Peter Burgess

The Federal Government’s proposed new tax on superannuation balances exceeding $3 million could have a negative impact on up to 50,000 SMSF members, with the mean additional tax liability exceeding $80,000 in 2020-21 and 2021-22, according to a research report released yesterday.

The report, by the International Centre for Financial Services (ICFS) at the University of Adelaide and commissioned by the SMSF Association, also found an estimated 13.5 per cent of affected SMSF members would have experienced liquidity stress in meeting the new tax obligations.

The research, which provides the first real glimpse of the potential impact of the proposed tax change on the SMSF sector, used data provided from more than 722,000 SMSF members (two thirds of the SMSF member population) for the 2021 and 2022 financial years.

Commenting on the release of the research study, Professor Ralf Zurbruegg from the University of Adelaide says this liquidity stress has been exacerbated by the inclusion of unrealised capital gains in the measurement of earnings.

“Taxing unrealised capital gains is a somewhat radical departure from existing tax policy and extremely rare in OECD pension systems.”

“There are potentially far broader consequences than those already outlined, and we recommend that the legislators carefully reconsider the implications of this proposal in its current form.”

The report also argues that the Government is potentially short-changing itself by taxing unrealised capital gains. ICFS Deputy Director George Mihaylov says it is important to highlight that using a measurement of earnings that aligns with existing tax policy (i.e., one that excludes unrealised capital gains), would not only alleviate the liquidity stress for some members in the short term, but is also likely to yield more tax revenue for the Government over the medium to long term.

“That’s because this new tax will still be levied on capital gains, but only when the underlying assets are eventually sold. Under normal asset price appreciation over time, the overall tax base will be greater.”

The report notes the treatment of unrealised capital gains and carried forward capital losses is highly problematic given the general nature of capital markets. It is common to see a string of bull market years followed by a sharp bear market decline. This means there is a strong possibility a member can effectively be cumulatively taxed on investments that make an overall loss without any real recourse to recover their tax expense.

SMSF Association CEO, Peter Burgess, says including unrealised capital gains means year-on-year tax liabilities will be directly related to the performance of investment markets, adding to the unpredictability and inequity of the proposed tax, and making if extremely difficult for superannuants to plan investments and manage liquidity.

“Asset rich, income poor SMSF members will find it difficult to cover their additional tax liability and this problem is likely to worsen over time as unrealised capital gains accrue while tax payments from previous years diminish liquidity.”

The research notes selling illiquid assets is typically associated with substantial transaction costs, market timing considerations and other macro-economic factors that are likely to further exacerbate the potential losses associated with meeting the new tax liability.

“Other recent studies show around one in four SMSFs that will be affected by this tax change hold property and, given many will be small business operators and farmers who hold their premises and land in an SMSF, it’s easy to see how disruptive this new tax will be not only for the SMSF sector but for small business operators and the broader community.

“Clawing back the superannuation tax concessions for high balance superannuants was one thing, but taxing paper capital gains that may never be realised, is something completely different,” Burgess says.

Read the report summary.

Read the full research report.

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Peter Burgess

Self-managed super funds (SMSFs) outperformed APRA funds when markets were contracting in the 2019/20 financial year and underperformed APRA funds in the bull market conditions of the 2020/21 financial year.

This was the pivotal finding from the annual SMSF performance tables released today by the University of Adelaide International Centre for Financial Services (ICFS), that showed the headline return for the SMSF sector for 2019/20 was -0.6% and 14.8% in 2020/21, compared to -1.2% and 16% over the same period for the APRA fund sector.

The report, titled ‘Self-Managed super fund performance 2020/21’, was commissioned by The SMSF Association and utilises data from Class Limited, BGL Corporate Solutions and SuperConcepts to delve into more than 310,000 unique SMSFs comprising nearly 546,000 unique performance observations over these two financial years. It is the second report by ICFS comparing APRA and SMSF sector returns, with the goal being to update the numbers annually.

Commenting on the report, SMSF Association CEO, Peter Burgess, says “The results contribute to the existing body of evidence on the strong financial performance of the SMSF sector.”

“We know the actual performance of an SMSF is dependent on the fund’s investment allocation and therefore may bear little resemblance to these headline investment returns.”

“However, what this report and the research released last year for the period 2017-19 shows, is that from an overall SMSF sector perspective, there is no systemic underperformance when compared to the APRA fund sector.”

The report found that in years where the APRA fund sector outperforms the SMSF sector, removing funds with balances under $200,000, and which have 80% or more of their assets invested in cash, accounts for much of the performance differentials.

Burgess adds that the research reinforces the Association’s stance on the importance of professional advice.

“The research couldn’t be clearer – helping SMSF members understand the benefits of asset diversification, and the performance headwinds encountered by small funds (balances under $200,000), will improve the overall performance of the sector.”

To test the hypothesis that the performance of the SMSF sector, relative to other sectors, is adversely impacted by a larger proportion of SMSF members in the pension phase (and therefore a larger exposure to defensive assets to fund pension payments), the performance tables also provide a return for the SMSF sector with SMSFs with one or more members in the pension phase excluded from the data sample.

The results showed a marked improvement in the performance of the sector in 2019/20 when investment markets were declining. However, removing pension funds from the data sample in 2020/21, when investment markets were performing strongly, had a very small detrimental impact on the performance of the sector.

Burgess said, “The difference in the performance of the SMSF sector when these funds were removed from the data sample could be traced, in the main, to pension phase funds having a larger allocation to Australian equities.”

