Still dealing with fallout from the federal government’s 2016 major superannuation reforms, the SMSF industry expected a quieter budget night this year.
However, on 8 May, Treasurer Scott Morrison delivered one curveball, which left many scratching their heads: a change to the annual audit requirement to a three-yearly cycle for SMSFs with a history of good record-keeping and compliance in an effort to reduce red tape and increase efficiency.
Selfmanagedsuper hosted its sixth annual SMSF Roundtable to examine the real repercussions of this proposal, as well as other developments in the works, including Labor’s plan to scrap excess imputation credits, the new education framework for advisers, the banking royal commission and the Productivity Commission’s assessment of SMSFs.
Chris Balalovski (CB): Chairman of the Self-managed Independent Superannuation Funds Association and partner at BDO Business Services.
Peter Hogan (PH): Head of education and technical at the SMSF Association.
Graeme Colley (GC): Technical and private wealth executive manager at SuperConcepts.
Julie Hartley (JH): Associate at Townsends Business and Corporate Lawyers.
Darin Tyson-Chan (DTC): Editor, selfmanagedsuper
Krystine Lumanta (KL): Deputy editor selfmanagedsuper
Malavika Santhebennur (MS): Journalist, selfmanagedsuper
DTC: Welcome to the 2018 SMSF Roundtable. One of the big talking points from this year’s federal budget has been the proposal to have a three-year audit cycle for supposed cleanskin SMSFs with no compliance issues and a good lodgement history. Did it take any of you by surprise, because it seemed to just come out of the blue?
PH: The [Revenue and Financial Services] Minister [Kelly O’Dwyer] had attended our trustee expo in Melbourne the weekend before the budget where she announced some of the other measures, which did come out on budget night. But the potential change in the audit cycle wasn’t something she raised at the time. So it did take us a little bit by surprise. As an association, we support the idea of making SMSFs efficient and cost-effective to run, and that was our initial response. But what came to light after we all had a chance to think about it was questioning – given the integral part of the audit in the whole compliance regime and the fact that the ATO does rely very heavily upon a robust audit program being undertaken through all SMSFs – the integrity of the system and whether that would be in jeopardy if there was a widespread three-year cycle. That’s an important point to focus on – the type of funds that would perhaps qualify for this three-year audit cycle would not represent much more than maybe 10 per cent of all the SMSFs out there, possibly a little bit more, but we’re not expecting that it would be much wider than that. Nevertheless, we still have to address the integrity issues, which we are doing with the Treasurer, the Assistant Treasurer and the ATO to make sure that those settings are right if they do choose to pursue the three-year cycle for some funds.
CB: At the Self-managed Independent Superannuation Funds Association (SISFA), it’s unfortunate to say we received explosive responses on both sides of the argument and some of them were not properly thought through. We feel that there is merit in an evidence-based analysis of what is in the best interest of the sector as a whole rather than any particular part of it. Sometimes that means someone doesn’t get 100 per cent of their wishes every single time, but if we’re talking about the integrity of the system and the integrity of individual funds, then there is always merit in robust audits. If we can come to a mechanism that allows for some sort of cost efficiencies and time efficiencies that mean some sort of an extended cycle – more than a year – we’re in support of it. But we haven’t completed that analysis at this point. It struck us as a surprise as well. It came out of nowhere with all sorts of speculation about why it’s occurred.
“My view is that a three-year audit cycle will clearly pose additional risk to the integrity of the system. It will clearly do that.”
DTC: Are any benefits really going to materialise out of something like this?
GC: It depends what the three-year cycle will be. The statements made at the Tax Institute conference was it will be a three-year audit, once every three years, so it covers a three-year period. Now some funds may find it particularly difficult to get their act together or they’ve made a bit of a mess of it in the first year of the three-year cycle, so that’s going to be even harder to audit because finding some of those records or tracing the history back up to three years can be a pretty hard road for some. This may even increase the cost of audits for those funds, but if it’s only 10 per cent as you guys are saying, then is it really going to be a material change in the way in which we see super funds or the SMSFs audited?
CB: We don’t know the number of funds that will be impacted, but it’s certainly not going to be 100 per cent. So it is a little bit of overkill to suggest there’s going to be that sort of impact on staffing. Perhaps more importantly is what sort of processes the auditor will need to have in place because the auditors’ experience today is that it can sometimes be difficult to collate all of the relevant information to come to an appropriate opinion each year. That’s exacerbated, in my view, by having to go back and ask trustees to retrieve material from three years ago or earlier. So there could be additional cost on the whole audit process, but also complexity for that reason, as well as impacts on an auditor’s practice, making things get bogged down and perhaps missing deadlines.
PH: It’s worthwhile mentioning that the costs of audits have come down, particularly as firms specialise in just audits and they’ve been the people who have been the most concerned, those where the majority, if not all, of their business is auditing SMSFs. There’s been quite a material reduction in cost of audits through that specialisation, through better data and digital data systems that are now available for SMSFs, their accountants and so on. The process is sorting itself out and cost savings are coming through in any event.
