Melissa Fuller

Leading consultants to the financial services and superannuation sector Rice Warner has outlined the scale of the retirement incomes bulge facing Australia’s ageing population, its policymakers, superannuation funds and product manufacturers.

The next 15 years will see more Australians leaving or winding down from the workforce than entering it. On Rice Warner analysis, Australia’s ageing nation will comprise two million men and 2.3 million women in retirement drawing a pension from their superannuation savings by 2029.

This represents a shift to around 40 per cent (or $1.3 trillion – in 2014 dollars) of Australia’s retirement savings assets being converted to some form of retirement income stream. Currently that number sits at 30 per cent (or $492 billion of total superannuation assets) in today’s dollars.

At a personal level, many retirees will not have adequate savings for their retirement. Rice Warner’s latest Retirement Savings Gap research, commissioned by the Financial Services Council, measured (at 30 June 2013) a $727 billion savings gap. This is $67,000 per person less than the amount required for an ‘adequate’ retirement, which would pay retirees up to their life expectancy (more than 20 years).

Compounding this issue is longevity risk: half of Australia’s retirees will live well beyond their life expectancy age.

“It’s great we are all living longer, but the fact is too many retirees will simply run out of money and be forced back on the Age Pension,” said Rice Warner CEO Michael Rice, who has led Rice Warner’s many contributions to the Abbott government’s Financial System Inquiry (FSI), chaired by Mr David Murray.

The FSI’s recent interim report specifically mentions the issue of retirement savings policy, calling for solutions to the problem. “The picture of Australia’s retirement demographic ‘bulge’ is not new. But new ways are needed to address the underlying problems of adequacy, funding and product design – even the fundamental need to deliver people more choice, greater dignity and a better standard of living in retirement,” Mr Rice
said.

“The problem represents a looming challenge requiring a comprehensive range of solutions from industry and government. Our own investigations show today there is not one Australian superannuation fund provider that has in place the right default retirement incomes package to meet the wave of retirees preparing to shift their super into pensions,” he said.

The Rice Warner Retirement Incomes Solution

Mr Rice said the current default option of the superannuation industry is to treat retirement income as handing over a lump sum payment to members when they retire.

“Superannuation fund members are currently given no default option for managing this lump sum. We believe there are better ways to approach this, and have devised what we think is the first comprehensive solution,” Mr Rice said.

Melissa Fuller, deputy CEO, Rice Warner and a leading advocate for the unique retirement savings needs of women in Australia, said the great anomaly is that Australia has a world class retirement savings system but “lags when it comes to an effective and comprehensive retirement incomes system.”

Ms Fuller said the Rice Warner Retirement Incomes Solution, which effectively takes into account the needs of members through the various phases of retirement, provides a comprehensive alternative.

“Rice Warner believes the essential solution is to separate the money needed for any lump sum at retirement and to invest the balance long-term to provide inflation and longevity protection,” Ms Fuller said.

“The account-based pension is converted to a distributing trust so members can derive income from stable fund earnings (and any tax refund from franking credits). Meanwhile, the capital would be projected to grow steadily in real terms. The risk of market volatility impacting the underlying assets is also reduced as the member is not spending his or her capital.

“We’ve received keen interest from some leading superannuation funds about implementing the Rice Warner Retirement Incomes Solution,” she said.

“Our thinking is based on many years of data and insight in this sector, and draws upon numerous submissions, research reports and intellectual property invested by our firm on behalf of clients and various government and independent inquiries held during that time,” she said.

‘We look forward to continuing our contribution to the debate in Australia, particularly as these issues become ever more prevalent in the future planning for the national interest.”

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Positive changes for SMSF pensions

Changes to how non-reversionary pensions are treated when a pensioner dies will have far-reaching tax implications for self managed super funds.

SMSF Professionals’ Association of Australia (SPAA) Director, Technical and Professional Standards, Graeme Colley, says the changes to the super law to allow the tax exemption to continue on the income from investments after the death of a non-reversionary pensioner until a lump sum has been paid or a new pension begins is a positive outcome for trustees.

