and the need for radical change.

The battle lines are still being drawn over the structure of the ­reforms. And there may be some surprises. Costello’s public stance for a government super agency and O’Dwyer’s effort to make this Turnbull government policy was one option. Another, likely to be embraced by the government, is the Productivity Commission-preferred model for an expert ­independent panel to identify 10 “best in show” funds from which default members can nominate thereby exercising choice.

Of course, yet another will be where Labor lands — it will probably seek to fix the problems of the underperforming funds yet retain the link between the super and ­industrial relations system.

O’Dwyer tells Inquirer: “It’s clear that superannuation should not be a plaything of the ­industrial relations system. The Productivity Commission has been very clear on that point. I like what the commission has come up with.”

This week’s events surely invite a reinterpretation of history. Quick quiz: what was the biggest mistake made by the Howard government in its final 2004-07 term? Excess spending? No. Excessive tax cuts? No. Surely its biggest mistake was running with Work Choices when it should have used its Senate majority to redesign the super system with a focus on member benefits and separating the funds from awards and the IR system. It had the legislative power but not the insight to grasp the situation of today.

Senior ministers have confirmed to Inquirer that the Turnbull government remains committed to the legislated timetable to ­increase the super guarantee rate in steps from its present 9.5 per cent of wages to 12 per cent by July 2025. The reality, however, is that it would be unconscionable for this rate to be lifted, allowing more savings to be compulsorily poured into the system, without prior comprehensive reform of the model that is ripping off so many member accounts.

The ACTU, the unions and the industry funds are unforgiving. The industry funds feel constantly vindicated, unsurprisingly, by their superior performance compared with the retail funds, owned to a large extent by banks. Costello says that with default funds event­ually reaching a trillion dollars in a system that was compulsory, it is time for the government to “show an interest” as the scramble continues between funds over who gets the money.

Costello tells Inquirer: “You can have a slug-out between the industry funds and the retail sector. It’s been going on for decades. But perhaps a new and original idea should be injected into the decision-making.”

Senior ministers such as Morrison and Cormann feel otherwise. But former ACTU chief Bill Kelty, one of the original architects of the system, says there is an “arguable case” for the Future Fund to operate a default superannuation fund, saying he doesn’t think “every idea” Costello has is “bad”.

But the Productivity Commission’s rejection of the Costello model rests on firm foundations. It warns the “biggest risk” with a government-owned monopoly default fund would be political pressure to “top up” for poor performance, at the further risk of exposing taxpayers. Even before this possibility, having government responsible for fund performance creates potential political problems. The report also warns that “such a fund would fail to harness the benefits of competition for better member outcomes”.

The commission says more than 80 per cent of men and women in their prime working years, 25 to 54, hold a super ­account. Fund investment performance varies wildly. Incredibly, four in 10 members have multiple accounts, usually unintended and at high cost in duplicate fees. There are 228 funds, mainly in four areas — ­industry, retail, corporate and public sector — and just under 600,000 self-managed super funds.

The system arose as a de facto extension of wages policy during the visionary Keating-Kelty 1980s Accord politics. Funds were tied to employers and unions via industrial awards and agreements. The commission’s analysis of 14.6 million accounts with MySuper products found those under­per­forming represented 31 per cent of member accounts compared with 67 per cent of accounts performing above the benchmark, many being large not-for-profit funds.

While a majority of members are in products performing “reasonably well”, this cannot be deemed to be satisfactory in a system based on compulsion.

Looking at the default segment in the decade to 2017, the top 10 MySuper products generated a median return of 5.7 per cent a year — but 1.7 million member ­accounts involving $62bn in assets were underperforming. The 26 under­­performing funds were made up as follows: 12 retail, ­10 ­industry, three corporate and one public sector. The dirty secret of the industry funds is that they have a long tail of underperforming funds.

The price of being locked into a bad fund is high: a typical full-time worker in a median underperforming MySuper product would retire $375,000 worse off than if they were in a median top-10 product.

A theme of the report is that the system seems more geared to the interests of the funds than the members.