JH: The last time we looked at it, the cost of audits have decreased, the average cost of an audit was about $700, which represents 0.3 per cent of the fund that has a minimum balance of $200,000. That’s decreased from about $715 in the previous year so the savings will be quite minimal considering how funds now have much larger balances.
DTC: Do you think the government’s aware there are potentially funds that are sailing pretty close to the wind and haven’t been picked up by the auditor’s report, yet could qualify for three-year audits?
PH: The criteria of who’s going to qualify and who isn’t is going to be fairly important and one would think for SMSFs in that circumstance where the auditor has said the fund’s running okay but they want to keep an eye on it because of certain concerns, these types of observations from the auditor should form part of the criteria. That then determines whether the fund actually qualifies for a longer cycle before being audited again.
Perhaps the underlying activities of the fund, the investment profile of the various fund members, and the fund as a whole as in all the types of assets it’s investing in, plus other activities they’re undertaking as part of their investment for retirement savings purposes and so on, should be all determinative. So it doesn’t become just any sort of concession that might be handed out to a fund. That’s why I think it shouldn’t be much more than 10 per cent, maybe 15 per cent, of SMSFs that will qualify for this type of concession if it was to go ahead, simply because we rely on that annual process to make sure everyone’s doing the right thing and some trustees are clearly better at understanding their responsibilities than others. But those who are less good at it need the regular guidance, which the audit process provides to make sure they’re running the fund the right way.
GC: But even those that meet good record-keeping criteria still require an annual audit because of some of the payments they made in the fund, like benefit payments. So while you might have a squeaky clean fund, you need to go back and have it audited for the year with regard to these particular payments.
“Some funds may find it particularly difficult to get their act together or they’ve made a bit of a mess of it in the first year of the three-year cycle, so that’s going to be even harder to audit because finding some of those records or tracing the history back up to three years can be a pretty hard road for some.”
MS: How much would the integrity of the system be compromised for the supposed gains and is it worth it?
CB: It’s unfortunate to say that in my practice, wearing a BDO hat now, I come across too many instances of mistakes having been made. The law is complex. Sometimes advice isn’t as robust and as accurate as it should be and things are allowed to get away from the trustees and before we know it, it’s too late. There are genuine attempts to rectify, but we have to go cap in hand to the commissioner of taxation to seek cooperation. My view is that a three-year audit cycle will clearly pose additional risk to the integrity of the system. It will clearly do that. Notwithstanding the criteria and whatever they may be – we can be as tight as we can with that – but by its very nature, the fact that these funds are operated by individuals on a day-to-day basis, who have access to the funds, means we have additional risk if we’re talking about a three-year period of essentially no supervision.
JH: Especially with the rise of recent exotic investments like cryptocurrencies, which are not even regulated but people are still suddenly all buying bitcoin. As everybody’s been saying, three years is a long time for a breach to exist and the earlier you catch it, the easier it is to rectify and the cheaper it is to rectify. And we see it so many times. How often do we see a breach of members lending money to their sister or spouse to quickly help them out in a financial situation and then repay the money back to the fund fairly quickly? That definitely will impact the integrity of the system.
KL: As a result of the audit announcement a new lobby group has been formed and there’s also talk of a new association. Are these developments necessary?
GC: I think you need to see what actually happens rather than guess what will happen in theory. There’s a lot of negotiations still going on and these guys aren’t in favour of it from an industry point of view. As we’ve identified, there are a lot of related issues as well as the possible increase in costs for those funds that may meet these cleanskin requirements.
CB: Just qualifying, Graeme, SISFA has not formed an opinion yet of the proposal. We’ll be announcing that as soon as we possibly can, but we welcome any new groups that might be formed as it is healthy competition and hopefully we’ll collaborate with groups that do get off the ground.
PH: Cleary there are groups of auditors who feel that perhaps they need to get together to form the right sort of position for them and their businesses. Whether they choose to do that independently or through an association is entirely up to them. With our audit members, they’ve done both and where they have set up their own audit group, we’ve asked them to put forward their opinions directly to government. I don’t think there’s any harm in having multiple approaches to Canberra about something that’s being proposed, even if it’s the same group of people just represented by different bodies.
KL: You don’t think the measure will go through?
PH: I don’t believe [the audit measure] is something the government is necessarily strongly wedded to. It’s not a critical policy they would hang their hat on and so I’m sure they will be quite sympathetic to the views of those people who are impacted by it. But it depends on how strongly the government feels this is going to be an important platform or something they felt that the industry would see as positive, perhaps without thinking through all of the peripheral issues that have now been raised by people who do this job on a day-to-day basis. As the whole process is properly considered, everyone’s views are heard and an appropriate decision is made in that regard; that’s the way it needs to go.