Colley says:  “It is now possible to sell investments supporting a non-reversionary pension tax free after the pensioner’s death and before it is paid to beneficiaries as either a lump sum or a new pension begins.

“These investments continue to be treated as remaining in pension phase although the pension payable to the deceased has ceased and during the time the trustees are working out who should receive the superannuation death benefit proceeds.”

Another change to the rules for non-reversionary pensions is the calculation of the taxable and tax free components. At the time a superannuation pension begins in the fund, a calculation is made to work out the taxable and tax free components of the pension.

Colley says: “This is called the proportioning rule and the proportions remain with the pension until it ceases.  Under the amendment to the rules for non-reversionary death benefit pensions the taxable and tax free proportions remain after the death of the pensioner and apply to any lump sum or new pension that commences from the death benefit.

“The rules allow any income earned on investments that support the pension assets after the pensioner’s death to be included in the pension account balance that is subject to the proportioning calculation.  However, any other amounts credited to the account from the proceeds of the insurance policy plus any anti-detriment payments are not included in the same calculation.

“As an example, George was receiving a superannuation income stream that was non-reversionary at the time of his death on 1 May 2013.  The tax free portion of his superannuation income stream was 45% and the taxable proportion was 55%.

“At the time of George’s death the balance of his non-reversionary income stream account was $500,000.  In addition, the proceeds of an insurance policy of $400,000 were added to the account after George’s death.

“Under the rules of the fund George’s adult son, Harry, is entitled to a lump sum.  The lump sum of $920,000 will consist of a tax free component of $225,000 (45% of $500,000), the taxable component of $275,000 and the proceeds of the insurance component which will have different tax free and taxable components,” he says.

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Graeme Colley, SPAA Director – Education and Professional Standards, said that the publication of the final ruling was eagerly awaited due to the significant impact it may have on funds that “are not doing the right thing in the eyes of the Tax Commissioner.” 

He said that the Draft Tax Ruling (2011/D3) was issued just over a year ago and the delay in publishing the final version was due to continued negotiation on some-wide ranging implications announced in the draft.  

“The negotiations that have been going on mean that the delay in issuing the final version has not helped those affected by the ruling. It would be good to see the final version published as soon as possible so that the relevant adjustments can be made if required.” 

Clarification in the draft needs to include: 

• The date of effect of the ruling (the draft  proposes that any change is to apply from I July 2007)
• Commutation of the superannuation income stream and the different treatment of current pension assets in the case of full or partial commutation
• Notification of when a pension starts
• The implications of pension entitlements on the death of a primary or reversionary pensioner as well as issues surrounding the notification of a pensioner’s death
• Implications surrounding breaches of the preservation rules if the income stream does not meet the requirements of the SIS legislation.

Colley said it was critical in considering the ruling about beginning and ending a pension to understand what was meant by a superannuation income stream.  

“Most of us think we know what the SIS legislation says by working out the balance of the member’s benefit and then working out the minimum amount.  In the case of a transition to retirement pension the maximum permitted payment is also important in complying with the SIS legislation. 

“However, you need to consider the impact of the SIS definition of an account-based pension. When is a pension transferrable and what is the impact on the death of a primary or reversionary pensioner. 

“Also, there are a number of minimum requirements to be met by a superannuation income stream to ensure any income and capital gains on investments used to support the pension remain tax free,” he says.  

Colley said cessation of an income stream was just as important as when an income stream starts. “In addition to the rules concerning commutation, if a lump sum is payable on the death of the member, it must also be determined when the pension has come to an end. This may occur at the time of death; however, in many cases notification may not occur until well after the member’s death.”

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It is surprising how often I receive calls from advisers asking me to explain how Centrelink will treat their client’s family trust or private company, predominantly for Age Pension eligibility.

(This story first appeared in the Journal of Financial Advice , Volume 3, Issue 4, 2010)

In many instances, ‘Mum and Dad’ had a family business for many years that has long since ceased to be a going concern and, but for the large loan account inside the company, would have wound it down a long time ago. In other cases, it is a family investment trust – testament to a wealth creation and/or asset protection strategy set up years ago with their accountant and financial adviser which may have provided some tax benefits and built scale in pooling family investment reserves. Sometimes, however, it is not necessarily Mum and Dad’s family trust or private company but their high-income-earning son or daughter who has set up the structure and asked Mum and Dad to be beneficiaries to help manage tax.

