On 9 May, Treasurer Scott Morrison delivered his second federal budget, which contained two new measures impacting on superannuation – the ability for Australians over the age of 65 to contribute $300,000 into their super fund from the proceeds of downsizing their home regardless of their transfer balance cap status, and the First Home Super Saver Scheme. The industry was thankful there were no other items affecting SMSFs as it was still busy dealing with the raft of changes handed down the previous year. Darin Tyson-Chan and Krystine Lumanta hosted the fifth annual selfmanagedsuper SMSF Roundtable to unpack what the new changes mean and to hear how the implementation of the 2016 super reforms has been progressing.
Graeme Colley (GC): SuperConcepts technical and private wealth executive manager.
Craig Day (CD): Colonial First State FirstTech executive manager.
Gavin Fernando (GF): Prosperity Wealth Advisers director and authorised representative.
Andrew Yee (AY): HLB Mann Judd superannuation director.
Darin Tyson-Chan (DTC): selfmanagedsuper editor.
Krystine Lumanta (KL): selfmanagedsuper deputy editor.
DTC: Welcome to the 2017 SMSF Roundtable. Now we are past 1 July, what areas or issues should advisers and their clients really start to prioritise in the new super environment?
CD: If you look at what people need to start thinking about pretty much after 1 July, it’s looking back at those transfer balance accounts. We know we’ve had to commute out the amount of the excess up until 1 July or before 1 July. Now depending on how you’ve set that up, we know that within SMSFs we’ll be able to put in place an instruction or have been able to put in place an instruction. Ours is to commute back to $1.6 million, but that will then depend on the valuation of the assets. Depending on how you set up, if you’ve got other assets as well, you may need to keep coming back to look at those values. If you do end up with a balance slightly over $1.6 million, then it will require following through and commuting out those excess amounts within the following six months to ensure you don’t get an excess transfer balance tax assessment. Obviously that’s under the transitional rules for excess of $100,000.
The other thing probably worth talking about for financial advisers is coming back to review things like salary sacrifice arrangements. So if they’re up and over $25,000, it means bringing them back down to $25,000. An important one will also be looking at your transition-to-retirement (TTR) pensions early on. You may have clients that have looked to optimise a transition of time and strategy where they’re still working and salary sacrificing. Now if they’ve done that, then what they may now need to do is actually think about what they’re going to do with that TTR balance going forward, because at the moment, taking into account the minimum drawdown requirements, they may have, post-1 July, no ability to salary sacrifice over and above $25,000. So they’re actually going to be generating too much income. It’s about reviewing that balance so that may involve a commutation to bring it back down to allow you to neutralise your income levels or equalise your income stream levels.
Another strategy may be to continue to receive those income payments and then put them back in as a non-concessional contribution (NCC) or actually contribute them through to your spouse if your spouse has a lower balance so you can equalise things. They’re some of the things that we’re talking to advisers about at the moment. Then the transitional capital gains tax (CGT) relief moving forward.
DTC: Gavin, being an adviser, are those the sort of issues you’ll be looking at post-1 July?
GF: Yes, quite a number of those. The other one that’s popping up is estate planning generally because of the changes around pensions from 1 July. There’s been more importance placed on a husband and wife to have equal super balances these days so we’re looking more and more into strategies around superannuation splitting and spouse contributions.
AY: Michael Hutton is the partner in charge of wealth management at HLB Mann Judd and estate planning is one of his bugbears and how unfair the new system is. We’re definitely looking across our client base on how current things fall between husband and wife in the same SMSF, whether they’ve nominated each other as death benefit beneficiaries, and if they have, are they reversionary pensions, or is it in a binding death nomination and so forth. So that’s a large focus for our firm, not just within the superannuation area, but also the overall estate planning of the client and super forms a large part of that under these reforms. That’s going to make a greater difference to us in terms of playing around with the $1.6 million cap and whether you can move it or use a reversionary pension. Is it a strategy that should be for all clients? There’s going to be a lot of work there, but there’s a lot to get through before we get to that stage.
DTC: We’re still seeing tinkering around the rules, such as the change to the treatment of death benefits with the timing issue there. Does that make it difficult to plan anything when the parameters are still being defined?
GC: There are a lot of unknowns about it and I think the estate planning aspects take it outside super because you’re not only looking at the individual circumstances within the fund, but you’re also thinking about what’s the impact upon their taxable income and whether they’ll take money out of the fund and give that to their kids. The actual commutation issues of those pensions, whether they’ll commute them or if they can commute them in some cases, there are issues there too. But the unknowns I think come out of the CGT reset and getting down to that $1.6 million with the transfer balance cap, because you’ll need to know which pension to commute if you need to do that. Because there are a whole range of moving factors there, it’s really hard to predict how people are going to react to them.
DTC: Dealing with clients face-to-face, from an estate planning perspective, are they aware there are some rules where super money has to be exited from the system?
GF: It’s something I’d say that our clients are not really aware of. What’s prominent in their minds and in the media is the $1.6 million transfer balance cap, so I guess it’s flown under the radar a little bit, not in the advisory community, but in the community generally about the impacts of the death benefit pension changes. But it creates a good opportunity for advice through having a conversation with the client and actually discuss in the planning whether super longer term is necessarily where we want the death benefit to go or whether we need to take the death benefit payment out. But typically they just assume they can keep the money in super on the death of a member and survival of the other. They’re very surprised that’s not the case. AY: I’d add that they’re not exactly aware that death benefits can’t stay in the fund as they currently can. So when they’re made aware of that situation they get quite worried especially if the spouse in the SMSF is not really active in the management of the fund. If this money has to come out of the fund, they’re not sure what to do with it or where the best place to put it might be. Do I give it to the kids? Will they come asking about this money?