MS: Do you think accountants will have to be even more diligent with documentation?
GC: They might be a bit more diligent in the way some audits are carried out. As for the accountant’s role, you still need to keep books and records for the fund and you need to lodge your tax returns on a year-by-year basis. It’s only the audit that’s being done away with for those interim two years. So it’s mainly on the auditor and the quality of those records being kept by the accountants which will be even more important with those funds.
PH: It will be interesting to see how this plays out as the industry moves to a more electronic basis of administration with the introduction of the TBAR (transfer balance account report) and the reporting regime slowly being introduced into SMSFs. There’s an expectation more and more of the fund’s records and information will be retained electronically in a far more sophisticated manner, which should facilitate good record-keeping. I guess the point is we’re not there yet as an industry.
“Increasing the number of SMSF members is something the industry has asked for on a regular basis for a long time, but not the change in audit cycle.”
KL: Hypothetically, should this measure go through, who actually makes the call for who qualifies for the new cycle? Is it the government? Is it the ATO? Who gets to decide the finer details?
PH: I presume the final call has to be the ATO’s, although one would think they would be relying pretty heavily on any comments made by the auditors, audit reports and annual reports being made by auditors in relation to a fund.
GC: I wonder whether in the longer term this might lead to accounting standards for SMSFs?
PH: Something better than what we’ve got at the moment?
GC: Yes, so there’s a standardised procedure to get all the accounts together. If you’re going to go to a three-year cycle, maybe that might make it easier to audit.
PH: But then you’re just replacing one set of regulations with another set of regulations so we’re not achieving what the government had in mind when they announced it because you just have to regulate somewhere else. That’s quite possibly the point the auditors are making, that this is an area that does need to be regulated carefully.
DTC: Again, speculating that this measure will be passed, do you think there’s a real danger it could reduce the number of approved SMSF auditors?
GC: It’s happening now. You just have to look at the attrition due to the ATO action on auditors.
CB: The current number’s about 4500 registered auditors from 7000 four or five years ago, so that is an attrition rate of around 700 a year.
PH: Although a lot of that was a hangover from the days when people did audit a handful of funds. A stronger review of the independence of auditors, along with that process of needing to audit more than a handful of funds a year so they can do a decent job, resulted in a big reduction.
CB: We all recognise SMSF auditors are performing a vital function for the protection of significant savings for a lot of Australians. Even though none of us want to see people out of a role or out of business, I’d hate for the tail to be wagging the dog, that is, to think we have to maintain a certain number of auditors in the industry so just because there are 4500 engaged in the sector today and we have to maintain it at that level. Really, if we’re talking about the protection of the savings in the sector, then it’s about what their role is, do they need to be doing it, how frequently they need to be doing it, and then letting the market sort itself out. It may be there’s a resulting reduction in the absolute number of auditors. It might sound a little bit like cold economics, but that’s the unfortunate position.
DTC: Another surprise announcement was the proposal to increase the maximum number of members allowed in an SMSF from four to six. What impact do you think this will have?
PH: A lot has been already said about it in terms of the problems that it might pose. You’ve got to remember that regardless of who the extra members of the fund might be – there’s been a lot of discussion about it being children, spouses of children and all those sort of people coming into the fund – you can’t lose sight of a number of issues, with the most important one being all trustees are members and all members are trustees, or directors of the corporate trustee. There are responsibilities which they need to understand when they take on the role.
We’ve had four members since 1994, or probably effectively earlier than that, so this is the first time we’ve had that increase in members. You shouldn’t lose sight of that. This is not a risk-free, obligation-free, “let’s just jump in here because it’s nice and convenient for mum and dad” or [other reasons] that have got nothing to do with why you should be a member of an SMSF in the first place.
GC: There are a few funds we’ve got where they have more than five in the family and what they’ve done is split the fund off so the kids will have one fund or they may even have individual funds and the parents will have their fund, and that seems to be the way in which it works at the moment. I don’t think they will be consolidated in any way.
CB: It’s more frequently being desired where there is a single asset that the family wants to participate in, or share in, or pass on down the line. So I can see the benefit there and it does certainly provide greater flexibility in those circumstances, but I’m not being trampled with a barrage of inquiries saying “this is the best thing we’ve ever had in the sector”. To Peter’s point as well, it comes with obligations and added complexities at various stages of the family’s existence.
JH: Penalties apply per trustee – having to pay four times the fines already is quite a load, but imagine having to do that six times where fines can reach $10,000 or $11,000. That is actually quite a significant change. So having kids involved, they may not realise this. They think “oh, it was mum and dad’s idea so they’ll pay the fine”, but it has to come out of their own pocket because ultimately they’re liable for what happens in the fund and how they conduct themselves. That, coupled with having more people involved in the fund, the risk of changing membership and trustees will also increase, and will hopefully drive up the need for people setting up a corporate trustee, which we all know makes life a lot easier as it makes a lot more sense.