The Productivity Commission assesses the system as a whole — its concern is not industry versus retail — and it finds the system wanting. Its analysis is based on member interest and returns. While ideology cannot be removed from this debate, the report, in effect, is telling the Turnbull government its focus must be system-wide reform based on public interest — not just bashing up the industry funds. Such an approach will be essential to obtaining sufficient support for major reforms.

The problems are systemic. The Productivity Commission makes clear the defects are fund governance, lack of competition, inadequate regulation, insufficient independent directors and unintended multiple accounts. It argues the dividends from reform would be immense — even for a 55-year-old today the improvement from a good fund could be an extra $60,000 by retirement and for a workforce entrant the gain could be $400,000 at retirement.

The report finds the defects in the system are highly regressive. The people being hurt are the young, low-income earners and people who frequently change jobs. For the unions and Labor, who campaign endlessly on ­inequality, this reveals a malaise inside their own castle. It presents them with a test of values and ­integrity — do they fix the infection or just defend their institutional vested interests?

ACTU assistant secretary Scott Connolly says superannuation is an “industrial right” — making clear it must remain anchored in the industrial system. “The suggestion that members’ interests are best served by breaking the link between industry awards, workers representatives and employer bodies which has driven the strength of industry super is badly misguided,” Connolly says.

He declared the for-profit funds “should be banned” and dismissed the Productivity Commission recommendation for an expert panel — separate from the Fair Work Commission — to draft the “best in show” shortlist to ­replace the existing default model.

The ACTU position was categorically rejected by the Productivity Commission. The report insists the Fair Work Commission should have no role in any new ­default model — its statutory ­responsibility is workplace relations, not dealing with super funds. The report says the time has long gone when super funds should be specified in awards and workplace agreements.

Industry Super Australia, representing the industry funds, ­demanded total control of the ­default process. Its chief executive, David Whiteley, said: “The job of government now is to ensure that workers who do not choose their own super fund have their interests protected and are defaulted into an industry super fund. This is currently the role of the Fair Work Commission and is in the best interests of members. Superannuation is deferred wages and a condition of employment.”

Get the message? Reform is OK but don’t use the public interest to dismantle the guaranteed flow of savings by law into the ­industry funds.

In the end this will become a huge contest over financial and political power, with the public interest being used as the rationale.

If you want to grasp the superior strategic skills of the broader Labor movement in Australia there is no better example than the creation, growth and present operation of the super system. The conservative side of politics is now deeply alarmed at this power and how it might be used. The real issue is: can the system be ­reformed or has it gone past the tipping point?

The Turnbull government has two super reform packages now being advanced. The first is a ­series of measures before the Senate requiring trustee boards to have one-third independent ­directors; to strengthen the powers of APRA to intervene and ­impose corrective action where a fund fails to uphold member interests; and to permit freedom of fund choice for about one million workers now denied it.

The second package was announced in the budget. It bans exit fees on all accounts, protects low-balance accounts by transferring them to the ATO after 13 months of inactivity and will empower the tax office to proactively reunite lost super with active accounts.

Reforming the system will be a difficult task for the Turnbull ­government — yet the public ­interest case for reform is unquestionably strong. The government, however, must beware merely waging an ideological war. It will be tempting. To an extent, it is ­justified. But it is not the road to success.

The Australian

June 2, 2018

James Kirby

Is your super fund any good? Is it suitable for you or did you just drift into it? Every single working person in Australia has super. It is quite simply a huge issue and this week the Productivity Commission produced a suitably huge report that could reshape super as we know it.

Better still, the report has managed to upset just about everybody in the industry, which is a good sign. It does not appear to favour anyone in particular.

There is one very big idea in the report — that everyone should have a single super fund for life. Whether this idea gets up or not, it at least drives home the point that if you have more than one super account you are working against your own retirement plan. Duplicate accounts erode your wealth and double your fees. One in three super accounts is still multiple.

The commission offers some powerful, and controversial, ideas that could have major ripple ­effects. For example, the “single fund for life” would be drawn from one of a top 10 list of funds chosen by an independent panel.

Moreover, all funds, including union-linked industry funds, would have to have a “critical mass” of independent directors.