KL: Looking at this year’s budget now, one of the measures announced was the First Home Super Saver Scheme. How effective do you think it’s going to be?
GC: Our policy is that we, as an organisation, don’t agree with it simply because you’re starting to mix different policies of government, that is, you’ve got the ageing policy mixed with retirement income policy. Once you start doing that it skews things. CD: Admittedly it’s got to get through Parliament before it becomes law. So if it does get through, the interesting thing we see about the First Home Super Saver Scheme is that whether or not it actually achieves the objective of allowing people to buy houses. One thing it certainly will do is that it will engage a lot more young people with their superannuation where they may otherwise be completely disengaged. At the moment if you’re looking at someone in their early 20s, superannuation is just a word they’ve heard that they don’t really engage with and also retirement is a long way away. Whereas what this measure will potentially do for a certain number of millennials or people looking to save to buy a house is bring super in as a consideration of a way to save.
The process the government has proposed is reasonably simple. It’s not as complex as those initial First Home Super Saver Accounts that we used to have. You’re just dealing with concessional or non-concessional contributions. There’s a maximum amount which has got to be over and above the super guarantee amount. There’s a bit more detail to be worked through in terms of how amounts are released to ensure the money can come out in time to allow you to settle or buy at auction. But I think the interesting thing there is it now brings superannuation into the realm of something to think about when you’re looking to buy a home, so it actually gives it another purpose for a group of people who would otherwise be completely disengaged.
GF: I think that’s a fair comment. I’m not sure whether it will achieve the policy objective, but in another part of our business we run the salary packaging administration for two of the local area health services, so a number of doctors, nurses, janitors, et cetera. We’ve been getting a lot of queries on this very measure: the First Home Super Savers Scheme. I think the point is that it’s engaging people with their super. Whether it achieves its objective I’m not sure. A side effect might be that it gets people engaged and understand a little bit more about superannuation and that’s a good thing. With caps becoming smaller and smaller, and the budget deficit measures, it means super is something that has got to be tackled now and in the future, so it’s far better to have people engaged with their super sooner in life rather than later.
CD: I think too it could get people to focus on super itself around things like what they’re paying for it, understanding if that’s the best place to save, if it’s maybe not the best fund to be in, or if they think their fund is too expensive. And that has a knock-on implication 40 years down the track, that is, you’ve got a bit more to retire on. That’s a positive.
GC: You don’t think it could have been done in another way through some sort of savings scheme such as a 401K-type plan like in the United States?
CD: That’s where we went to initially with those First Home Super Saver Accounts and when you looked at the concessions available under that scheme, they were much more generous than what’s been proposed under this new scheme yet it did not prove popular at all because it was just too complex. The potential benefit of the new scheme is it’s leveraging an existing system that will require minimal implementation, maybe a bit of administration from the ATO rather than having to build a whole new set of accounts or a whole new structure, and whether or not the providers would even be interested in doing that, given the poor track record of the previous scheme.
GF: One point about the strategy itself to be cautious about when saving for their first home is that I’m not sure what the implications are if you start aggressively saving through super for your first home and then life takes a different course. You may need the money for something else like medical expenses because of where life may have taken you. If you’ve preserved your funds in super, you won’t meet a condition of release. I haven’t heard anything more about that so, again, I just caution people to make sure that even if it does look like a good way to save some more money for a first home, that this is definitely what’s going to transpire.
CD: It is a potential issue that may turn some people off – if they don’t end up actually using those funds to buy a first home, they might be locked until retirement, so that would be something people would need to take into account. Some people may simply say, “I don’t want to take that risk.”
AY: From my preliminary inquiry seeking opinions from the younger staff in our firm, they don’t seem to like it. They think it’s a bit cumbersome and the way they’re delivering this policy is just too unwieldy. So I don’t know if it’s got any legs to go forward. It might end up the same way as the other scheme. They just can’t see how you can mix superannuation with buying your first home, and then how you’re going to get that money out to go to an auction and bid for your first home. How does that all work? They just see it involving too many steps.
KL: What about looking at the scheme from the perspective of SMSFs? Should SMSFs avoid these sorts of arrangements because of other considerations and risks, such as opening up the fund to family law courts?
CD: I don’t think you want to use SMSFs for something like this. Your average fund is made up of mum and dad and they might have young kids. Using an SMSF for these types of contributions, it obviously involves bringing the child in as a member of the fund and therefore a whole lot of other issues in doing that. Potentially there are issues with the divorce side of things. But if you do have a younger member of the family getting married, then going through a divorce and ending up not actually buying a house, then yes, there may be some super-splitting issues. These types of schemes are probably better for the types of funds where young people are setting out on saving for retirement – that’s where most of the action will be happening here. I can’t really see that people would want to use it inside an SMSF. The simple fact that it involves bringing a younger member into the fund and having trustee obligations, it may not be appropriate. GC: Although we are seeing younger people come into SMSFs; they’re 40-plus.
KL: With the deemed return rate on that money of 4.78 per cent, wouldn’t then SMSFs be the only appropriate vehicles to participate in it, seeing that a lot of big funds probably won’t guarantee that return?