Nevertheless, in all the cases I have looked at, no-one has ever had the forethought, a decade out from retirement, to ask; “Will this impact on our ability to qualify for the Age Pension?”

What are the Attribution Rules?

The attribution rules were introduced from 1 January 2002 and became effective from 30 April 2002. Their purpose was to assess interests in family trusts, testamentary trusts and private companies under both the Income and Assets Tests.  This would effectively remove a ‘Centrelink shelter’ that had allowed many people to qualify for Government assistance who otherwise would have been caught if assets held in these structures had been invested in their own names.

Trusts and Private Companies

Without going into “what is a company?” and ‘“what is a trust?”, details of which I am sure we are all cognisant, consider what Centrelink and the Department of Veterans’ Affairs (DVA) defines as a private company or private trust. According to the Centrelink Financial Information Services (FIS) Fact Sheet FIS022.0905, a private company,

“is a separate legal entity, set up to run a business or to hold investments, registered under Corporations Law, owned by shareholders and managed by its directors who are elected by the shareholders.”

Centrelink will deem the entity as a private company if, at the end of the last financial year, it met any two of the following three criteria:

1.    the consolidated gross operating revenue of the company and any subsidiaries was less than $25 million;

2.    the consolidated gross assets of the company and any subsidiaries were less than $12.5 million;  and

3.    the company and any subsidiaries had less than 50 employees.

Most of the Mum and Dad enterprises I have encountered are certainly within that range, and if private companies hold many millions in Net Tangible Assets (NTAs) it generally means the directors hold significant wealth in their own names and in family trusts and Self-Managed Superannuation Funds (SMSFs), so they will not be looking to qualify for Centrelink anyway.

In terms of private trusts, again referring to the aforementioned FIS Fact Sheet, Centrelink includes family discretionary trusts and testamentary trusts with fewer than 50 ‘members’. Now, trusts generally don’t have ‘members’, they have beneficiaries, or objects (in the case of a discretionary trust). But for the purposes of the attribution rules, a trust with more than 50 members is deemed to be a widely-held trust in the same form as listed (or unlisted) property trusts, managed share trusts and other public trading trusts. In these cases the member’s holding is treated as a financial asset and deemed for income using the normal deeming rates.

The Assessment Tests with regard to Private Companies and Trusts

One of the difficulties faced by many people seeking to apply to Centrelink or to the DVA for financial support, particularly when they become eligible for the Age Pension, is determining how they will be assessed when there are often some seemingly minute and innocuous associations to a private company or trust. For instance, in the examples mentioned above where Mum and Dad are directors of a defunct company that ceased trading many years earlier, or where they are objects of a family trust and have never received a distribution, are they still caught by Centrelink/DVA?

There are two distinct tests that apply jointly to determine the inclusion of assets and income from a private company or trust. These are:

1.    a Source Test; and
2.    a Control Test.

Simply speaking, the Source Test relates to the source of funds introduced to a trust or private company, and the Control Test relates to who is in control of the trust or private company – for instance, directors of the company or corporate trustee, individual trustees, appointors and beneficiaries/shareholders.

By applying the attribution rules, a person applying for Centrelink/DVA support is attributed with the assets or income of the private trust or company and those assets and income are treated no differently to how the person’s own assets and income are treated.

1.    The Control Test

You might think, “Well, the trustee has control of the assets of the trust so it is likely they will be ‘pinged’ by Centrelink/DVA”. And it is true that the director of the private company or the trustee of the trust does have control of the assets. But consider also, apart from the day-to-day management of the trust, who else can exercise effective control of the trust. Centrelink considers that anyone that can dismiss and appoint a trustee, veto a trustee’s decision or change the trust deed is also included; that is, an appointor, principal or guardian. Centrelink will also look beyond the normal trust law auspices where it deems a person might have influence over the trustee, or where the trustee might be expected to act for the benefit of that person.

