Pass the parcel – super as an intergenerational wealth tool

While the industry consults on the objective of superannuation, the Treasurer has flagged its function as an estate planning tool as troubling. Krystine Lumanta investigates whether the industry regards super’s use as an intergenerational wealth transfer vehicle as yet another problem it must tackle.

In February, during the SMSF Association National Conference in Adelaide, Treasurer Scott Morrison used his address to state his concerns about superannuation being used as an estate planning tool.

“It’s important to remember why superannuation exists,” Morrison said at the time.

“This is a very important point. It’s not there to be a tax-incentivised estate planning vehicle … superannuation is a system that can do with some refining and aspects of the system are too rigid.”

Ahead of the May budget, Morrison said the government was targeting unfair incentives and planned to cut superannuation tax concessions to block wealth creation.

But the suggestion of super being exploited to build substantial wealth to then transfer to the next generation may be a surprising one, with many Australians expected to struggle to reach even a comfortable retirement income level, let alone have an abundance of leftover capital and assets to spare.

This claim also goes against the message of encouraging Australians to save as much for retirement as possible. So is Morrison’s criticism warranted?

When SMSFs were first introduced in 1994, the average member balance was just over $100,000. “Over the past 21 years, particularly those members that have been in their funds for a long time, their pension and accumulation balances have grown substantially; for some, well into the millions,” NowInfinity principal Grant Abbott tells selfmanagedsuper.

“Through natural growth many funds now house the majority of members’ overall wealth, resulting in estate planning being a key issue within these funds, planned or not planned. Plus, as members get older and friends pass away, estate planning comes to mind.”

From a technical perspective, the sole purpose test includes estate planning as a key super benefit, Abbott says. “And coupled with certainty and security using binding death benefit nominations to pass out benefits, tax concessions throughout the life of the member and the SMSF have overtaken the family trust as the preferred savings and estate planning vehicle,” he explains.

Miller SuperSolutions founder Tim Miller says without any proof, it’s hard to know what triggered Morrison to come down heavily on this particular aspect, that is, if there’s strong evidence of super being misused in this way.

“I don’t think it is a concern, and if it is, the government created it,” Miller says.

“The government removed the compulsory cashing restriction for when a member attained 65, so they removed the link between the sole purpose test core purpose and what they allowed members to do. I see more evidence of trustees minimising the tax impost of estate planning rather than accumulating wealth.”

No cause for concern
Examining the size of super balances that could be regarded as being evidence of an estate planning agenda, for example millions or billions of dollars, Miller says: “It’s subjective – death isn’t dictated by account balances. Just because large balances are being transferred, it could be reflective of untimely death, not wealth accumulation post-retirement.”

Abbott underlines the contribution rules do not allow significant contributions to be transferred into funds for wealth creation or estate planning. “The big factor that has seen the growth in size of members’ balances, and the corresponding capital accumulation for disposition beyond the end of a member’s life, was the abolition of the reasonable benefit limits regime in 2007,” he says.

“If that was still in place, the discussion around estate planning would be silent.”

SMSF Association head of policy Jordan George says whether an amount is an inappropriate bequest coming out of super depends on a lot of factors, not just the dollar amount. “Factors such as whether an amount is a tax-free or taxable death benefit, if it is a lump sum bequest, death benefit pensions or reversionary pensions paid from super and whether the death benefit payment is made to financial dependants or non-dependants all need to be understood to judge whether an amount paid on death is a bequest that should be targeted,” George explains.

“We agree the purpose of super should not be for estate planning and should be focused on providing retirement income. However, we do not believe estate planning is necessarily a significant problem for the system.”

He says SMSF sector statistics from the ATO that show over 90 per cent of benefits are taken as income streams indicate SMSFs are achieving the system’s goal of delivering income in retirement. Furthermore, Australian Prudential Regulation Authority (APRA) figures indicate for APRA-regulated funds in 2014/15 the total death benefits paid totalled $4.361 billion, representing 9.1 per cent of all benefits paid from these vehicles.

“We do not believe that this amount/percentage is indicative of serious misuse of superannuation for estate planning purposes. If it’s only a very minor number of superannuants doing this, does it need to be addressed by the industry and government? The system does not need an overhaul to focus on the activity of a minority of super fund members, especially if the measures taken to stop estate planning in super, such as lowering contribution caps, would affect people’s ability to save adequate retirement incomes generally,” George says.

Miller agrees. “I don’t think it warrants widespread changes, although I think there is opportunity to rebalance the equation,” he says.

“I believe there were a number of changes introduced as a part of the widespread Better Super initiative from 1 July 2007 that to a degree have compromised the system as being heavily weighted in favour of those with higher wealth.”

Timing longevity
While it’s not a specific purpose per se, a leftover super balance is a natural outcome of what the system is trying to achieve: for Australians to be self-funded retirees. Thus, avoiding leftover wealth in the context of longevity risk is no easy feat.