It’s a blueprint for a substantially different, more efficient system that is — never forget — compulsory. The outstanding points are these:

• Despite numerous failings that need to be reformed, the report says unequivocally that most people are well served by the system. The long-term average return rate is 5.6 per cent per annum, a perfectly good outcome.
• Better still from a social policy perspective, the default sector, which serves the majority of workers, actually outperforms the wider system.
• For the one million people with SMSFs, which have been under attack from all sides, especially from industry funds, the report makes the point that the average SMSF fund has done as well as larger funds.

But inside those headline numbers lurks a range of problems.

Sure, most people do well, but one in four funds are what the commission calls “persistent underperformers”. If you are in one of those 25 per cent of funds that are below average you are losing out big time. The report shows that over an average member’s working life, being stuck in a poor performing fund can leave you with 40 per cent less in retirement.

The report also shows that the miserable business of trailing commissions in super, which most people thought had finished years ago, is alive and well. When the government brought in the Future of Financial Advice reforms in 2013, they left existing trailing arrangements alone; that is, they were “grandfathered”. It turns out five years later there is still a staggering 663,000 accounts in the market paying more than $200 million on these commissions.

Political reality

The sharp end of the report, led by PC deputy chair Karen Chester, is where it rubs up against the interests of industry funds. Leading funds such AustralianSuper, Cbus, HostPlus and REST currently stand as the clear winners in the system, topping the performance tables on a consistent basis.

Any fund that reckons it will be left outside the top 10 is going to resist this idea. But it may well come to pass. In a statement sure to turn heads across the sector, opposition treasury spokesman Chris Bowen said he would consider backing the top 10 idea.

For SMSF operators who represent only a fraction of total super holders but a big section of wealthy investors, there was mixed news. It argues that success among SMSFs is effectively restricted to those with more than $1m in their fund. The average SMSF fund has $1.2m so technically the sector should be pleased, but those averages are skewed higher by a small number of very rich funds. The median level of ­assets in an SMSF is much lower at $641,000 (according to most recent available figures, from 2016.

But this PC suggestion is debatable: SMSFs have major advantages that do not stand up to the commission procedures. They allow the member to choose their own investments and have their hand on the steering wheel in terms of asset allocation.

Importantly, SMSFs can also borrow for property or other assets. Significantly, the commission has no problem with geared super funds and says as much.

If the report has a weakness, it does not give sufficient air to the disrupters coming through the system that are not traditional players, such as the big four banks and insurers, and are not industry funds either.

Some of the new major online offerings from both traditional players, such as a low-fee specialist ING Direct, or robo-adviser operators such as Six Park or Stockspot, all offer very simple products that often depend on the new “indexed” products that have emerged, such as exchange traded funds. These funds are an alternative, as are the youth-focused funds appearing on the scene, but have been damaged by a serious of unfortunate events, particular at Spaceship Limited.

The Australian

June 2, 2018

Adam Creighton

Machiavelli wrote “nothing is more difficult than to initiate a new order of things, for the reformer has enemies in all those who profit from the old order and only lukewarm defenders in those who would benefit from the new”.

Forget lukewarm, try clueless. Whatever the impediments to 16th-century reform in Florence, they were nothing compared with what Financial Services Minister Kelly O’Dwyer faces if she tries to improve the efficiency and competitiveness of superannuation. Abysmal standards of financial literacy are endemic. Almost a third of Australians would rather be given $200 in cash than receive $2000 in superannuation, according to a 2014 Westpac survey. O’Dwyer will have the two most powerful vested interests in the country — finance and unions — arrayed against her.

Compulsory super, in place for more than a generation, has created the world’s longest gravy train, delivering more than $30 billion a year in fees to a vast army of fund managers, administrators, financial advisers, custodians, bankers, directors, unions, employer associations, lawyers, accountants and pen pushers. The flow of cash easily will exceed the national defence budget within a few years.

The Productivity Commission’s landmark report into super, released this week, laid bare the extent of the inefficiencies: one in three super accounts is unintentional, draining almost $3bn a year in fees from savings; poor-performing funds are setting up millions of workers on ordinary earn­ings to retire with $600,000 less in savings than they should receive.