2.    The Source Test

The Source Test, on the other hand, seeks to attribute capital invested in a trust or company with the person(s) who originally transferred assets (which can include non-tangibles such as services), into the company or trust. If there has been no consideration paid for these assets, then there is necessarily an assumed retention of control by the transferor, unless in the case of a genuine gift.

If, after applying the above tests, a person is attributed with a share of the assets and/or income of a private trust or company, then the person’s share of the market value of the attributable assets, or the portion of net attributable income, will be assessed as being his/hers.

Strategy Considerations

There are some positives and negatives when applying the attribution rules.

Negatives

Many would consider it a negative to be assessed in the first place.  In addition to this, not all deductions allowed under the Tax Act will be allowed by Centrelink/DVA as a deduction to reduce income. These non-allowable deductions can include:

• prior year losses;
• losses from unrelated businesses;
• deductions caught up in the definition of Reportable Employer Superannuation Contributions (RESC); for example – salary sacrifice, and certain capital expenses.

Positives

There are some positive aspects however. On the assets side, a principal residence owned by a family trust will not be assessable. Also, assets are net of liabilities (if those liabilities are attributable to assessable assets). If a person is deemed not to be the controller of the trust of a private company, the person will not have the market value of the assets assessed against him/her, but will be assessed on the actual distributions or dividends (including imputation credits) made by the private trust or company for twelve months after the date of distribution.

However, the strategic advantage of the attribution of private trust/company income comes from the fact that private trusts and companies are not deemed for income, as are other financial assets, such as listed shares, term deposits and managed equity trusts.

This provides for the ability to manage the amount of income that is assessed to the Age Pension applicant. It can also have a positive outcome in planning for aged care as the use of a private trust may be useful in reducing the income-tested fee with only the actual (taxable) income of the trust assessed under the Income Test.

The following is an extract from the Guide to Social Security Law, 4.12.7.10, which contains the general rules regarding the attribution of income to an attributable stakeholder:

‘Attribution of the income of a private trust or private company

• If the assets (1.1.A.290) of an entity are attributed to a person (the attributable stakeholder) then all of the income (adjusted net profits) generated by those assets will also be attributed to them (subject to the percentage of attribution of the assets),
• Income from the entity for an attributable stakeholder will NOT be deemed, actual income will be used and will generally be assessed on an annual basis from the income tax return,
• If the attributable stakeholder(s) choose to distribute entity capital or income to other people, the amounts distributed are to be treated as gifts by the attributable stakeholder and are subject to deprivation (1.1.D.110).

Exception: Distribution of the income of an entity to the partner of an attributable stakeholder is NOT treated as a gift of the stakeholder and is NOT subject to deprivation.
Note: An income support recipient who is an attributable stakeholder of a controlled entity can request a reassessment of their circumstances at any time.’

Therefore, in order to manage assessable income, a non-interest bearing deposit (or an insurance bond purchased by a private trust where there are no withdrawals) will generate zero assessable income for tax purposes. This means that while the value of the insurance bond will continue to be assessed under the Assets Test in full, there will be no assessable income, thus resulting in minimising the assessable income of the trust.

Of course, the benefits of the treatment of income from a private trust or company as opposed to the  deemed income from financial assets needs to be weighed up against the reporting and other associated costs of running a separate investment structure.

But what about the mum and dad with a loan to a defunct company, or the elderly parents who are trustees or minor beneficiaries of their children’s family trust?

Other Options

According to Centrelink, any person who has a loan to a private trust or company will be assessed under the deeming provisions, irrespective of whether he/she is a controller or non-controller. On the surface it sounds fairly black and white. This is, however, where the ‘Special Assessments’ area of Centrelink earns its stripes. In the case where a private company has a debt to the directors that will never be repaid (because the business that the company ran ceased to be a going concern a long time ago), it is worth going the extra step to push pass the initial bureaucracy and appeal the decision. I have seen instances like this where the loan was ignored, pending the winding-up of the company, without the amount being seen as a gift and deemed for a period of five years (as might normally happen).