CD: There needs to be an understanding of what that 4.78 per cent return is. It’s not actually the real investment return to the fund. What the proposal says is that you’ll make these initial contributions, so it is $15,000 a year up to a maximum of $30,000 total and then that amount will be able to be released back to the member to buy their first home. Now they’re then saying the amount that can be released will be indexed by 4.78 per cent with a little shortfall interest charge rate going forward, so it’s not necessarily return-dependent. It’s actually just the amount you’ve got in. If it’s $30,000 over two years, that amount will continue to appreciate. The amount that you can release will continue to appreciate at that deemed interest rate and that’s completely separate of the return to the fund. So the return to the fund could actually be negative if we go through a downturn. That amount would still be able to be released, including the increased amount, so it’s not actually the investment return you’re looking at, it’s the calculation of the release amount that’s relevant.
DTC: If the return is negative though, the contributed amount plus the deemed appreciation is still going to have to come from somewhere.
CD: So if you put in $30,000 and if that’s been funded with concessional contributions, then you’re taking off the tax, and let’s say you end up with an amount that can be released, say $33,000, and it’s been there for a couple of years. If those contributions are actually now worth less than $33,000 taking into account investment return, then obviously in that situation you’re dipping into the capital of the fund. It’s not just the funding of those contributions that can be released. So yes, you’re right. AY: Would you have to set up a reserve?
CD: No, they’re saying that those amounts could come out of that member’s balance. So as long as they’ve got other balances there it would then start dipping into their accumulated amounts over and above what they’ve put in. But I suppose taking into account the tax rate coming out, remember if we’re putting in let’s say $10,000 worth of superannuation guarantee, that’s going to be an amount of $8500. You’re going to have to see quite a significant reduction in the member’s account balance before you’d actually start digging into the account, taking tax and other issues into consideration.
AY: But if the member’s account is less than the amount they can take out, that will have to come from somewhere else?
CD: Would it be taken from the other members? I suppose we’d have to wait and see that detail, but the release amount would have to be restricted to the maximum of the member’s account, so as long as they had other contributions in there.
GF: We haven’t given any advice to clients to do this yet, but I think if we were to do so, if this proposal gets up, it would probably be presented as contributing money for the purpose of ultimately withdrawing for a first home deposit. We’re probably looking at, over time, transitioning the asset allocation with more emphasis on defensive elements and even cash towards the end allocation amounts which we were going to withdraw. That doesn’t mean the whole fund is in cash, but it means the amount of money that we want to get at is not subject to as much volatility as the other. Does that mean that the funds are protected? Well no, there’s still a diminution in value, but we’re not selling any of those diminution values assets to pay out the benefit. I think it’s probably somewhere around there that we’d sort of work with. Drawing a line through previous comments you probably wouldn’t want to start saving in isolation for that very reason. If there’s a diminution in value, you might struggle with it anyway.
KL: From a practical perspective for someone who wants to participate in this sort of scheme, would you recommend that a second bank account or something else be set up?
GC: You could certainly do that if you’re going to use an SMSF, but I think with some of the comments here it’s going to be difficult no matter what type of fund you’ve got, whether it’s big or small, and if you do want to do that. There’s nothing wrong with setting up a second bank account within an SMSF and calling that your home deposit account. Some clients do like to slice and dice their funds in a whole range of ways. CD: From a large fund perspective, we’ve had a look at this, and in terms of the increased exposure to cash we might need to hold compared to the amount of rollovers that we’re doing on a daily basis, the extra cash that this would require is just not significant in any meaningful sense. So from our perspective they would look at this and say there is no requirement for us to, in any way, modify our investment strategy or asset allocation to cash because we’re already holding a certain amount of cash to fund rollovers, and this would be a very, very small kind of figure on top of that, so we would not increase our cash holding. In terms of an SMSF, once again that’s probably one of the reasons why this may not be appropriate if, all of a sudden, you’ve got a requirement to pull out maybe up to a maximum of $30,000 and you don’t have that amount of cash sitting in the bank account, that’s going to have to require the sale of assets and a consideration of whether that’s appropriate for the fund. It’s another deliberation for whether we want one of these things sitting inside the SMSF.
GC: You might need to withdraw in cash too. Would you withdraw it in-specie? The answer’s probably not because you need it for that deposit don’t you? I’m sure people will give that a go.
CD: Have you ever showed up with some BHP shares to buy a house?
KL: Another 2017 budget measure was downsizing the family home to get an additional $300,000 NCC top-up in super for those over age 65. Was this change a good idea?
GC: For us, we’ve had more inquiry about that from people who are 75 and older than we had about the home deposit announcement. They’re asking, “How much can I take out? What can I do with it?” We don’t know the detail of that at the moment. I think there are a lot of definitional issues around it because what does downsizing mean? It seems to be that it’s just the sale of a house. Someone put it to me as, “Well I’ve got rental properties. Is that downsizing of a house too if I sell them?” I’d say no, but once the definitions come out we can make some decisions as to whether it’s appropriate.
CD: They could put something like that in there, but in thinking about the rules around it, I can’t even begin to imagine how you would specify that or require it. To put something like that in the conditions obviously requires a whole lot of administration that comes at a cost. So I’d say more than likely downsizing is just the word they’ve used and it will relate to the sale of the principal home that you’ve held for more than 10 years. Once again, we’ll have to wait and see the legislation.
KL: Could the definition mean the measure will end up being quite restrictive?
