Graeme Colley

The end of the financial year is the time for SMSF trustees to focus on financial planning and strategy, particularly as it relates to superannuation.

SMSF Professionals’ Association of Australia (SPAA) Director Technical and Professional Standards, Graeme Colley, says there are various strategies to get the best outcome at 30 June, including making after-tax contributions, and, if aged 60 or above, using the higher tax deductible contributions or drawing down a lump sum.

“Making after-tax contributions to super, which could come from your personal savings, transferring personal investments or an inheritance, is one effective way to minimise tax.

“This financial year the maximum personal after-tax contribution is $150,000; however, if you are 65 or under you can contribute up to $450,000 over a three-year period.

“This allows you to make substantial contributions to super and build your retirement savings.  But remember. While this is a real bonus, it’s critical not exceed the after-tax contributions caps because there can be tax penalties as high as 46.5%.

“Remember, too, that from 1 July 2014, the after-tax contributions cap increases to $180,000. This means if you can trigger the bring-forward rule that a total of $540,000 can be contributed over the fixed three-year period.”

Colley says it’s important for anyone aged 60 and above to note that the maximum tax deductible contribution cap is $35,000.

“These contributions include amounts you make as salary sacrifice, the Superannuation Guarantee or, if you qualify, personal deductible contributions.  If you want to maximise your contributions before 30 June, make sure you talk to your accountant, tax agent or professional adviser so that your salary sacrifice agreement with your employer allows the maximum to be salary sacrificed.

“If you are 65 or older you will need to meet a work test to contribute to super in most cases.  You will need to work for at least 40 hours during 30 consecutive days at any time during the financial year to make tax deductible and non-deductible contributions to super.”

Colley says don’t forget that once you reach 60, all lump sums from all superannuation funds, with some exceptions for government funds, are tax free.

“However, before age 60 any lump sums that include a taxable component can be taxable.  The taxable component includes the tax deductible contributions plus any income that has accumulated in your superannuation benefit.  No tax is payable on taxable amounts of up to $180,000, in total, you receive before age 60.  This amount is indexed annually.

“If you are eligible to draw amounts from superannuation you may like to defer receiving the amount until after reaching age 60 or until a later financial year when you may end up paying a lower rate of tax.”

Finally, as the clock counts down to 30 June, make sure that you get the timing right to ensure:

• You maximise the tax benefits from contributions to superannuation;
• You make sure you meet the pension rules correctly;
• That income and deductions for your SMSF are made to the best advantage.

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The penalty must be paid by the trustees, with all trustees jointly and severally liable. The penalty cannot be paid using the assets of the SMSF and trustees cannot seek reimbursement from the fund.

The government supported the Stronger Super recommendation to impose administrative penalties against SMSF trustees on a sliding scale reflecting the seriousness of the breach.

This measure is part of the suite of Stronger Super measures to address potential risks and inconsistent burdens that exist under current law.

For more information, click here

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Australia’s life insurance gap has reduced over the last six years, according to a new report from Rice Warner Actuaries.

As at June 2010, the overall level of underinsurance is $669 bn to meet the subsistence needs of families and dependants after death, which compares with $1,000 bn in 2005 on a like for like basis – a reduction of 33 per cent over the six years.

On an income replacement basis, the level of life underinsurance is $3,073 bn. Meanwhile, for total and permanent disability (TPD), the level of underinsurance sits at $7,182 bn and income protection underinsurance at $437 bn.

Michael Rice, Managing Director and Head of Strategy of Rice Warner Actuaries, attributes this shift to significant demographic, financial and life insurance market changes over the past six years and in particular, an increased focus on personal financial risks post-global financial crisis.

“Increased levels of personal insurance have been driven by an increase of default cover within superannuation, a greater focus on risk insurance by financial advisers and superannuation fund trustees as well as the growing direct life insurance market,” said Mr. Rice.