The inefficiencies ultimately all stem from a level of compet­ition “at best superficial”, the commission said. Indeed, six years on from the previous Labor government’s MySuper reforms, average fees fell a risible 0.03 percentage points to 1 per cent — about triple what large pension funds charge overseas — between 2016 and last year, according to Rice Warner. That means a typical family with a combined $300,000 is paying, probably unwittingly, about $3000 a year in fees, more than for electricity and gas combined.

Fees are evidently a sore point in the industry: fewer than 10 per cent of the 208 large super funds surveyed by the Productivity Commission bothered to provide any detailed information to it on investment management costs.

The heart of the commission’s solution was to wrench super out of the industrial relations system, creating a list of 10 funds to be chosen by an expert committee. For all the drama, this wasn’t particularly ambitious: only new workers, mainly disengaged young people, whose compulsory contributions amount to about $1bn a year would face the new list. Funds receive about $85bn a year in employer contributions.

The biggest vested interests, for-profit or retail funds run mainly by the banks and AMP, and the not-for profit or industry funds with links to unions and employers groups, were nevertheless outraged — the former because their woeful performance was highlighted once again, and the latter because any change could upset their ingrained advantages.

Industry funds trounced retail funds across the 12 years to 2016, delivering annual net returns of 6.8 per cent a year compared with 4.9 per cent by retail funds, and they will continue to.

Industry funds, born of the industrial relations system and deeply embedded in it, receive a huge advantage. They make up about 70 per cent of the default superannuation funds that appear in industrial awards and enterprise agreements, compared with 17 per cent for retail funds. These are the funds to which employers pay 9.5 per cent of workers’ wages if they don’t choose their own fund. Up to two-thirds of workers default into these funds when they start a new job, providing a reliable and growing river of contributions to default funds.

Ian Silk, chief executive of Australian Super, the biggest industry fund, conceded as much in an interview with former Labor MP Mary Eason published in her 2017 book, Keating’s & Kelty’s Super Legacy. “This has been the single most important investment-performance differentiator between the industry and commercial funds,” he told her. “The (industry fund) trustees could do, frankly, whatever they liked with the money knowing they weren’t going to be put under pressure by members saying ‘I want my money out’ ”. A captive market lowers advertising costs, too.

“The retail funds have not been able to do so to the same extent because most of their members are either themselves more engaged and more likely to move their money around … consequently, the liquidity requirements for retail funds are much higher.”

Indeed, for the past four years industry funds have enjoyed about 55 per cent of the compulsory contributions flowing into MySuper funds, more than double the share heading to retail funds. Across the year to March, industry fund assets grew four times as fast, up 16 per cent to $599bn, as retail funds. It’s not all easy money, though. Industry funds’ model and frugality also have helped keep costs low. For a start, no shareholders means no dividend cheques for shareholders.

“The pay in industry funds pales in comparison with what top bankers and fundies are earning,” says a Sydney partner of a multinational law firm who has worked in superannuation for decades. “The philosophy is totally different; they hate bankers driving Maseratis through Vaucluse.”

By way of example, AustralianSuper, with $123bn in assets across 2.15 million accounts, paid its chief executive, Ian Silk, under $900,000 last year, while its chairwoman, Heather Ridout, earned $192,000. Meanwhile, former AMP chief executive Craig Meller took home more than $8 million in pay and bonuses while his chairwoman, the now departed Catherine Brenner, earned $660,000. National Australia Bank’s wealth boss earned about $4m, about half what its chief executive earned.

“We’ve generated scale benefits to members as we’ve grown larger, through lower investment costs via better buying power with external fund managers and some internal investment management,” says Damian Graham, chief investment officer at First State Super, one of the biggest industry funds with around $90bn under management.

Industry funds also have kept costs down by sharing and owning support services run by intellectual fellow travellers. Industry Super Holdings, chaired by Garry Weaven, perhaps the most powerful man in super, is at the heart of a complex web of companies including Industry Funds Management, Frontier Consulting, Indus­try Funds Services, IFS Insurance Solutions and online newspaper the New Daily. Owned by the major industry funds, it has never paid a dividend. ISH now has more funds under management ($90bn) than Westpac.

Directors typically have strong links to the union movement. The wife of federal Labor leader Bill Shorten is a board director of some related companies.