GC: I don’t think it will be restrictive. If you’re going to downsize, what does that mean? Do you go from a three to a two-bedroom place, or do you go from a flat to a larger place that’s cheaper? There are all those variables with it, so it would be relatively flexible, but it may have some definition. It might be restricted to your principal residence, those sorts of things. What happens if you’re on a farm and you decide to sell the farm? Would that fall into the definition of downsizing your residence, particularly where it’s all on one block, because usually that’s the case with many rural properties. So that may be something you need to consider as well.
CD: The other thing here, for anyone who might be interested in using these new rules should they make it through, is that while there are concessions around being able to get the money in, being $300,000 per person, there’s no corresponding concession from the assets test. So anyone that’s receiving a means-tested age pension, I doubt that this would cause them to go and sell their house to go into a smaller house with the intention of putting the difference in super, because what they’re essentially doing there is taking a non-assessable asset and converting at least part of it into an assessable asset. I don’t think you’ll see people jumping at it for that purpose. Being in that sort of situation comes back to those people that either need to or have to sell their house, so then it’s an option for them to consider.
So then you’re looking at the tax situation. Those clients may be no worse off actually continuing to hold those assets in their own hand because these days with the senior pensioner tax offset, the low tax threshold, you can actually hold a lot of assets in your own name, assuming you’re not earning any income, employment income and still not paying any tax anyway. I suppose in that situation for those people it might be convenient just to put it into super so they can commence a pension and it’s simple and easy. I can see it being considered from that perspective. Therefore it kind of does then leave us with those self-funded retirees. But once again it becomes a tax consideration. If I go and put it into super, can I get it in pension phase and am I getting a tax benefit from that? Otherwise I might be putting it into super and if I’ve already used my transfer balance cap, then I’m paying 15 per cent on it. What tax rate am I going to be charged if I hold it outside super? So it kind of did sound interesting on the night of the budget, but when we began to slice and dice it, the conclusion was you may end with quite a small group of people being interested in using it.
GC: I think that’s where we’ve had inquiries, from those that are 75 and above, because they can’t contribute into super anymore. But there’s a risk associated with that for the time that money may be in the fund in any case.
CD: But also will you get a benefit out of it? Will it actually result in a reduced tax rate for you? It may not.
AY: There may be some people who haven’t been in the super system, they’re over 65, they don’t work, they could be 90. This is an opportunity to put some money into the super system and receive a tax benefit, so there are those people out there.
GF: Drawing a line through that, the legal policy objective for housing was to release and encourage the release of more stock. It might end up being an interesting option for some that might otherwise, for some other reason, find themselves in the situation of potentially having to sell their house, rather than being a trigger for some people who weren’t thinking about it.
DTC: If the objective is to release more property, would it be so restrictive as to say that downsizing only counts when you sell the home and move into an aged-care facility? Otherwise won’t it just mean further competition in the property market?
GC: They’re trying to get out of their property at the same time that people are trying to get in. And they’d want the same property as the first-time buyers, so yes.
DTC: It would appear that this measure itself is to try and address the supply issue, so unless they do make it more restrictive, won’t it be irrelevant?
CD: I suppose it just comes back to the cost of that restriction. If you are going to really lock it in and prescribe what you can go and buy, then there’s a whole level of compliance that sits on top of that to say, well we’re only giving you that on the basis you can prove to us that you’ve actually gone and bought something smaller. So then you’re engaging people to actually go through that whole process, sign everything off and how costly is that? Does the government want to engage in it or do they just basically allow you to sell your property in the hope that you are potentially going to an aged-care facility?
GC: The policy in the budget certainly doesn’t indicate that type of limit on it as to categorise it. It seems a little bit contrary to aged-care policy because aged-care policy is to keep people in their homes, so what do you want to do? Push them into aged care, give them the $300,000 in super? I don’t think so.
KL: Do you think the allowance needed to go further than $300,000 from the sale proceeds to actually have an impact?
GF: That may have worked. It may be more of an incentive. It’s not a policy I’ve seen clients coming forward to say, “I will now sell my home.” I don’t think even that was going to trigger them to do so.
AY: It might be just a benefit of people selling their home in the normal course of life and this is an extra handout from the government that you can take advantage of rather than the other way round.
DTC: Moving onto limited recourse borrowing arrangements (LRBA), there was an announcement that the treatment is going to change as far as the application towards the transfer balance cap and the slight tweaking since then. What did you think about that?
GC: Well our first reaction to the announcement was: “What was that?” We were trying to work it out because we hadn’t heard it mentioned before anywhere. It was so out of the blue. Then we saw credits being treated as debits and vice versa, which was difficult to appreciate because I’m an accountant and that confuses me. Then we saw that we’re only really talking about segregated funds and we’ll have another look at unsegregated funds at some later stage because it’s about value shifting from accumulation to pension phase. That is difficult to appreciate as well because if you’ve got an unsegregated fund, you don’t shift, everything stays still and you just re-proportion the fund. So they are our thoughts on it. It’s very unusual as to why it came out of the blue like that and it seems it hasn’t resolved itself.
CD: I agree with Graeme. When that was first announced we were really scratching our heads to say: “Where has this come from?” I’d never heard of anyone implementing any sort of strategy that came close to it. The other issue is, when we looked at the rules when they came through, I just don’t see the requirement for these rules because there are prohibitions on doing this anyway. I mean what you’re essentially doing is taking a return that belongs to an accumulation member and you’re crediting essentially to the pension member’s account by paying an expense that relates exclusively to the pension member. Now from my understanding, there are requirements in the Superannuation Industry (Supervision) Regulations to treat expenses on a fair and reasonable basis, which means you allocate them to the account or interest that it relates to. There are also minimum benefit standards which would prevent you from taking any sort of money that belongs to an accumulation member and crediting it across to, in any way or fashion or form, to a pension member. So from my perspective you couldn’t do what they were suggesting anyway, but they’ve created some laws to stop you doing what you couldn’t do. That’s where I was really scratching my head with it.
