Australian Financial Review
13 April 2020
There has been an unprecedented spending initiative by the government to prop up the economy and its citizens through a virtual shutdown for the next six to 12 months. But although self-managed superannuation funds (SMSFs) will probably be hit hard through this crisis, we’re not hearing much about help for them.
An SMSF retiree’s asset balance is vital because it is from this that future income is generated to help fund living costs and expenses. Periods such as this can cause great anxiety while doing irreparable damage to future income streams as asset values plummet, particularly if there is a prolonged period of volatility.
Compounding the stress is that many retirees were lured to the sharemarket because there was nowhere else to generate a reliable income stream. But in the recent wave of dividend deferrals and cancellations, dividend-income expectations are being cut significantly.
The Australian Prudential Regulation Authority (APRA) delivered a regulatory mandate to cut dividends as it cautioned banks and insurance companies on paying out too much in dividends. This relief lever was seized quickly by the Bank of Queensland at the time of its half-year result.
Unlike share prices that are subject to sentiment, dividends paid by a company tend to reflect the economic reality a business faces. With declines in profitability and free cash flow expected for the coming six to 12 months, the income reality from the sharemarket for retirees on a risk-adjusted basis is bleak.
The outlook for other asset classes in which SMSFs traditionally invest doesn’t look much better. The property market is at risk of seeing its income dry up, leaving many retirees in the lurch. With the rising call for government-mandated rent deferrals, the SMSF property investor who previously received 4 per cent rental returns is likely to be affected significantly.
Further, investors in property trusts, exchange-traded funds (ETFs) and listed and unlisted funds could face a freeze on their distributions should conditions and asset values deteriorate further.
And let’s not forget those who sought the safety of cash and term deposits in the recent turmoil – $1 million held in cash-like products returns an absolute maximum $15,000 a year, well below the regular JobSeeker payment. With interest rates to remain lower for much longer, there is little in the way of hope.
Huge fall in earnings
Should economic and investment conditions worsen, an SMSF retiree could potentially see earnings fall by well over 60 per cent. For SMSFs on the margin, this could fall well below the age pension and JobSeeker payment level.
According to the SMSF Association, there are 560,000 SMSFs comprised of 1.1 million members. The Australian Taxation Office (ATO), in its last published SMSF quarterly statistical report for the three months ended September 30, showed that 37.1 per cent of all SMSF members were of retirement age, which equates to more than 400,000 individuals.
The federal government’s decision to reduce the minimum SMSF pension withdrawal requirement by 50 per cent is important – particularly as this amount is calculated based on the asset value at the start of the financial year.
But another part of the government’s support package was to drop the deeming rate used in the income test to determine qualification for financial support such as the age pension. Without going into the technicalities, the decrease in deeming rate means a reduction in accessible income that would result in those who receive a part pension being able to receive more and, in theory, potentially help some SMSF members on the margin to be eligible for at least a part pension.
The statistics, however, show that for SMSFs, this will probably not be the case. In the ATO report, while there is no breakdown as to whether the SMSFs are in accumulation or pension phase, the median average balance of all SMSFs per member was $408,237. The reality is that older SMSF members tend to have larger balances and therefore would most likely be disqualified from receiving the age pension as they fail the assets test.
Before this correction, an SMSF retiree couple with $1.2 million between them, who owned their own home and earned an income of 5 per cent on a balanced portfolio of assets, would derive in total $60,000 income for the year ($2307 a fortnight). A 60 per cent drop in future income results in $923 a fortnight, which is more than $370, or 30 per cent, less than the age pension.
Of course, where asset values do fall below the upper asset threshold ($869,500 in the case of a married couple who own their own home), they will qualify for a part pension under the current rules. But it is important to note that asset values in property and unlisted trusts often lag, with revaluations conducted sparingly.
Although the income hit of suspended distributions will probably be felt early, any asset revalue relief from non-shares assets may be some time in coming – supporting the idea of immediate income support in the near term.
SMSF retirees who fail the assets test will have no option but to dip into their savings, rendering the government drop in the minimum pension withdrawal level totally useless. This drawdown will result in a lower asset base for future income generation, making it more difficult for them to be self-sustaining and increasing the future burden on government.
For the same duration that JobSeeker, JobKeeper and other spending initiatives are implemented, a possible aid package to SMSF retirees might include the assets test being waived and a regular ongoing payment equal to a minimum of 50 per cent of the current full age pension.
Although this in a few cases may still fall short of past income levels, it would provide urgent short-term income relief. It would reduce the need for excess drawdowns on assets when prices are challenged and/or liquidity dries up.
Further, for those who under normal circumstances pass the assets test, but receive a part pension due to other income generation, for the same period they could automatically be eligible for the full pension to compensate for loss of income.
The main intention would be to deliver some basic support to the large number of forgotten SMSF members whose income even when investments were stable was inadequate.