However, while the report points to a welcome development in the face of Australia’s continuing underinsurance problem, Mr. Rice warns we’re not out of the woods yet.
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“While the market is now providing a substantial proportion of subsistence life insurance cover, this is still only half the amount of cover required to ensure that family members and dependents can maintain their standard of living after the death of a parent or partner,” explained Mr. Rice.
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“Apart from individual detriment, underinsurance also comes at a substantial cost to the government. Currently the total cost to the government of life underinsurance across Australia is calculated to be $140 million per year as publically-funded social security benefits fill the gap. Meanwhile the situation regarding disability underinsurance is even more serious, costing the government nearly 9 times this amount!”
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Mr. Rice believes there are things the government could do in the short term to remove glaring distortions and inequalities in the market in order solve this ever-present problem.
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“The underinsurance issue would benefit from the government considering the removal of stamp duty from all life, total and permanent disability (TPD) and income protection policies; removal of GST on TPD and income protection products sold by General Insurers; equalization of the tax treatment of risk insurance inside and outside superannuation; and implementation of the proposed ‘scaled advice’ model with a particular focus on risk insurance.
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“While the report proves the issue of underinsurance is still a significant one for the financial services industry and the government in Australia, it also reveals a positive step in the right direction.”

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Managing Director of The SMSF Academy, Aaron Dunn, said the topic was decided in response to continuing Australian Taxation Office (ATO) concerns about whether trustees and/or the professionals advising them, are correctly calculating and applying tax exemption on income generated by the fund, as members move from the accumulation fund to retirement.

“With an aging population and a focus on maximising tax exemption within SMSFs, it is critical that advisers have a better understanding of actuarial requirements and strategies to obtain fantastic outcomes for their clients,” Mr Dunn said.

The one-hour interactive webinar, which will run on Wednesday 22 June, 2011 from 12:30pm, will be co-hosted by Mr Dunn and Senior Actuary at Bendzulla Actuarial, Geoff Morley, who will discuss and provide examples on:

• Understanding the unsegregated method for SMSFs
• Common mistakes and tips when using the unsegregated method
• How segregation works within a SMSF

Time will also be made available at the end of the session for questions from the webinar audience, including discussing current ATO issues.
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Mr Dunn said he is delighted to be joined by someone of Mr Morley’s calibre.
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“Bendzulla Actuarial specialises in providing practical solutions for SMSF trustees and their professional advisers and has won every BRW Client Choice Award for Best Actuarial Firm since 2007,” he said. “Geoff is an acknowledged expert in his field and has over 19 years experience in actuarial consulting in Australia and the UK.”

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Russell Investments is calling on trustees and industry regulators to consider more than just current assets and membership when applying a “test of sufficient scale”. Russell suggests a scale test which incorporates assets, membership, growth, net investment performance and operating reserves. This follows the government’s support of the Cooper recommendation for fund trustees to assess whether they have sufficient scale to support a MySuper product. Many are expecting regulators to step in with scale requirements based on size of assets under management (AUM) leaving the industry divided as to what the requirement should be.

While Russell thinks size can bring cost efficiencies, looking at size alone could potentially close down some high performing funds. This could leave the market dominated by large funds or force unnecessary mergers.

“While we agree trustees should ensure they have the scale benefits to support a MySuper option, focusing purely on current size may cause the industry to lose some of its better performers, to the detriment of members, ” said Tony Miller, senior consultant for Russell Actuarial.

Mr Miller said that without careful consideration of the issues, many medium sized funds run the risk of falling below an arbitrarily selected size limit (depending on where it is drawn) but have other features which make them competitive and good value for money. For example they may know their members particularly well, have good cost structures and performance and can tailor services accordingly.

In addition, basing scale on size does not recognise new or growing funds. For example, a fund could potentially fail under size requirements even though its projected member growth means it could comfortably pass a size test in three or four years’ time.

“Not everybody values service quality to the same degree when it comes to rationalising on cost. Big does not always lead to better service quality and therefore better overall outcomes for members. The cost to a member of inappropriate, slow or poorly executed advice at a critical time may be more than all the cost efficiency gains of a larger fund,” he said.

He also suggests long term investment performance credited to members, net of fees, could also be objectively examined by trustees to ensure persistent good performance is adequately recognised.