GC: Well in some cases you are bound to have a corporate trustee because of the state laws restricting it to four individuals, New South Wales is a good example. Corporate trustees probably will be the way to go.
JH: From what we see, clients don’t think in the long term. They think about the costs upfront and even then maybe that might be the tipping point going from four to six. From what we hear clients still say “no, I don’t want to spend $500 or $600 now to set up a company”. They just think about the benefits of saving from a tax point of view but not all the practical implications that come with it.
DTC: Will it encourage more family-structured SMSFs?
CB: From my experience, yes it will. I don’t have anecdotal evidence to suggest that it’s going to encourage non-family participation. They are today and will remain, in the six-member limit, as almost exclusive family dynasty vehicles. Rarely have I seen that it is non-family members who participate, be it a business partner or a neighbour. It’s a psychological thing – it’s seen as long-term estate planning and that’s a very personal vehicle for the family group. I don’t think that’s going to change because of the additional two members. Family dynasty vehicles is the perception.
PH: I think that’s right. To the extent to which there is a family business of some description being undertaken and there’s multiple generations working in that family business, then it’s logical you would use a single fund rather than have multiple funds and associated costs and so on. It has the benefit of increasing the pool of money available for investing that could lead to allocations to assets in which the trustees wouldn’t otherwise be able to participate. Joint ownership of assets between SMSFs simply because of limitations on numbers of assets has never been a great structure.
MS: With these risks in mind, will funds need to include written consent to be able to remove children from the fund?
GC: Your trust deeds are usually structured so they can kick anyone out if they want to.
JH: It might not be that easy to do, but yes, you can. If you structure your deed properly, you could get around it. But you run the risk of kids ganging up to exclude the parents from the fund. So it does create complications and, as we know, families fall out all the time.
CB: It can be hardwired in the SMSF trust deed itself, the dispute resolution mechanisms and the entry and exit mechanisms as well. But it doesn’t hurt to have those conversations with the family so everyone understands the situation and a deed is tailored for the family’s needs as well as ongoing family succession-type strategies. When does the family, as a group, accept that the next generation is allowed into the fund? It might be a very significant size, $20 million or $30 million, so do we want decision-making to be made by certain individuals at a certain point or are they external to this entirely? So that happens at a family level. Families need to decide this. There might be family constitutions or charters or some sort of philosophy document that sits outside the SMSF deed, but once those decisions have been made it can be hardwired and tailored for every family in the trust deed itself.
PH: But those sorts of issues are not unique to SMSFs either are they? There are structures of business that have been carried on through their family discretionary trusts, controlled by certain individuals, which face the same problems.
KL: There’s been speculation this is the government’s attempt to neutralise Labor’s policy to scrap excess imputation credit refunds. Is this valid?
PH: Last time I looked, Labor wasn’t in government. You can only pass legislation when you are, so it is a bit of a speculative sort of assumption to say that’s been their motivation for doing this. Our understanding is that Labor still intends to go to the next election with this policy, so they’ll get a mandate for it if they’re elected or feel that they will. The other thing lost in the discussion is franking credits are also assessable income. Another comment to be made is that it will impact the way trustees mix up their investments anyway. SMSF trustees are a bunch where if they don’t like something, they will respond, so we may well see, if it does come through, there’ll be other responses they make in terms of the investment choices.
CB: When you say it might be an attempt to neutralise the proposal for the imputation credits regime, I think you mean it is a foil to that strategy and an SMSF-friendly policy to say: “Labor doesn’t really like SMSFs, but we [the government] do because we’re offering six members and we’re offering a three-year audit cycle.” Some cynics have suggested exactly what you’ve said, that the two measures came out of the blue, there wasn’t any consultation and it does seem that way – the opposition has got something that impacts SMSFs negatively so the government’s going to make a couple of announcements that impact positively. I’ve heard that, but I can’t confirm it. Though it does seem that way on the face of it.
PH: Although increasing the number of SMSF members is something the industry has asked for on a regular basis for a long time, but not the change in audit cycle.
KL: Would increasing the number of SMSF members risk turning the structure into more of an intergenerational wealth transfer vehicle, which the Treasurer has repeatedly warned he did not want to see?
GC: It will happen in some funds because of the nature of the asset.
PH: Remember too, we’re not necessarily transferring wealth between generations because that’s not possible. Essentially your money is your money. When you die, it can only be paid to certain people. It has to come out of super. In many instances now with the new [super] regime it can’t just be left in the fund and reallocated around. The ATO put out an interesting SMSF bulletin recently on use of reserves which makes it pretty clear that reserving strategies inside SMSFs have a very limited use in their view, which I do tend to agree with. And so it’s perhaps maintenance of a particular asset in a structure which sees members come and go from the fund, and the asset remains an asset of that fund. Of course, that still has to be supported by the members moving their own retirement savings into the fund in a sufficient size to actually be able to retain that asset inside the fund because in the end if you can’t, then your only choice is to sell that asset out.