AY: I think it’s part of a broader policy shift to reduce or totally get rid of LRBAs in SMSFs. We were surprised about the announcement, so it’s probably part of that movement to take borrowing out of super. I suspect it’s coming from the non-SMSF sector, but I don’t know.
GF: As well as the implications on the debits/credits for the transfer balance cap, the interplay between the valuation of the gross assets and your ability to contribute, I think that’s particularly punitive where you’ve got a reasonably significant borrowing inside in the fund. Maybe several months or years ago it was predicated on the fact that you would continue to contribute at some level, whether it’s at $180,000 a year or $100,000 or even $50,000 for that matter, but if your ability to put non-concessionals is, just with the stroke of a pen, wiped out, that puts some super fund trustees in a very difficult position where they’ve got existing borrowings. It ties their hands behind their back in terms of what options they’ve got.
DTC: Has there been enough consideration as to those sorts of implications?
GC: There didn’t seem to be a great deal of community consultation on it. And most of us have got contacts that are pretty close to the fires.
CD: Reading between the lines, what it’s really saying to us is that come 1 July – including that provision as well as the provisions announced in the 2007 budget around focusing on expenses related to the non-arm’s-length arrangements – what the government are really saying here is we’re going to be focusing in on these thresholds. They don’t really want to see any strategy or mucking around or people playing games to try and squeeze themselves under and reduce or compress an amount to get them under these caps. I think the message is loud and clear: those rules are there for a reason and the government doesn’t want people playing around or want people playing games with them. Whether this particular requirement or proposal was required around the limited recourse borrowing, the credits for those pension payments, whether it’s gearing, whether it was required or not, I don’t know. But what it does say is clearly that they’re not going to be tolerating any games with the caps and people implementing strategies to get around them.
DTC: To Andrew’s point and if you have a look at the history, is there some sort of strategy by stealth to try and make LRBAs so unattractive, instead of outright banning them, that you’re not going to consider them in reality?
GF: If it is a strategy, it’s working. We’ve been seeing clients who were initially interested in the concept of borrowing within super, but then when we raise all that needs to be done to comply with that strategy, just the compliance aspects themselves let alone any of these new rules, there has been a watered-down desire to proceed.
AY: I think mixed in with this is maybe the government seeing younger people setting up SMSFs and then borrowing to buy a property, and potentially being sold properties by property promoters and spruikers – these are the things going on in the mix and tainting the whole LRBA concept.
GC: But if that was the case, we would have seen massive increases in the percentages put into LRBAs, and we didn’t. It’s gone up to around about 3 per cent of total assets in SMSFs, let alone in super. The bigger superannuation funds do it and can get away with it quite nicely. If it went up to 5 per cent or 10 per cent, you’d really get worried and probably would want to put a stop to it because it would be starting to skew the whole investment process. But 3 per cent in any portfolio is not a high degree of risk.
DTC: The shadow treasurer, Chris Bowen, made a statement to say that he’s looking at banning LRBAs because it’s allowing SMSFs to overheat the housing market again. Is this hysteria also playing into the demonisation of these types of strategies?
GC: It could be. You’ve only got to look back a few years when the Reserve Bank of Australia came out and made statements about it, which is very surprising because they’re very conservative and they look at it on a very broad economic point of view. Yet they made statements specifically directed at SMSFs and property investment. So there’s a hidden agenda here, we think, maybe to make LRBAs a little bit more unattractive by fiddling around with it, making it confusing and putting these rules in to make it relatively unattractive.
AY: But if it’s only 3 per cent of the SMSF market, then why is there all this movement to make it so unsavoury?
GC: I did some calculations on this and if you added up all of the residential properties purchased via an LRBA, it wouldn’t even amount to one suburb in Sydney, so that doesn’t change Australia’s attitude toward real estate surely. That doesn’t put enough pressure on the market to change prices. It ignores the use of commercial property and I know from some things I’ve seen that around about two-thirds of many LRBA portfolios looked after by some administrators, not necessarily us, was all in commercial property because there are good tax reasons for putting commercial property in the superannuation fund, far better than residential.
DTC: The ATO has officially said it doesn’t like two-fund strategies, one for accumulation phase and a spare one for pension phase, as it may create some Part IVA problems and tax avoidance concerns. How different is it if you separate it into two funds, as opposed to still doing the same thing but just having two phases within one fund?
GC: This is going to have to be on a specific set of circumstances. It’s going to be highly tuned for that too because you can use industry funds or retail superannuation funds and do exactly the same thing. You need to identify what that scheme is and I think people like to say this is a scheme or it’s in breach of the sole purpose test, but they don’t really understand what’s required to prove that there’s a scheme or that it is a breach to the sole purpose. So what is the scheme in splitting a fund? Is there any more tax payable by doing it in that way or is there any less tax payable? And a whole range of things about purpose need to be considered. It’s going to be a tough one for the commissioner to prove.
