The Productivity Commission’s latest draft report on the efficiency and competitiveness of superannuation – along with all the ensuing media attention – focused mostly on the activity of industry and retail super funds, but when it did touch on self-managed superannuation funds, it made some interesting points.
Firstly, the commission did report that SMSFs with low balances produced poor net returns compared with Australian Prudential Regulatory Authority (APRA)-regulated funds, due to their administration costs.
This does highlight one problem for the SMSF industry. Administration charges have been inflated over the years by some practitioners and service providers. In these instances, the value of a member’s balance, rather than the actual cost of administration and compliance, determines what the cost will be.
It can be hoped that one outcome of the Productivity Commission’s review will be a ban on administration costs based on the value of an SMSF’s assets.
Secondly, one of the Productivity Commission’s findings – which I disagree with – is that small SMSFs, those with less than $1 million in assets, perform significantly worse that institutional funds. The commission held that this was due to the materially higher average costs that they incur, due to being small.
This finding does have some foundation when looking at the administration costs of a super account in accumulation phase. But when members commence account-based pensions, the difference in administration costs for an SMSF with less than $1 million in assets is not that great even when compared to industry funds.
Accumulation versus pension
SMSFs in accumulation phase have no hope of competing with industry funds. An accumulation account has administration costs ranging from $80-$250, while administration and compliance costs for SMSFs are generally in the range of $1500-$3000.
When an account-based pension is commenced in an SMSF, there should not be a large increase in administration costs; however, when a member commences an account-based pension, even in an industry fund, the administration costs increase dramatically.
For example, a member with a balance of $500,000 in an account-based pension pays just over $600 with AustralianSuper and almost $900 with UniSuper. In a two-member SMSF with balances of just under $500,000 each, the administration cost at this phase can be $2200, only slightly higher than the administration cost of some industry funds.
Beyond costs
Focusing just on costs ignores one of the major reasons people set up SMSFs: control.
I have had some clients that set up an SMSF invest only in very secure areas, such as bank term deposits, and despite having it pointed out that they would be better in an accumulation account within an industry fund, say they do not care because they want to have the control over their superannuation retirement assets.
Limited recourse risk
The depth of the assessment the commission has undertaken cannot be questioned, given the draft report was in excess of 500 pages. Interestingly, though, SMSFs got almost only a passing mention.
One of the more interesting facts in the report concerning SMSFs related to limited-recourse borrowing arrangements. The finding reflects what I have experienced as an adviser to SMSFs for more than 30 years, and contradicts what some critics of SMSFs have been saying.
The commission, in its 65-page overview report, stated that due to the small number of SMSFs that were entering into borrowing arrangements – about 7 per cent of SMSFs, with a value of only 4 per cent of total SMSF assets – “such borrowing is at present unlikely to pose a material systemic risk”.
Despite limited-recourse borrowing arrangements presenting no material risk to the superannuation system, I believe there should be greater regulatory scrutiny of super funds that have been and are being set up as a means for property developers and their spruikers to sell real estate.
Max Newnham is in public practice, specialising in small business and retirement tax planning. He is an SMSF specialist and advises on portfolio construction and investments.