As well as lowering costs through ISH, industry funds’ increased size and scale enable them to bring services in-house. First State Super’s investment team has grown from about 12 a few years ago to about 70, for instance.

The Productivity Commission’s report focused on efficiency, or lack thereof. Compulsory super’s structural flaws, however, are causing problems far beyond just a financial feast for the industry that puts pressure on the Age Pension. Union-sponsored directors on industry funds, which typically make up half the total, tend to give their fees to their union, while directors of for-profit funds keep theirs. In the four years to last year, the former gave more than $18m to their sponsoring unions, according to the Institute of Public Affairs. It’s telling the industry funds successfully blocked the government’s attempt to legislate quite modest tweaks to superannuation — requiring a third of directors on super boards to be “independent” and more granular disclosure of fund costs to the Australian Prudential Regulation Authority.

Even Bill Kelty, grandee of the union movement and a father of superannuation, this week declared an “arguable case” for a government-run default fund, putting him on the same page as former Liberal treasurer Peter Costello, who has suggested the Future Fund should take default contributions.

The Productivity Commission dismissed the idea this week, but chronic apathy among members is unlikely to provide enough discipline to lower fees dramatically, however short the “best in show” fund list becomes.

New Zealand, Chile and Sweden have public tenders for the right to manage default pension funds. “This has reduced average annual super fees to between 0.30 per cent and 0.55 per cent in those countries. In Australia even default funds still charge double to triple this because of their risky active management strategies,” says Chris Brycki, chief executive of Stockspot. The giant US-based Thrift Savings Plan managed American retirement assets of about for less than 0.03 per cent a year in 2014, or 29c for every $1000 invested.

Fees are the biggest predictor of returns, given the impossibility of fund managers consistently achieving returns above the average after deducting fees. Industry funds have done a better job than retail funds of growing members’ funds — I’m in one myself. Yet a government fund could achieve the scale benefits of industry funds without the politicisation.

Meaningful reform has been glacial. O’Dwyer has a fight on her hands if she wants to take up the thrust the Productivity Commission’s recommendations, let alone back a government-administered no-frills option.

The Age

June 1, 2018

Peter Martin

We’re apathetic about super, until we’re not.

On Tuesday phone lines to Australia’s biggest bank-run super funds buckled under a deluge of calls from customers wanting to close multiple accounts. Traffic to the Australian Securities and Investments Commission’s website for consolidating your super jumped 500 per cent.

Recommendations from the Productivity Commission will boost your super and simplify the system. Economics editor Peter Martin explains.

And in at least one school, Year 12 students were shown two videos; one produced by the Productivity Commission depicting super funds as pigs, and the other prepared by this newspaper, making the point that multiple and poorly chosen accounts can cost members in excess of $400,000 over their working lives.

Asked to check in on their own accounts as homework, some discovered they already had more than one. They had been working casually, flipping burgers and selling clothes. Each new account furnished them with a new insurance policy, which sounds like a bonus until you realise they were getting insured more than once against death and losing their income. They were aged 16 and 17.

Every additional insurance policy, whether junk or not, costs $85,000 over a working life, according to the Productivity Commission report that set off the avalanche of calls. (In reality many wouldn’t cost that much, because they would drain inactive accounts first.) That super funds have knowingly allowed multiple insurance policies to accumulate in the accounts of people too young to benefit is one of a number of scandals uncovered in the report.

The commission’s suggested solutions to the problems of multiple and unsuitable insurance policies are simple: funds would be prevented from foisting them on anyone aged under 25 without their consent; inactive accounts would have their policies stopped. People with inactive accounts are almost certain to have another active account with insurance or no income to insure.

Treasurer Scott Morrison commissioned the inquiry a year ago, at a time when he was still implacably opposed to a banking royal commission. Its head, Producitity Commission deputy chair Karen Chester, refers to it as the “not-so-royal commission”.

Morrison wanted it to examine the costs, fees and net returns of super funds, the role of insurance premiums in eroding member balances, and the antiquated way in which people are pushed into default funds that are tied to jobs, not people. The lines between the two commissions will blur in the coming weeks, as the banking royal commission itself turns its attention to super.