CD: There may be very, very valid reasons to have more than one SMSF. You just need to look at the recent court cases around estate planning where you’ve got blended families and you may simply decide you’re quite happy to have an SMSF with your current wife, but I’m going to have a separate SMSF with benefits going to the children from your previous relationship. It would be really disappointing to see those kinds of legitimate arrangements being attacked on the basis that there was some implied tax benefit coming through. You need to understand that there are reasons why people may wish to have two or more SMSFs that aren’t necessarily specifically around tax.
Also to Graeme’s final point under the pre-1 July rules, a fund could have segregated accounts: it could have an accumulation account and pension account, and the interesting thing is once you sit down and do an analysis of it, you might get a tax benefit out of using a segregated method. But that’s a tax benefit based on a different level of income coming through because you segregated different types of assets, then comparing that with a proportional approach and figuring out what the tax difference was based on the 15 per cent tax rate. In a lot of circumstances yes, you might get a benefit out of using a segregated method, but it’s very small and completely balked by the additional tax or expenses that the accountant’s going to apply to the fund just to run two different segregated pools for you.
I think the same thing here would potentially apply. You may have funds that may get a really significant tax benefit out of doing that, but at the end of the day a lot of funds will look at this and consider the cost of running a second SMSF and say there might be a tax benefit in it, but it’s pretty marginal or it’s wiped out by the cost of running that second fund. There might be a lot of hot air, but we’ll wait and see what happens.
GC: I agree. There’s one case I’ve got where we ended up splitting a fund into three funds and you might think, why did you do that? Well they were such segregated people, these two couples wrote their name on every cent that went into the fund. You end up saying, “oh thank goodness they’ve split the fund up”. It’s certainly not for tax avoidance. It’s for our peace of mind. But I have seen a couple where what they’re doing is isolating particular assets to what they call their pension fund or their accumulation fund because they’re speculating on the value of that investment within a relatively short period, and they’re saying this thing will go from $1 to god knows what in three years. Okay, well you may as well go to the horses on that one.
AY: Is that tax avoidance?
GC: It probably is closer to it where you’re isolating your capital gain there into a pension fund.
AY: But not enough for Part IVA? What’s the scheme involve? Is it the dominant purpose?
GC: I really can’t tell you.
AY: That’s what I’m saying; it’s going to be very hard for the ATO to argue Part IVA on this type of arrangement. It has to be the dominant purpose, in the forefront of the person’s mind that they did this to avoid tax and that’s going to be very hard to prove or show.
GC: You’ve only got to look at the non-arm’s-length income issues with the Allen’s Asphalt case. That was a pretty obvious fraud.
AY: That was quite blatant.
DTC: So if the industry can see how difficult it would be to prosecute a case against it, why would the ATO consider even firing that shot across people’s bows?
AY: It’s good leverage for them just to put it out there. If it stops this happening, it saves them issuing a ruling, which they probably couldn’t justify.
GC: You’re probably right there.
CD: Even if you read through that, the LCG (Law Companion Guideline) for the transitional CGT relief, I think they’re taking an approach where we just don’t want people playing games with this stuff. If it’s potentially perceived that way – that you’re playing the system to get a better tax outcome – then the ATO is giving you the warning it might attack you.
DTC: Another one of the flow-on effects of the super changes is the increased emphasis on real-time reporting, and accurate data and balances. The ATO has mentioned a soft date for the introduction of this, around May or June next year. Will the current systems will be ready?
GC: Ours will be. There are some guys in our organisation who aren’t sleeping at the moment to make sure that software will be right by the time we start preparing the accounts, because, for us, it’s not about preparing for May next year, it’s being ready for 1 July this year as we’ve got clients knocking on our front door to get their tax returns in so they can get their franking credit refunds. That’s their main interest at the moment and the rest will all fall into place. The continuous reporting issue, we don’t see that as a problem because that’s happened before. Reasonable benefit limits (RBL) and the superannuation surcharge were good examples of that and for most SMSFs we don’t see that as a problem either because it will mainly be when you start the pension. It may encourage people to do their accounts or keep records a bit more fastidiously than what they do now. Often you’ll see certain administrators or accountants taking their time to get around to it and the clients going to their adviser and saying, “I wanted to start a pension on 1 July last year, but my accountant didn’t have the records ready for me.” So how do we know what the value of that was for the previous year? If the result is a tightening up of this area, I think it will be a good thing.
CD: Where a problem will come about is, and this is moving forward once we’re into the new super system, where people are moving between worlds, so where you’ve got an SMSF and the clients have decided for whatever reason that they don’t want an SMSF anymore. Maybe they’re getting more elderly and it’s time to move back to a large retail fund. That’s where you’re potentially going to see some problems for advisers. When that money comes across to the large fund, there’s going to be pretty much real-time reporting of the pension commencement, but the commutation coming out of the SMSF may not be reported for some time. I think they’re talking about 10 days after the end of the month. If there’s a lag between the two funds regarding the processing of the transaction, what the ATO is telling us is they’re going to be running transfer balance account assessments every single day and if there’s an excess because you’re getting a double counting of an amount and the commutation hasn’t been picked up, then the client is going to get an excess determination. That’s going to come back to the adviser and then the adviser’s going to have to go back to the ATO to say, “No, and this is why.” So there’s going to be a lot of noise around those types of transactions.
AY: The problem I see from the ATO side is whether their records or their systems are capable of handling all this extra compliance.
GC: And also the time they’ve got to keep the records for. I remember with the RBLs, when that was set up the regulator had to keep those records for 80 years and it’s the same thing with this. You think of disability pensions being paid to 20 or 25-year-old people or even younger now, or child pensions – those records are going to be hanging around for a long time.