Mr Miller also believes scale is about the capacity to absorb market shocks and meet future contingencies without drawing heavily on members, so also recommends fund specific liquidity and other tests around the ability to sustain a certain level of operating reserve.

Knowing your fund first

The expectation of ever increasing regulation has left funds considering how they will respond to this new set of challenges.

Mr Miller says that “before trustees become overly concerned about lack of scale we urge them to first examine what they really need by assessing a variety of factors including future growth potential, member retention levels, age demographics and liquidity as well as their objectives and relationship with their members.”

There are many aspects to “scale” and Mr Miller affirms what is already being seen – that for many funds there are alternatives to a merger such as outsourcing operating functions like administration to cut back on costs and arrangements to gain access to investment scale.

Last year Russell launched its Total Fund Evaluator, a comprehensive tool that allows a super fund to model future cash flows based on member movements including investment choice decisions and market conditions. Russell’s modelling tool allows a highly complex analysis ideally suited to providing much of the information needed by trustees to undertake a test of sufficient scale.

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The changes to the limited recourse borrowing rules for SMSFs apply to arrangements put in place on or after July 7, 2010 or to refinances of existing loans on or after 7 July.

Pre 7 July 2010, more than one asset could be acquired and assets did not have to be the same form or type in order to undertake a single limited recourse borrowing arrangement. For instance, a portfolio of
shares in different companies could be acquired under a single arrangement

“We believe the definition of a single acquirable asset may catch out SMSF members who are not aware of the legislative changes,” said Mr Burgess. “This is because the changes mean separate borrowing
arrangements must be in place for shares in different companies or even different classes of shares in one company, with compliance potentially messier than when dealing with property.”

The acquisition of real property on separate titles is also not permitted unless a separate borrowing arrangement is put in place for each title. For example, several residential units in the same apartment
complex with the same characteristics will need separate borrowing arrangements.

“The Australian Taxation Office (ATO) has recently advised that where assets are for practical purposes inseparable, or where there is an incidental ancillary asset of a very low value, the assets may be treated
as one asset. However, it is still unclear how this will be determined so SPAA believes advisers and trustees should proceed on the basis that each title represents a separate asset,” Mr Burgess said.

“The single acquirable asset rules have implications for advisers and trustees regarding the way in which assets can be acquired and the number of borrowing arrangements which may need to be put in place,”
he said.

Another contentious issue concerns improvements to properties for which limited recourse borrowing arrangements have been put in place after 7 July 2010. In essence, renovations or improvements are not
permitted as they may give rise to a different asset to the single acquirable asset that was the subject of the arrangement. Importantly, this would be the outcome regardless of the source of the funds used to
renovate or improve the asset.

“In the context of real property, the inability to improve the asset during the life of the loan is a significant issue and extreme care should be exercised where it is the intention of an SMSF trustee to alter a
property acquired under a limited recourse borrowing arrangement,” Mr Burgess said.

If the property is improved, the limited recourse borrowing arrangement will have to cease and the improved property transferred to a new borrowing arrangement. In situations where it is the intention of
SMSF trustees to improve a business real property, Mr Burgess said the parties could consider an agreement with the vendor to do this before the SMSF purchases it and consider adding this to the sale
price of the property.

“The rules which apply to a limited recourse borrowing arrangement put in place on or after 7 July 2010 are much more restrictive than the previous rules which applied to arrangements put in place prior to 7
July 2010. Trustees looking to use the limited recourse borrowing rules should seek sound advice from a SPAA Specialist Adviser to fully understand the opportunities and the risks involved,” Mr Burgess said.

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A Discussion Paper Presented to Minister Bill Shorten

1.1    The objective of this paper is to highlight some issues that exist in the Australian financial services industry that may not get raised by the Institutional and Industry Fund sectors but deserve serious consideration.