GC: You’d think there’d be some restriction there because of the caps. I think that will slow things down.
CB: Do you think insurances could help in those circumstances? So insurances in the fund can be used to then pay out benefits or retain assets, the big lumpy assets and so the next generation coming in doesn’t have to make the $10 million contribution?
PH: One of the ways of getting around that was to own something outside of super and then make contributions to the fund, but, of course, now contributions are limited so even insurance as a solution has been reduced in terms of its effectiveness. And once insurance was used to fund an income stream until the money ran out and then people would just roll whatever was left of their entitlement back to accumulation phase and let it sit there. You can’t do that anymore either. And if you receive a death benefit pension and you commute it, then you have to pay it out under the new regime as a lump sum rather than just roll it back to accumulation phase. So there’s been quite a number of significant changes that make the more aggressive, if you like, wealth transfer between generations impacted even at the SMSF level.
DTC: What does the rest of the panel think of the removal of excess imputation credit refunds?
CB: Horizontal equity is not provided for. What I mean by that is that it would seem that certain taxpayers do not benefit from the imputation regime if the change is imposed, so they’re not getting the full franking benefit, a refund of excess imputation credits. It is unfair therefore horizontally across different types of taxpayers. If the mischief is that there are excess amounts being returned to certain individuals or family groups, then that should be articulated by Treasury or the government and we should hear something about a threshold amount above which it cuts out or tapers out or something, but I’m not hearing that at all. It is just from dollar one for this type of taxpayer.
The $1.6 million measures that were commencing on 1 July 2017 did have a threshold, a dollar figure and in all discussions with Treasury and in all consultations with Treasury it was about fairness and if you are going to benefit from tax concessions, then there is an upper threshold, enough for an individual to retire on, adequate income in retirement. I’m not hearing that with this debate. It just seems that it’s from dollar one and it does seem to me that it’s unfair horizontally. If that’s not the intended consequence, if the mischief is significant amounts being returned to individuals or groups, let’s hear something about what that threshold number is.
JH: I’ve heard a lot of clients are not happy because they look to be losing about $30,000 or $40,000 a year.
“If we get something that will increase the standard in the education of advisers, [seeing] advice will be relied on by the trustees in running a fund, that is really important because trustees are ultimately liable.”
GC: With higher wealth individuals who I think it is directed at, and Chris talked about large refunds of franking credits, the way in which they’ll structure their fund is all in franking credits and they’ve been forced to do that. They’ve been forced to move their pension assets over to accumulation phase and they’ll structure their assets. They might go for overseas assets and maybe some non-franked assets we can provide higher rates of return on. As for people with balances of less than $1.6 million, if they’re in pension phase, that can be an issue with them. So you’re probably discriminating against some SMSF trustees, that’s the equity issue you were talking about, but I think it’s probably more exaggerated than what Chris described.
DTC: Would having a grandfathering measure, which I have not heard been discussed, make it more palatable, more equitable?
CB: Simply, yes, it would. It provides a transition, restructuring of assets, recalibrating strategies. It certainly would, but ultimately the result is the same. We still get to horizontal inequity. You just get there over a longer period. So it would be welcome. Better than a drop dead date, but ultimately the result is the same.
PH: There will be a number of opportunities to grandfather different provisions to make it a more appropriate introduction over a much longer period of time, should the government of the day decide that’s the measure they want to put forward and introduce. It may also be the other areas of concession that they apply, although it does seem counterproductive to encourage people to save money, but spend it quickly so they end up on the age pension, ending up better off than if they didn’t do it. That does sound counterintuitive.
KL: Still on imputation credit refunds, some have suggested a move like this would be inevitable from either side of government. Your thoughts?
CB: In my experience as a practitioner over several years, it is a fact that some funds have had tremendous financial benefit to the point where individuals have expressed embarrassment at the situation. Zero tax on their pensions, significant savings, accumulating tax-free and then also receiving significant hefty refunds. Some have honestly even suggested to me that they’d like to write in a voluntary cheque to the commissioner of taxation. I offered my bank account details. But “unsustainable” was the phrase used. Now whether it’s unsustainable or not, whether the budget can sustain it is a matter for Treasury to determine, but I think everyone knew the writing was on the wall and that there would be some form of change. So I do think everyone expected it be coming from one of the parties.
PH: A lot of the numbers that have been thrown around in terms of budget savings on this are also based upon old data, particularly old SMSF data, so it’s worthwhile to look at the 1 July 2017 changes and their impact because clearly some of the examples of people who perhaps might have been rather embarrassed by the size of the refund cheque they get are people who run very large pension accounts in SMSFs and they can’t do that anymore. Now there will still be some people [affected] because of the way they choose to invest and the proportion of which they choose to invest in Australian shares can generate franking income.