AY: Or the old surcharge system. You get a system that’s set up a few years down the track, but they just couldn’t keep up.
DTC: Do you think we’ll see a trend in administration costs potentially going back up a little bit as a result?
AY: You would think so because there’s extra reporting, keeping tabs on these balances and tabs and so forth, with the debits and credit system. You’d think there would be extra admin involved. Maybe over time when technology catches up again, then costs will drop down again. So I guess you might see a spike up in costs and then it will peak and go down again as we go along.
GC: I’m not so sure about that. There’s a lot of pressure on administration costs and different ways of solving the problem. I think administrators will probably either keep it around the same levels as they are now and maybe even drop them further.
DTC: Would this also help the ATO with their constant problem of enforcing lodgement, since your record keeping will supposedly be pretty good?
GC: There are always slackers. It doesn’t matter how hard you try, you’ll still get that percentage that will never lodge unless you put a bomb under them. There was that case in Melbourne where the recommendation to the magistrate was to put a custodial penalty on the non-compliant person. But the ATO said maybe not in this case, so that may have changed the tide a little bit – having a person going to jail for non-lodgement of their super fund returns. That’s the closest someone’s gone for a bit of a stay inside.
KL: Speaking of lodgement, we had the ATO announce that it will extend the lodgement deadline for 2016/17 returns in light of all the super changes that advisers and accountants have been dealing with. Is this a good result for the industry?
AY: It’s a great thing, especially for accountants as they’re always striving for lodgements with the rest of their client base. It was very pleasing for the ATO to provide that extension and understand there is a lot of work involved in these new changes in educating and informing clients. I think the extension was warranted because by the time these changes were announced we didn’t really have a lot of time, and because they were such massive changes to the system we probably still didn’t have a lot of time. But the extension helps, definitely.
GF: It was a state of flux I think for super fund trustees. They’re grappling with the changes that are coming in, as well as showing interest for more information, and what they might need to do, which is overloading their compliance obligations and lodgements. As an advisory and administration business we found it most helpful because it allowed us enough time to get through all of the things that we need to get through, not only the lodgements but also the advice.
KL: What are your thoughts on the pension commutation treatment in the Practical Compliance Guideline (PCG) 2017/5?
GC: They’ve been great. The Law Companion Guideline and the PCG have been fantastic. I think the best clarification was that you just need to request the intent to commute in writing and that you don’t have to know what the number above $1.6 million will be, but the excess will be worked out when the accounts are being done. That will give many people time, right out to May when they start lodging their returns and earlier for others that want to get done sooner. But it really puts it into the same time as the account preparations for the super fund, which is an excellent decision. So when you do the accounts that will be the time when all those adjustments will be made, which fits in with the natural way that SMSFs operate. It’s going to work well, there’s no doubt about that. With some people, I think they want to commute their pension around July for various reasons, not necessarily to get it down to the $1.6 million, but they don’t want all those other things to cloud the process so they think, “Okay, well I’ll have to wait until the accounts are prepared before I commute that pension” and they just continue on in their normal way.
CD: It was certainly welcome. It allows advisers and trustees a level of certainty that they’re going to be able to put something in place that achieves the policy objective and get things back to $1.6 million. In a larger way it puts SMSFs on a level footing with a lot of large master trusts that will be doing their accounts on 30 June. We’ve got clients who are giving instructions to commute anything over and above $1.6 million back. I suppose where it’s a little bit difficult is those clients in the superannuation wrap accounts because if you’ve got a balance over $1.6 million, balances are moving around a lot at the moment, and a lot of these funds are requiring commutation requests to be lodged in early June. As a result of that, there are a lot of advisers having to sit there and really guess what they need to commute back, or implement strategies about leaving a bit more than $1.6 million and using the transitional provisions, or are we going well below $1.6 million and topping up afterwards? This PCG gave SMSFs the certainty not to have to live in that uncertain world.
AY: You might have clients that are close to the $1.6 million. You don’t know until you get all the information.
CD: So your instruction is to commute anything above $1.6 million. If you’re not above $1.6 million, there’s nothing to commute.
KL: This year’s budget has opened up superannuation for other purposes such as housing affordability as opposed to just supplementing or substituting the age pension as recommended in the Financial System Inquiry. Where does that leave us now with enshrining the definition of superannuation in legislation?
CD: They would have to amend that definition or the purpose of super to include something along these lines. If the First Home Super Saver measure gets through, you’ve now got superannuation being used for a different purpose, so I’d imagine that you would have to think about how that is worded. GC: Add a little footnote: “And any other things.”
GF: It’s an ancillary purpose, no different to insurance. The primary purpose will remain.
CD: Yes, that may well be how they look at it, so some sort of amendment to this sole purpose test to include that housing affordability aspect, but maybe no requirement to change the purpose.
KL: Does this mean we should expect more tinkering with superannuation within the budget cycle? How many ancillary purposes can there be?
GF: There will always be tinkering of superannuation. It’s a huge line item in the revenue side of things and we have a budget deficit, so there’s got to be areas which the government looks at. So will it be constantly tinkered with? Yes, but it’s always been that carrot and stick approach with super and nothing’s really changed there. Even the clients we see these days, some of whom are very much affected by the transfer balance cap introduction, they’re certainly put out by what extra taxation they’re now going to be paying inside the super fund. But we compare that to the next best alternative that they could use for their retirement savings. There has to be tinkering because of the importance it has to the budget line, but will it really change where superannuation sits in terms of it being the pre-eminent retirement savings vehicle? I don’t think so.
