In this post-truth world driven by social media and fake news, it seems there are few certainties beyond death and taxes. Even the latter appear to be optional for many large corporations, high-net-worth individuals and the growing number of citizens inhabiting the cash economy. However, there is a third certainty, namely the enthusiasm with which Australians embrace self-managed superannuation funds (SMSFs).
The statistics are remarkable. SMSFs, of which there are more than 600,000, now account for more than 99.5 per cent of all superannuation funds and over 30 per cent of superannuation assets; their average balance exceeds $1 million.
What’s driving this astounding growth? Could it be the generous tax breaks? I suggest not. After all, the same breaks apply to the superannuation system as a whole, not just to SMSFs. My 30 years of experience observing and advising thousands of superannuants has convinced me that it’s all about a desire to exercise control. This often misguided and irrational desire has never diminished and there are no strong signs that it will do so any time soon.
Indeed, in the three decades since the inception of this form of superannuation, clients have rarely needed any convincing about the merits of establishing an SMSF. By the time they consult a financial adviser or an accountant, many have already persuaded themselves they can achieve a better rate of return than the professionals and that even if they can’t, at least the money will be kept out of the hands of the forces of darkness – the financial institutions, whom they love to hate. This is an attitude often encouraged by accountants and specialist administrators who are keen to develop an SMSF administration book. Even when a superior return is not achieved, fees are excessive and financial advisers/accountants are clearly not acting in their clients’ best interests, it makes no difference.
Clients want to keep control at almost any cost.
Industry within an industry
This amazing phenomenon has given birth to an industry within an industry: representing the so-called SMSF sector. The new industry contains articulate and well-funded lobby groups claiming to be professional associations supporting the public interest, while enthusiastically promoting the merits of SMSFs over any other form of superannuation. And in the most recent decade, we have seen the rise of SMSF educators, whose principal purpose appears to be to convince hapless (and poorer) members of the public to use SMSFs to gear into the great Australian dream, on the basis that real estate is always a winner.
SMSFs’ inexorable growth has somewhat disturbed the traditional superannuation industry, principally inhabited by large financial institutions operating retail funds. Initially, their reaction was to criticise SMSFs as irresponsible tax avoidance schemes that were risky for members and regulators alike. However, in recent years, realising that they couldn’t beat them, they’ve joined them, buying ownership in existing SMSF advisory and administration firms or establishing such a service from scratch. There’s considerable irony here because many fiercely independent clients have ended up in the commercial clutches of the very institutions they were so carefully seeking to avoid in the first place.
So where does the industry go from here? There is no doubt that recent legislation moderating tax breaks at the high end has taken the edge off superannuation as a vehicle for the rapid accumulation of vast sums of tax-effective savings that may be passed on to children. The days of the $30 million SMSF are over, and so they should be. Once its consequences filter through to the general public (for example, the $25,000 cap on concessional contributions), the legislation may have a heavy impact on the SMSF sector in terms of a diminishing growth in numbers established.
Having said that, reports of the death of SMSFs have been greatly exaggerated on many occasions. Making a prediction about their imminent demise would be premature. Such is the desire by members of the public for direct control of their superannuation savings, and such is the unlimited creativity of advisers in working out ways to use and abuse the system (I could write a book on that subject and may well do so one day).
SMSFs face two big threats
The real challenge to the viability and credibility of the SMSF sector is twofold. The first is the ability of trustees to legally borrow (gear) in order to buy real estate and other assets, such as shares. This law, which the Murray Financial System Inquiry wisely recommended be repealed, introduced unnecessary investment and regulatory risk into the system. Allowing SMSFs to borrow is poor public policy and it should be repealed; however, the government has decided to review the law in “a few years”. It is unlikely that a review will ever happen (such is the nature of the political process), although the occurrence of a scandal involving SMSF gearing would greatly increase the likelihood of a review.
So it’s a case of “watch this space”.
The second challenge is much greater than the first, but is rarely discussed because its consequences are potentially enormous and a politically acceptable solution is not obvious. The issue is the ageing cohort of SMSF trustees and their diminishing ability and enthusiasm when it comes to managing and controlling their superannuation affairs.
In the not-too-distant future, there will tens of thousands of SMSF trustees in their 70s, 80s and beyond. This presents risks at many levels. There is the regulatory risk that trustees will fall short in their compliance obligations – but that’s the least of our worries. There is also the risk of poor investment decisions caused by incompetence and diminished abilities. Then, sadly, there is the risk of elder abuse by professional advisers and relatives seeking access to the large sums of money SMSFs typically hold. These risks are not just theoretical. They are a real and present danger, as acknowledged by the Australian Law Reform Commission. It’s not a case of something that may happen. Something will happen. I confidently predict that unless we urgently develop and implement public-policy responses to eliminate these hazards, scandals and personal tragedies will result. The problems will be widespread and will seriously damage the robust superannuation system that has been developed in this country since the 1980s. Not to mention costing the taxpayers billions of dollars to remedy the situation.
A contribution to public policy
I do not claim to have all the answers to this challenge, but express the hope that an urgent conversation might be started in the industry to offer solutions before extensive damage is done. This is one subject on which the financial services industry has the practical experience and knowledge to make a meaningful contribution to public-policy development without waiting for government to act through legislative amendments. Thankfully, on this unusual occasion, the public interest and the commercial interests of the industry are in alignment. So there’s no excuse for avoiding the conversation, which will only become more difficult, emotional and costly the longer we put it off.