For beneficiaries or shareholders with minority interests, Centrelink will look at the trust’s history of income distributions, or the company’s history of dividend payments to ascertain a payment pattern. If Mum and Dad are objects of a trust that has been in existence for a long time and have never received an income distribution (and are not deemed to be controllers of the trust or to have been an initial or subsequent source of transferred capital), then Centrelink has, in the past, been shown to disregard the holding, pending surrender of the holding.

In the case of a trusteeship or a directorship that has precluded eligibility for the Age Pension, the trustee or director can relinquish control, that is, resign as the appointor and/or trustee of a trust or, for a company, relinquish all formal roles, directorships and shareholdings. They are, of course, considered to have gifted all the assets held by the trust or company and the deprivation rules will therefore apply where the market value of the amount foregone/gifted, is assessed as an asset for five years and deemed for income.

According to Centrelink, it will accept a genuine resignation has occurred where, in respect of the private trust or company, both the controller and his/her partner:

• relinquish all formal roles and control;
• relinquish all beneficial interests; and
• make a written declaration that they will not exert any control over, or benefit in any way from, the trust or company.

Excluded Trusts

For the purposes of the Centrelink/DVA means test provisions, and in particular the attribution of assets or income of a private trust to an individual, the Social Security (Means Test Treatment of Private Trusts – Excluded Trusts) (DEEWR) Declaration 2008 specifies classes of trusts that are ‘excluded trusts’ for these attribution purposes, including:

• pre-10 May 2000 community and fixed trusts;
• trusts where the sole or dominant purpose of a trust is to receive, manage and distribute property transferred to it by a government body for a community purpose; and
• trusts that hold, manage, or dispose of indigenous-held land for a community purpose or where the sole or dominant purpose of a trust is to receive, manage and distribute income generated from the use of indigenous-held land for a community purpose.

It is also important to note that certain ‘Court-ordered trusts’ and, particularly, Special Disability Trusts, have different treatments again imposed by Centrelink and the DVA. But these issues are beyond the scope of this paper.

Conclusion

There are three important aspects of dealing with private trusts and companies to bear in mind:

1.    Make sure your clients fully disclose all beneficial interests and any trusteeships or directorships they might have.

2.    Know the attribution and deprivation rules and how they will impact on your clients’ chances of qualifying for Centrelink/DVA support before you implement any strategies to maximise their pension amount.

3.    An initial Centrelink assessment should not be taken as the be-all-and-end-all – there are avenues for appeal.

And get some good technical advice!
 

Note: The accreditation for this CPD article is no longer current. Please visit our CPD section for current CPD quizzes. 

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Standard & Poor’s believes that, other than creating a social welfare net, the most important benefit in developing a successful pension system is the way that it can help strengthen domestic capital markets.  According to John Bailey, Managing Director Standard & Poor’s for Pacific, in many parts of Asia, undeveloped financial systems are a major weakness and prevent effective intermediation between Asia’s large savings and investment needs. In contrast, the fund flows into compulsory superannuation in Australia has provided a steady stream of investment opportunities and has provided a strong source of demand for equity securities.

“The development of Australia’s superannuation system has built up some important wealth-management skills, such as equities and fixed income analysis, funds management, trustee services, and clearing and settlement skills, that have significantly enhanced Australia competitiveness,” Mr. Bailey says. “These skills are critical building blocks in creating a strong economy, and would be a major benefit to emerging economies in Asia”.

Standard & Poor’s also believes that a strong pension system is an important means of funding infrastructure projects. “In Asia, many infrastructure projects have found it difficult to find funding from the domestic capital markets” said Mr. Bailey.  “In contrast, the Australian system has a successful track record in helping generate funding through bonds and syndicated loans for major infrastructure projects, such as utilities, toll roads, and hospitals. Infrastructure is seen as a natural fit for superannuation investment because of its predictable cash flows.”

While the report recognizes that the Australian system faces a number of challenges, it offers several key insights about developing strong social security and pension systems. “If Australia can free up its financial services sector and become more outwardly focused, there could be some significant export of financial services skills and know how into the broader region,” Mr. Bailey said.

The executive comment, “Does Australia’s Pension System Chart a Future Course For Asia?” is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. Members of the media can contact Sharon Beach for a copy.

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