1.2    BASIC ASSUMPTION – The Government wants a healthy independently owned sector to maintain balance and choice for consumers with advice and product. The only other option is an industry totally dominated by the Banks, Life Offices [Institutions] and Industry Funds. The independent advice market represents approximately 15% and currently contracting due to Institutional purchasing activity and day to day operational difficulties smaller practice principals are facing. It is common for the smaller groups to sell/join the larger national independent groups who are then selling to the Institutions.

2.1    LOSS LEADING BUSINESS MODELS – The Institutions own or directly influence over 83% of the advisers in the market. The far majority of these institutionally owned practices operate at a significant annual loss whereas the independently owned sector must prove solvency to ASIC to maintain their AFSL. The Institutionally owned practices are permitted to ‘hide’ these annual losses in the balance sheet of their parent company and subside their practices with the embedded profits the Institutions make on the book of business accumulated in their wealth division [from the activity of the practice].

2.2    Essentially, the Institutional practice is a ‘funnel’ for client monies into their wealth division, they are permitted to operate at a loss and the wealth division profits subsidise the advice delivery. The ratio is around 10 to 1 i.e. for every $10 million the institutionally owned practice loses on advice they make $100 million on the embedded profits in the wealth division on the book of business the practice has delivered.

2.3    We have raised this matter with ASIC some time ago, they acknowledged its existence, dismissed it as irrelevant and declared ‘we must cater for all business models’.

2.4     Industry Funds are also operating unprofitable advice practices but are subsidising the practices out of general revenue from other profit centres within their platform business model.

3.1     FOFA REBATE PROPOSAL – The AIOFP agrees that commissions from investment products should be eliminated from the market but however contend that platform rebates/dividends should be treated differently.  A Platform is an administration service that reports to its members, it is not a managed fund or similar. Consumers do not invest into a platform [like they do with a managed fund] they are charged a fee to use the platform to deliver a reporting service back to them. Industry Super Funds are also a platform with similar functionality and service to their members. It could be argued that all Industry Fund members pay for a loss leading advice function that only a fraction use.

3.2    Like Institutions and Industry Funds, Independents want to also use platform profit margins to subsidise advice delivery. Platform profits are a critical revenue source to the survival of the independent sector.

3.3    This begs the most obvious question – why can’t independents operate the same business model as the Institutions and Industry Funds with their white label and private label manufacturing platform models? This strategy allows the independents to use their scale with the Platform providers to get an institutional fee structure that delivers superior pricing to the consumer and a margin/dividend to the independent practice shareholder to subsidise advice delivery.

4.1   TRANSPARENCY IN ADVERTISING – Pre 2005, institutionally owned practices had to clearly demonstrate on all business cards, advertising and paperwork who owned the license they are operating under.  This gave consumers upfront clarity on who they were dealing with and the likely direction of the advice.

4.2    Since 2005 this ‘mysteriously’ changed with Institutionally aligned advisers being allowed to masquerade as an ‘independent’ with no indication on any advertising who they are licensed to. They now only have to divulge their ownership in the FSG during the first client interview. At this point the ownership issue is used as a ‘comfort’ strategy after the adviser’s ‘sales pitch’  and all the clients monies would commonly be channelled in one direction. We raised this issue with Nick Sherry in 2007 who demonstrated genuine surprise the practice had changed.

4.3    Successive Government’s over the years have insisted on transparency as a key     plank in the quest for a professional industry, this is a very fundamental function that has escaped scrutiny.

5.1    INDEPENDENT TRUSTEE/RE ROLE WITH ADMINISTRATION/FUNDS MANAGEMENT – During the 1980/90’s this role was exclusively with the independent trustee sector, the Institutions have now taken control of the functions in house with staff and paid ‘professionals’ on the trustee  committee. Considering the function is largely a supervisory role ensuring that the administrator/custodian/fund manager is adhering to all laws and acting in the best interests of the clients/members, surely this should be performed by an APRA approved third party to avoid conflicts.

5.2    The institutions also treat it as a healthy profit centre charging clients around 12 basis points whereas the cost from the independent trustee sector can be as low as 4 basis points. A change in policy will provide consumers with lower costs and integrity in the process.