MS: Will this measure force trustees to invest more in risky asset classes?
GC: I don’t think it will. I had a seminar with my clients and they were looking at ways in which they can construct their portfolio to even out the effect of the franking credits [removal], but they’re certainly not looking at more risk; there’s no way. In fact, they’ve probably got enough risk by investing in Australian shares rather than diversifying across an international portfolio and that’s where the main risk is associated.
MS: So will that lead to more diversified portfolios?
GC: Only to the extent they would go for other unfranked shares or other investments that don’t bring franking credits with them, because the theory there is that they would get a higher rate of return. Whether or not that happens is another question.
KL: While the excess imputation credit removal is only a proposal and not policy, should practitioners prepare for change or is that jumping the gun?
CB: My view is it’s probably a bit premature. An election is a way off and has to be won by the opposition. Then they have to adopt it formally and fully articulate the policy, and that might all change even if they did form a government. So it would be premature. It’s healthy to keep it in mind and discuss it with clients, reminding them of the fact it is a possibility, but advising clients to restructure portfolios or restructuring a practitioner’s business to get ready for it is probably a bit too early.
GC: So you’re not out there buying non-franked shares at the moment?
PH: One of the interesting things that happened is very soon after the Labor announcement, a lot of trustees thought it was law and responded accordingly. Some started selling portfolios down, so advisers need to reassure their clients that it’s not law yet, but it might be something that comes along in the future. Having said that, some people have said: “Ah yes, but the market’s already moving; it’s already responding to the possibility of that and I need to move now to extract the benefits out of investments.”
DTC: Moving away from the budget now, one topic causing quite a bit of angst in the financial services sector more broadly has been the formulation of educational requirements by the Financial Adviser Standards and Ethics Authority (FASEA). What are the panel’s thoughts about this process?
CB: SISFA would always welcome further education of the sector, whether it’s advisers or trustees and the structuring of that regime is all important. Unfortunately for a long time in Australia advice to SMSF owners has been almost unregulated and when I say that I mean the professional standards of that advice or the adviser. It’s welcome if there are measures that are put in place to professionalise the delivery of that service and if that requires certain mandatory education standards, we would prima facie support that.
I think it’s very evident that there have been cases, some very public cases, of horrific advice to retail investors of any description, SMSFs included, and anything that attempts to mitigate those sorts of instances occurring again has got to be welcome, but it’s the old ‘using a sledgehammer to crack a walnut’ analogy.
The well-resourced parts of town that have an adviser network should have been able to prepare for this well in advance to inform their advisers of what the requirements are and to help fund it. For some of the smaller practitioners, sole practitioners, it might present a little bit of a challenge, but I think there might be a little bit of a shake-up in the industry. It would be unfair if that was merely because of cost and the ability to get around to doing the courses. So I think it should be facilitative. We should be making this as easy as possible for good advisers to qualify.
PH: I was involved in the consultation process and, as you probably know, FASEA held a number of lengthy three-hour presentations to a wide range of stakeholders. The position FASEA is proposing and asking for submissions on has been well telegraphed. It has moved a couple of times, that was to some extent perhaps due to the CEO leaving and then a new interim CEO taking over, and that always makes it organisationally difficult to move things ahead. But the timeline’s very tight. We’ve passed the last day for the submissions on the new code of ethics. The end of June is the closing date for submissions on the educational time phase and I understand there will be some consultation around CPD (continuing professional development) and so forth. There’ll be some draft legislation towards the end of the year and then a very short period of consultation before the end piece of legislation gets passed before the 1 January 2019 start date. So that’s the timeline FASEA has to work within. It’s not always great when you have relatively short time frames, but this initial consultation period has been quite lengthy in the scheme of things – three months to have a think about some draft proposals, which were put out in March, and having until the end of June to comment has been quite an extensive period of time.
We would support as flexible a system as could possibly be. For new entrants into the industry, I think an undergraduate or a master’s entry-level, whichever is appropriate, is not such a bad idea, and bridging courses for everyone else provides flexibility in terms of the subjects that can be undertaken. Other than that, there are some compulsory subjects envisaged by FASEA as well, which we don’t have a problem with, but again, being as flexible as we possibly can with the balance of any curriculum that someone might do to relate it to their business is to our view. Our submission will be supporting that. We’ve spent a lot of time talking about this and we started thinking about this around this time last year, not even knowing what FASEA might come up with. We feel probably our membership is a little different to a lot of others in that a lot of our members probably have qualifications which would satisfy FASEA as it is, so they might be looking at maybe one to three compulsory subjects they’ll need to do because of the type of membership we have.
Clearly other associations and other professions like stockbrokers, insurance brokers, mortgage brokers, accountants with limited licences and so on are only being caught up in perhaps a potentially far more complex education regime than what they feel they need to be involved in. It’s not for me to talk to those professions, but that’s something that needs to be considered.