CD: I’d agree with that. I remember reading somewhere, and I don’t know how they came up with this stat, but they reckon since the Superannuation Industry (Supervision) Act was introduced back in 1993, there’d been over 600 changes to the superannuation system. Look, there may well have been, we certainly get a continual shifting of the sands, but a lot of that is minor and I think at the end of the day it is still proving to be the most effective way for people to save for retirement, and it’s important that we continue to understand that and communicate that to clients.
DTC: Does it mean that we can abandon all hope that superannuation will be ever taken out of the budget cycle?
GC: Well it’s a cost to government. Despite the fact that you’ve got compulsory superannuation, you would think that it should be taken out of the cycle simply because it’s compulsory. So it’s something that the government knows it’s going to cost, the super guarantee, so why do you want to add that in as a budgetary item and get attacked through all the lobby groups saying we’ve got to reduce the cost of superannuation when you really can’t because you’ve got compulsory super there? I wouldn’t say it’s a conflict, but it’s a bit of a conundrum.
DTC: Would it not instil a little bit more confidence in the system if it was removed from the budget cycle?
CD: Is there a little bit of political reality about that? If the government does continue to play around with super, does that become an issue in terms of who they’re looking to support? I have to admit for this year’s budget, two weeks out I was thinking surely they’re not going to introduce any sort of superannuation measures and if they did, they’d be crazy to do that. People are exhausted by the amount of change. But they did come out with those two superannuation measures, though that was fairly minor tinkering at the edges compared to major change. So it may well be they don’t want to touch super for a while because people are a bit over having their superannuation meddled with.
DTC: It’s been suggested that the monitoring of the $1.6 million transfer balance cap could result in some pension accounts coming out of the woodwork that advisers didn’t know about. Does this mean the anticipated government revenue resulting from these changes will be higher than first predicted?
CD: I think that’s going to happen anyway. The system was always going to pick that up. What I think about those uncertainties for advisers is asking those questions of their clients and making sure that they understand that you need to know about any other pension accounts. Now where we see this a little bit is where you’ve got clients that have previously been public servants and they’ve got some sort of defined benefit income stream either accruing or actually being paid, and they come in to see the adviser and they want advice about their accumulation assets or their mum’s super, but they don’t want them going anywhere near that defined benefit pension. So they may not even tell them and that’s a real trap going forward for advisers. If you don’t capture that, then you can’t include that in terms of their total super balance. Now there’s ways you’ll be able to check. You’ll be able to go into the ATO website and look at the MyGov website, but that will be part of the process going forward from 1 July – that before making any sort of non-concessional contribution, even if you think the client is nowhere near $1.6 million, you’re going to have to double check. GC: That’s a mistake that can be made. A client may have $800,000 in their SMSF. The first question you should ask them has nothing to do with that fund. You should be saying, “Have you got any other super?” And defined benefits funds in corporates or government will emerge.
CD: The question could be as simple as: “Have you ever been a public servant?” because that will tell you whether or not they potentially have an accrued defined benefit interest or actually a pension there. The adviser may not be advising them around it, but they need to know the details of it.
DTC: Gavin, does that scenario concern you a little bit as an adviser?
GF: I’m not really concerned; it’s just another thing to throw in the mix, another piece of data you’ve got to collect. A little bit similar in effect to excess contributions or exceeding the caps in years gone by. It may not be your advice or the fund that you’re managing for the client, but you’ve got to collect a lot of data. I guess you learn that the hard way on occasions, but it’s the same sort of thing – you’ve got to make sure that your collection of data from the client is broad enough to cater for all these things that pop up.
DTC: Is the new superannuation system almost impossible to navigate without getting advice?
GF: With more moving parts, the importance of advice comes to the fore. It’s like digging a hole. You can use a shovel or you can use a toothpick, and some people might choose to use a toothpick in the absence of advice.
AY: The system is now more complicated – going from a simple super regime to transfer balance cap regime. There are definitely more complexities in the system and clients can’t do it all themselves. They can’t track every one of these things. They need advice. They need administration. They need to hand over a lot of it. So definitely advisers and administrators will come into play more.
GC: Certainly more estate planning aspects of it too.
AY: Exactly right.
CD: I really support that. Going through and implementing it, there’s a lot of hard work being done at the moment to get us over the line and get us away into the new regime. I hear it even in my own team, a bit of grumbling, but really when you look at these new rules they represent a massive opportunity for advisers to put the hard work in, understand how these rules work, and understand the strategy or opportunities that are there for their clients, because clients won’t be able to do it themselves. They will need help and if you develop the knowledge and the strategies to put the clients in the best position, then you’ve got a clear advantage over your competitors. There’s a lot of noise and there’s going to be a lot of hard work in it, but there are certain opportunities here for advisers.
GF: We have a diversified business and we’ve been able to get in front of clients from other divisions that we previously haven’t been able to because of the requirement for advice that is completely and utterly investment agnostic – nothing to do with where you should invest your money. If you have more than $1.6 million in superannuation, then you need some advice. If you have a windfall and you’re thinking about using super, you need some advice. We’ve found that it’s really important that advice comes to the fore.
AY: It’s client engagement. Clients who maybe you haven’t seen for years suddenly turn up to your door and you have a meeting. It definitely helps the client relationship and the service that you can provide to them. It’s probably not too great for clients [in terms of dealing with new super changes], but it’s been great for advisers in that aspect.