6.1    CONFLICTED RESEARCH HOUSE BUSINESS MODELS – Research is the most important function in a practice, it is fruitless to have the best staff, practice, administration and have a flawed approved product list. The practice is therefore an accident waiting to happen.

6.2    The industry largely relies upon Research House ratings to assist their client recommendations. Most advisers do not have the time, expertise or resources to perform the task personally or internally. Over the past 25 years it     has become acceptable in Australia for product manufacturers to pay research houses to rate their products. This profoundly conflicted process has been blamed for a number of second tier product manufacturers ‘buying’ favourable ratings to give them legitimacy with the market. Basis Capital, Westpoint, Great Southern, Timbercorp, Astarra and Willmotts are only a few examples of groups     that purchased a rating and ended in catastrophe.

6.3    If the Government is serious about protecting consumer assets this culture has to be eliminated. Elimination of conflicted research practises will lead to an elimination of “dodgy” product manufacturers from the market.

6.4    Product failure is by the far the greatest cost for consumers with in excess of $6 billion being lost over the past 5 years. The attached article (fig. 1) demonstrates that US Congress has finally dealt with the matter.

6.5     The major issues affecting the research industry are too many operators in the market, insufficient revenue and larger practices negotiating group discounted deals further diluting the revenue pool.

6.6    The Research Houses have become the ‘gate keepers’ in the industry with advisers needing a rating and product manufacturer’s needing inflows. These ingredients have lead to a conflicted dubious environment where inexplicable ratings have been ‘shopped’ around and paid for, leaving clients and advisers the victims.

6.7    Our suggestions are each adviser is levied a fee, the pool is managed by ASIC with 2-4 Research Houses tendering for revenue to deliver advice to advisers and  paying for ratings legislated against. The other option is self regulation by boycotting those who accept conflicted payments. There are only 2 conflict free retail Research Houses in the market, Mercer and McGregor the other 8 accept conflicted payments of varying descriptions.

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Many of these, however, who do not obtain specialist advice, remain unaware of the potential tax implications and penalties that may be incurred.

Analysis undertaken by Perpetual Private Clients and Capital 360 estimates that approximately 15 percent (or around $34.2 billion) of SMSF’s existing allocation to cash and shares will be redeemed to acquire property over the next few years.

With this in mind, Perpetual Private Clients and Capital 360 are holding education workshops to help investors understand the legislative requirements and portfolio considerations of gearing to invest.

Mr Chris Balalovski, senior manager strategic advice at Perpetual Private Clients, says that they have seen a noticeable rise in the number of clients seeking advice and strategic guidance on borrowing arrangements in SMSFs.

“With recent legislative changes, more SMSF trustees are considering borrowing to invest in property. However, putting the right strategy and structure in place is a complex process, so trustees need to ensure they understand the legislative and compliance requirements.

“Firstly, it must be established that the trust deed allows a borrowing. The strict rules then state that the borrowing must be in line with the fund’s investment strategy and take into account the future financial needs of all members. Failure to do so may result in a fund becoming non-complying and losing its tax concessions. It’s also important for trustees with existing arrangements to have their deed reviewed to ensure they comply.

“When people seek our guidance, we find the most commonly neglected elements are the nature of the holding trust (which has the custody over the property) and the details of the loan documentation. The result of this could mean unexpected stamp duty and capital gains tax liabilities,” Mr Balalovski said.

Mr Sean Preece, executive director of Capital 360, said that trustees should also take into account the time to retirement and income requirements of their members in order to find the right property for the fund to invest in.

“Investors in property need to take the same analytical, unemotional approach to their property purchase as they do to any other asset class, such as shares or bonds to ensure they achieve the right mix of diversification, return and capital growth in their property investment.

“It is worthwhile taking the time and effort to get it right, as historically residential property has delivered solid, reliable returns over the medium to long term, and can add significant value to an investment portfolio,” Mr Preece said.

The workshops will be held in Sydney on Saturday 30 October 2010 and Melbourne on Saturday 13 November 2010. For more information, or to register, visit www.capital360.com.au/perpetual.

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