This is the difficult part of getting a policy right around bequests from super, George says.

“We need to balance it with the importance of people having adequate retirement savings to manage risks of ageing and retirement, including longevity risk,” he suggests.

“So, in essence, we need to accept that having a super balance left after we die is not always an estate planning outcome, but possibly the result of prudent savings and drawdowns in retirement.

“We think it is more important that people are encouraged to build adequate retirement savings in the first place and then manage estate planning issues as a secondary issue.”

Abbott says this outcome is profoundly true because for many members, capital preservation is fundamental.

“With the potential for a member to need upwards of $550,000 for a refundable accommodation deposit in an aged-care facility, capital hoarding is absolute,” he says.

“If eventualities do not arise, then by its very nature excess will be transferred to the next generation. As an aside, in all my years as a SMSF adviser I have only ever seen one client run their fund as an exclusive estate planning fund – it is always used for retirement income purposes. And if there is money left over, then it is left over.”

Accumulating estates
Strategy Steps director Louise Biti does not believe the issue of super as an estate planning tool is in relation to how much clients are dying with, but about whether they are still accumulating rather than de-accumulating in the later stages of their retirement.

“Except for using a lifetime annuity with no residual, it is impossible to time exactly a person’s life and money running out at the same time,” Biti says.

“In planning for retirement, clients need a de-accumulation strategy. For most clients, there is a trade-off between spending money now and preserving balances to protect against longevity risk and to fund unknown expenses, and clients may sacrifice lifestyle to reduce the risk – these clients are likely to have balances left to pass on as inheritances. For other clients it could be possible they have more than they need to live on, so accumulation throughout retirement becomes inevitable – these clients are likely to continue to accumulate wealth to pass on to the next generation.”

Therefore the concerns voiced by the Treasurer were not so much that clients pass away with specific dollar balances, but the evidence shows clients are still accumulating funds in the later years of their retirement, she explains. “This indicates that clients do not need super and the tax concessions to fund their own retirements, but are using it as a vehicle to accelerate the accumulation of estates,” she says.

“Strategies to reduce this accumulation in later years, if at the sacrifice of lifestyle in earlier years, may include legislative change to allow deferred income streams to commence in later stages of retirement.”

She says this gives clients a specific time frame to plan lifestyle and drawdown of assets to match that time frame. But while it eliminates longevity risk, clients still need to manage market risk.

Another strategy could be the greater use of lifetime annuities to ensure base income needs are met throughout the full lifetime so clients can have more confidence to draw down on assets to meet lifestyle expectations, she reveals.

Biti says there has been much discussion over the past decade on whether we can afford to continue the tax-free status of super withdrawals for clients over the age of 60.

“The message the Treasurer was giving is that the government is willing to consider allowing these tax concessions to continue if they are needed by retirees to fund their income needs, but not if they are only contributing to wealth accumulation for the next generation,” she says.

The return of death duties
Should the government look at introducing measures to minimise the transfer of leftover wealth from super, a possible scenario could be the return of high death duties as a penalty.

Essentially there is a tax payable on super upon death, but it can be avoided by withdrawing from super while still alive.

Otherwise individuals considered non-dependants, children over the age of 18, are subject to a 17 per cent tax on receipt of a death benefit under tax law.

Miller says the payment of a death benefit after retirement is an ancillary purpose, not a core one and should a new penalty apply, it wouldn’t be a matter of double taxation.

“Rather, what is the applicable taxation rate that applies and is it applied at the beneficiary or estate level?” he says.

“That may be determined by whether payments are received directly or indirectly.”

George says the politics of introducing taxes that could be regarded as death duties probably discourages governments from bringing in these types of arrangements.

“What we are more worried about are measures which can be applied earlier in people’s life cycles, such as lowering caps or taxing super at a higher rate, which will affect adequacy,” he warns.

“The arrangements around taxable and tax-free death benefits can be complex, but we would not consider them to be death duties or double taxation. Describing them as a claw-back of tax concessions might be more accurate.”

Avoiding super wealth creation
Getting the objectives for superannuation right is the key step to prevent ulterior uses.

George also recommends ensuring adequate retirement savings are part of those objectives, so that building healthy super balances is not regarded as part of estate planning.

According to an SMSF Members Association survey, one of the most important things trustees desire is the need to look after the family financially, along with having a secure retirement income stream.

“It is not foremost in members’ minds to use an SMSF as an estate planning tool. It is happenstance,” Abbott says.

“With current low interest and low return environments many older SMSF members are chewing through their SMSF capital courtesy of minimum pension drawdowns and aged-care deposits. I’m sure the next generation are wishing for their SMSF parents to have lots of money when they die, but I think that may not be the case anymore.”

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