“This explains why removing these funds from the sample in a bull market actually has a detrimental impact of the performance of the sector.”

“But there is no evidence the performance differential is due to pension phase funds having a higher allocation to defensive assets, as the research found both pension and accumulation phase funds allocated remarkably similar proportions of their overall net assets to cash and term deposits.”

The report also provides further evidence of the risks associated with using the ATO’s published SMSF investment performance data to compare the performance of the SMSF sector to the APRA fund sector. The ATO’s estimated SMSF investment return for 2019/20 was -1.5% and 12.9% for 2020/21, compared to -0.6% and 14.8% for the same period calculated by the University of Adelaide.

Burgess said the differences relate to the data inputs and the methodology used. The University of Adelaide uses a calculation methodology directly comparable to the data inputs and methodology used by APRA to calculate returns for the APRA fund sector.

Commenting on the report’s findings, University of Adelaide Research Professor Ralf Zurbruegg said: “Our results show that overall financial performance of the SMSF sector remains robust, weathering the 2020 COVID-induced market storm relatively better than the APRA fund sector.

“Our analysis also continues to highlight how SMSFs benefit from professional advisory services, especially underscoring the value of trustee education on the benefits of diversified asset allocations and the importance of individuals selecting into SMSFs appropriately based on threshold superannuation balances of more than $200,000.”

To access the performance brief and the University of Adelaide report visit: https://www.smsfassociation.com/smsf-performance

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John Maroney

The investment performance of a typical self-managed super fund (SMSF) improves as the fund balance approaches $200,000. Once this threshold is reached the fund achieves comparable investment returns with APRA regulated funds, according to comprehensive research released yesterday by the University of Adelaide’s International Centre for Financial Services (ICFS).

In its report, titled “Understanding self-managed super fund performance” the University used data provided by BGL Corporate Solutions and Class Limited from over 318,000 SMSFs between 1 July 2016 and 30 June 2019, to identify the minimum amount of capital required for an SMSF to achieve comparable investment returns with much larger funds.

When coupled with research by the actuarial firm Rice Warner in late 2020, which found SMSFs with balances of $200,000 or more were cost effective compared with industry and retail superannuation funds, it mounts a compelling argument for the competitiveness of SMSFs with balances of $200,000 or more compared with larger funds.

The SMSF Association, which commissioned the report, says the research supports the regulatory focus on fund size, but it also suggests that current regulatory guidance around minimum SMSF balances is poorly calibrated.

In their guidance to licensees and advisers on the disclosure of SMSF costs (INFO 206), ASIC states that “on average, SMSFs with balances below $500,000 have lower returns after expenses and tax than funds regulated by APRA”.

Association CEO John Maroney says: “The research data revealed no material differences in performance patterns for SMSFs between $200,000 and $500,000, so the notion that smaller SMSFs in this range deliver materially lower investment returns, on average, than larger SMSFs in this range, is not supported by the research results.”

“The research results suggest a more appropriate threshold is $200,000”, Maroney says

The research also found that, when compared to the rate of return (ROR) performance measure used by APRA to calculate investment returns for APRA regulated superannuation funds, the ATO’s calculation of SMSF returns produces lower estimates of investment returns all else being equal.

“Most of the differences arise because the ATO’s calculation is based on data derived from SMSF annual returns whereas APRA uses information from superannuation fund financial statements”.

“The research study overcomes this by using SMSF financial statement data to calculate an annual ROR for each fund in the data sample”, says Maroney.

When comparable data inputs and calculation methodologies are used, the median investment performance of SMSFs, particularly those with balances of $200,000 or more and which are not heavily invested in cash, was very competitive with APRA regulated funds during the period in question.

“This is a very significant development for the SMSF sector – not only does this research cast new light on the performance of SMSFs compared with APRA regulated funds, but it also illustrates why the ATO’s published SMSF investment returns should not be used to compare the performance of the SMSF sector with other sectors”, Maroney says.

Commenting on the research, Professor Ralf Zurbruegg from the University of Adelaide says the way in which the ATO calculates SMSF performance is different to how APRA calculates performance of APRA regulated funds.

“When we account for the differences in how the performance of these funds is calculated, neither APRA regulated superannuation funds nor SMSFs with balances above $200,000 consistently under or out-perform each other”, Zurbruegg says.

The research also found SMSFs generate greater variation in fund-level performance relative to APRA regulated superannuation funds which the SMSF Association says highlights the role of professional advice and a sound investment strategy.

Maroney says: “The greater variation in fund-level performance, and a higher tendency to outperform relative to APRA-regulated funds, presents opportunities for advisers to add value and deliver higher rates of return for suitable superannuation investors.

“It also presents opportunities for advisers to assist those SMSF investors who have a higher tendency to underperform”.

Consistent with standard finance theory, the research shows on aggregate, SMSFs with more diversified asset allocations achieve higher returns.

Zurbruegg says: “The performance benefits of adding a second, third or fourth asset class are strong and consistent across the 2017-19 period.

“The results provide a useful reference point and education tool for SMSF professionals and investors and supports the regulatory focus on SMSFs with inadequate levels of diversification.”

The report notes that the sample made available for the research study was a significant point of strength and differentiation. Overall, the study observed the financial performance of more than 318,000 SMSFs (representing over 50% of the entire SMSF population) and almost 500,000 unique performance observations.

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