It’s been said there are no certainties beyond death and taxes. Even the latter appear to be truly optional for many large corporations, high net worth individuals and the growing number of citizens inhabiting the cash economy.
There is another certainty, however, namely the enthusiasm with which Australians embrace self-managed superannuation funds (SMSFs). The statistics are remarkable. There are more than 650,000 SMSFs, which now account for more than 99.7 per cent of all superannuation funds and more than 30 per cent of superannuation assets, with an average balance of more than $1 million.
What is 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. Three decades 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.
Over 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 that 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) they love to hate. Even when a superior return is not achieved, it makes no difference. Clients want to keep control at almost any cost.
This 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.
This sector’s inexorable growth has somewhat disturbed the traditional superannuation industry, which is principally inhabited by large financial institutions operating retail superannuation 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 the children. The days of the $30 million SMSF are over, and so they should be. Once its consequences filter through to the public, the legislation may have a heavy impact on the SMSF sector in terms of a diminishing growth in numbers of new funds established. Having said that, reports of the death of SMSFs have been greatly exaggerated on many occasions. Therefore, 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 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.)
The real challenges to the viability and credibility of the SMSF sector are twofold. The first is the ability of trustees to legally borrow (gear) to buy real estate and other assets, such as shares. This law, which the Murray Financial System Inquiry wisely recommended be repealed, introduced an element of unnecessary investment and regulatory risk into the system.
The second challenge is much greater than the first, although it is rarely discussed because a politically acceptable solution is not obvious. The issue is the diminishing ability of an ageing cohort of SMSF trustees to manage and control their superannuation affairs – and their diminishing enthusiasm for doing so. In the not too distant future, there will be 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. That’s the least of our worries. There is the risk of poor investment decisions. 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, particularly the latter, are not theoretical. They are a real and present danger, as the Australian Law Reform Commission recently acknowledged. This is not a case of something that may happen, it will happen. I confidently predict that unless we urgently develop and implement public policy responses to combat these risks, they will result in many personal tragedies. The problems will be widespread and will seriously damage the robust superannuation system that has been developed in this country since the 1980s. And that’s not to mention the billions of dollars in costs to the taxpayers to remedy the situation.
I do not claim to have all the answers, but I 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 in 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 legislation. On this unusual occasion, the public interest and the commercial interests of the industry are in alignment. So there’s no excuse to avoid this conversation, which will only become more difficult, emotional and costly the longer we delay having it.
TOPICS: self-managed superannuation funds (SMSFs)