Tuesday’s report is a draft. The Productivity Commission can’t be certain when it will deliver the final report partly because the banking royal commission is taking up so much of bank executives’ time that it would be unfair to ask them to deal with the super report until the banking inquiry is out of the way. But the commission is keen to hear from the rest of us immediately.

On Friday it added a new ‘Brief Comments’ section to its website. Ordinary Australians will be able to upload up to 200 words without the need to make a formal submission. Their names won’t be published but, if they agree, their comments will be. When Chester did this before in an earlier superannuation inquiry, she was able to put the lived experience of Australians to fund representatives in public hearings and get them to concede that things weren’t as rosy as they had been suggesting.

Without putting too fine a point on it, their members would have been better off paying them to do nothing.

Their investment performance is disheartening. Super funds are made up of asset classes; things such as property, shares, international shares and government bonds, assembled in certain proportions.

By examining the average performance of each of the underlying asset classes and assembling them in the same proportions as each of the regulated funds – in what it thinks is a world first – the commission has been able to compare what the fund’s performance would have been if no special skill had been added with the results they actually delivered over more than a decade, taking account of fees and tax.

Shockingly, it found that the 228 funds taken together (accounting for 93 per cent of all accounts and 61 per cent of all superannuation assets) did worse than if the managers had just set the proportions and then done nothing. Their attempts to pick stocks consistently cost their members money. Without putting too fine a point on it, their members would have been better off paying them to do nothing.

The retail funds, mostly run by the banks, are the worst. Instead of producing the 6 per cent per year they would have if they had just set their asset allocation and sacked their stock pickers, they produced 5 per cent. (Stock pickers in the union and employer-controlled industry funds did add value, but not much, boosting annual returns by 0.2 percentage points.)

The commission says it’s at a loss to understand how the retail stock pickers can be so bad. On the face of it it would take a rare and perverse skill to consistently produce worse results than leaving things alone. Keen readers of the Productivity Commission website will find a clue in one of the submissions, from Kevin Liu and Elizabeth Ooi at the School of Risk and Actuarial Studies at the University of NSW.

Despite their complaints about how the directors of industry funds aren’t independent (most are employer and union representatives), most of the directors of retail funds aren’t independent either. Four out of five are affiliated to the bank or larger entity that owns the fund, often by working for another part of it.

Liu and Ooi find that the more affiliated directors a retail fund had, the worse it performed. And the more related-party service providers it used, the worse it performed. The effect was “both statistically and economically significant, and consistent across different measures of investment performance”. The implication is that affiliated directors put the interests of the bank or larger entity first, perhaps by loading up super funds with products it wanted to shift.

Looked at this way, the superior performance of the industry funds isn’t so much the result of superior skill as it is the result of doing a job well in a straightforward way without a conflict of interest.

It’s also the result of scale. Many of the retail funds are deliberately small. There are around 40,000 of them, a number so big as to almost certainly be designed to confuse and beguile the customer rather than help. It’s no accident that Australia’s biggest industry fund, AustralianSuper, is always one of the top performers.

But some of the industry funds are also small, and are shockers when it comes to performance, sitting alongside the worst of the bank-run funds. Appallingly, new employees and people switching jobs continue to get funneled (sic) into them because of the provisions of industrial awards. For as long as that happens their directors will be tempted to keep them open, pocketing board fees for running an organisation that stays subscale but open as the trickle of members leaving is replaced by a stream coming in.

It’s why the commission wants super to follow the person, not the job, with every new labour market entrant (and everyone changing jobs) presented with a list of the top 10 funds and invited to pick and stick for as long as they like, without accumulating multiples. Labor and the Coalition have cautiously welcomed the idea.

It is competing with another model, proposed by Future Fund chair Peter Costello, in which the government would run the only default fund, freezing the top 10 out. It says a lot about how bad the performance of the bank-owned funds has been that some in the Coalition are prepared to countenance it – and also a lot about how much they despise the top-performing union and employer-controlled industry funds.

Australia’s superannuation system is 25 years old. The pool of super savings has climbed to $2.6 trillion. By 2030 it’ll be $5 trillion. It’s important to get it right.

Peter Martin is economics editor of The Age.