GC: As administrators, we deal with accountants and financial planners, so from our point of view better education will mean better-quality SMSFs that we deal with, particularly for strategic advice. One of my observations from my university teaching is that the younger people these days see financial planning as a professional career rather than a sales job. I think that’s a really important distinction.
JH: I agree with Graeme. If we get something that will increase the standard in the education of advisers, [seeing] advice will be relied on by the trustees in running a fund, that is really important because trustees are ultimately liable. It also raises the point of what practical impact that will have on the profession. Will practitioners who are closer to retirement want to take that step back and re-educate themselves? Or will they choose to leave the industry, which will in turn leave the younger entrant without the experience and somebody to mentor them and bring them into the profession? There’s also the impact on women. Women having to find the time to fit in education with family life and working life, it might not be the easiest thing for them to do and so will that impact their choice of following that career? Will they decide it’s too hard and too much and can’t fit it all in to the detriment of my family life and therefore will choose a different career? Again, what impact will that have on the industry?
MS: At the SMSF Association National Conference, Deen Sanders, the FASEA chief at the time, said designations are not qualifications. What is the status of professional designations?
PH: That’s a wait and see. FASEA has asked for submissions in relation to what various interested groups believe prior CPD activities and/or prior designations should be recognised appropriately going forward, or at all. I can’t say anything more than that. Whether that ultimately forms part of what we get or not is something we won’t know until later on in the year, but we would think that designations, which have gone through an appropriate educational framework, whether it’s been through an official higher education institution or perhaps directly via associations and so on, is something at least potentially should be considered rather than dismissed outright. You’d think 30 years’ worth of CPD points should be worth something. It’s valid for the industry to ask FASEA to consider it and give it some sort of value.
DTC: Even though the SMSF sector wasn’t directly in the firing line of the royal commission on banking, how do you think the SMSF sector has emerged from the advice segment of it?
CB: It’s very unfortunate for those organisations because although some of the stories that have emerged are horrific and with terrible outcomes, they’re very large bureaucracies and controlling every single individual and every single decision they make in every single client matter is a near impossibility. Almost irrespective of what the recommendations are, for example, with regard to vertical integration as a business model or anything else the royal commission might recommend and the government of the day adopt, we will never be able to eradicate bad outcomes. It will always occur, whether SMSF advisers to trustees or any other part of the advice sector. It’s unfortunate. But the sector as a whole should be commended for monumental changes over the past decade or so with regard to a genuine desire for professionalisation, and a genuine desire to collaborate with government and professional associations to raise it to the level where it is seen today as a genuine career. Advice is a genuine career, a legitimate career path for someone coming in to entry level.
That’s a fundamental shift in where Australia was more than 10 years ago. There’s more to be done. There’s a bit of sensationalism that comes with the royal commission, but facts are facts. Those things have actually happened. Shining a light on them hopefully will lead to positive results, but I’m afraid to say we will never, irrespective of how many royal commissions we have, ever be able to eradicate the sorts of things that we’ve seen.
PH: Some of the examples of poor advice involved SMSFs, but I don’t think that necessarily reflected it was an SMSF structurally that was the problem, it was the advice given that happened to be around investment advice and other activities were being suggested could be done for a particular client who happened to have an SMSF. The SMSF Association is not part of the official program and process of the royal commission, but we believe anything that improves advice generally across the board is going to improve advice to SMSF trustees. I don’t think anyone would logically turn around to FASEA and say “you’re being too tough on financial advisers”, given what’s come to light from the royal commission. Maybe it was coincidence in timing, but in that sense they seem to have worked together to produce a result which ultimately is going to make it harder [for misconduct to occur].
Our association was set up years ago to improve education and advice to SMSF trustees because we felt that it was fairly poor back then. It’s certainly moved and I would agree it’s come a long, long way in the 15 years the association’s been around. But there is still an element that needs to be improved and the combination of all these things going on at the moment is going to have a very positive impact on that advice to trustees and any investor in Australia, regardless of who they might work for.
DTC: On a positive note, ASIC reported back on unlicensed accountants and the advice or services they were providing and gave them a green tick. Is that an added bonus for the sector to say that regardless of what’s happening out there, this area is operating pretty well?
PH: Yes, I think a lot of people were concerned because they were looking at what they could see in the public domain and sort of saying this is not stacking up and, in the end, what ASIC found was they were actually doing the right thing and the regulator’s concerns were around fairly minor stuff – unlicensed accountants hadn’t updated their website properly with disclosures or hadn’t quite got their paperwork quite right, which is normal when you think of what financial planners have gone through over the years.
GC: You’re seeing more and more with both financial planners and accountants being reluctant to provide advice when they know they haven’t got the right licence. We get a number of referrals because we use our taxation licence for various things and financial planners who don’t have that tax licence aspect will [seek out] advice, which is a real change.
KL: Peter, you talked about how all these different moving parts should help lift advice standards. Do you think the establishment of the Australian Financial Complaints Authority later this year will also have some sort of positive impact as well?
PH: My concern with those disparate bodies in the past, being someone who trained as a lawyer, is the lack of appeal from the process. That will continue on, but putting that aside, the people who have been appointed so far at this stage are well experienced so one would expect the process will be streamlined. And it makes sense to have one large body, with one secretariat, providing very similar sorts of services rather than three or four running location costs and so on.
One hopes the size doesn’t impact upon the work of that organisation. We’ll have to wait and see how that process goes through and the backlog of complaints clearly needs to be fixed so people can move on, and on both sides. A financial planner doesn’t like sitting for two years wondering whether they’re going to be found to have provided inappropriate advice and fined, just as much as the client doesn’t want to wait that long for compensation if they’re entitled to it. So the quicker it can be processed and put through and come to a resolution, I’m reasonably optimistic that streamlining those processes will hopefully do that.
DTC: The Productivity Commission handed down findings about the superannuation industry and obviously they’ve made some judgments around SMSFs. What are your thoughts on it?
GC: The $1 million threshold was a little bit puzzling and the costs and the way in which they said initially that – they used the ATO statement that it’s not possible to compare SMSFs with the bigger superannuation funds, yet in the report, guess what they did? They compared the costs, so that was a bit hypocritical. There was nothing new in that low-value superannuation funds were high cost and that the higher the amount you paid for your investment didn’t necessarily give you an equivalent increase in the rate of return.
The other thing which wasn’t a surprise was that rates of return, net rates of return from SMSFs are roughly around about what the big funds are doing. So that confirmed what the ATO was saying some years ago, which I thought was good but unfortunately they didn’t talk about the risk. The downside risk for SMSFs is lower than what it is for the bigger superannuation funds and that’s shown year after year.
PH: I suppose that comment, particularly on the small funds, is yes, it’s obvious that the fewer dollars you have and the set costs, then the more expensive they’re going to be proportionately. Our view though is that very few SMSFs these days are set up to hold $50,000. They’re either on the way up or on the way down and we would certainly agree that to set up a fund to invest $50,000 or $100,000 whatever is clearly inappropriate. If cost is your driving factor, and that’s the other if, of course, the assumption is that cost is your primary focus and that’s not always the case for SMSF investors either, but putting that aside, our view is, and what we see generally, is either people have run down their fund and by the time they get to $50,000 then yeah, they probably should wind it up and move what’s left, if that’s all they’ve got left of their savings. So they’re probably quite elderly as well and maybe running a self-managed super fund in your 80s is not such a great thing to be doing anyway.
Of course you’re going to be established with small amounts of money and it might even take some time to roll over large amounts of money from other superannuation arrangements. It might take time and there might be complications and all sorts of reasons, so you need to keep that in mind. I think the trend if you like for funds that were small five years ago and you look at them now and they’re well in excess of a couple of hundred thousand dollars, which is again what you would say was probably a minimum entry level. They’re building up and the average minimum-sized SMSF is certainly steadily growing in size.
GC: That’s recognised in the report. They talk about the small funds and all that sort of stuff. But they still pick on it don’t they?
PH: I would agree with Graeme in the sense that $1 million sure would make an SMSF very cost effective, and that might be comparable to the very best APRA (Australian Prudential Regulation Authority) funds being run. But we all know there are lots of other funds out there. We’re of the view that a lower fund size – so we’re not talking about individual account balances, we’re talking about total fund size – you can’t be smaller and still be very competitive in terms of overall cost compared to the alternatives out there in the marketplace.
CB: That’s a snapshot, a simplistic argument and it is simply just looking at costs. I’m yet to encounter a significant number of clients who are coming to the SMSF world because of costs. It’s because of the flexibility that’s afforded in terms of investment strategy, distribution strategy, members and estate planning as well.
CB: Yes. Costs are a factor, there’s no doubt about it. For the very cost conscious it’s indeed a very significant factor in making a decision about establishing, sustaining, winding up, but it’s not by a long shot the dominant factor. So the $50,000 snapshot I couldn’t agree more, it’s not going to be cost efficient. But wait a minute, we’re starting out and we’ve formulated an investment strategy we think is going to get to a million dollars if everything goes right.
What’s wrong with that? What’s wrong with incurring some proportionately additional costs early if we’ve got a well-articulated strategy that’s going to get us to cost efficiency and significant wealth in retirement? So it’s a simplistic review. That’s what they were charged with. That’s the responsibility of the Productivity Commission and they’ve done a good job given their mandate. It would be very refreshing for the mandate to be expanded: are SMSFs the more appropriate vehicle for Australians seeking a comfortable wealth retirement level, taking into consideration all the facts I just mentioned?