SMSFs, past present and future by John Maroney

Volatility back on the table for 2020 following benign 2019
January 30, 2020
Fidelity finance and Australians overall wellbeing
January 30, 2020

MEDIA RELEASE: John Maroney, CEO SMSF Association

The history of self-managed super funds (SMSFs) dates back for several decades. Today I will focus on the past 20 years, which is the time when the responsibility for self-managed super funds shifted from APRA to the ATO.

For those interested in the history of the sector, there is an interesting cabinet submission that details the rationale for the shift which was recommended by Stan Wallis and the Financial System Inquiry in 1996.

20 years ago, there were around 200,000 excluded funds regulated by APRA which held $55 billion in total assets. I find the use of the term excluded funds quaint, as it shows the mindset that these funds were not regarded as a key part of the superannuation system. Technically, it referred to their exclusion from certain prudential regulations which were not necessary as most of the members were trustees and hence were looking after their own interests and their own assets.

Since the ATO became the regulator, there has been major growth in the SMSF sector to almost 600,000 funds and over $750 billion in total assets. This sector now represents almost 30% of the total superannuation system compared to 10% in 1997.

The regulation of SMSFs by the ATO has evolved over the past 20 years and has been the subject of or affected by a number of reviews and inquiries since the reviews by the Wallis inquiry and the ISC. These reviews have included the superannuation system review undertaken by Jeremy Cooper, the future of financial advice inquiry undertaken by Bernie Ripoll, the Financial System Inquiry undertaken by David Murray and the most recent inquiry by the Productivity Commission. I should mention that both Jeremy Cooper and Bernie Ripoll are now on our Public Policy Committee and Bernie recently joined our Board. We highly value the input they provide.

All of these reviews have had an impact on the SMSF sector but they have generally been supportive of the sound operation and high degree of integrity that exists in the sector. This does not mean there were no areas identified for improvement and many improvements have been implemented over the past 20 years.

The SMSF Association came into existence in 2003 at the encouragement of the regulator and the government to ensure that the level of integrity and professionalism within the sector would be improved over time through the adoption of quality education standards, accreditation standards and encouragement for all participants to act in the best interests of those who choose to use a self- managed super fund for their retirement savings.

Over that time frame, a sophisticated and dynamic SMSF ecosystem has developed and there has been substantial investment and utilisation of information technology solutions and platforms by most funds to replace prior manual and spreadsheet based record keeping systems. This use of technology has dramatically expanded the ability for members and their advisors and accountants to improve engagement and efficiency and to ensure that regulatory requirements, including audit requirements, are satisfied by the vast majority of SMSFs. The use of cloud based technology is the most recent trend and this is a major enabler to ensure that the future of the SMSF sector will embrace consumer expectations for real-time information and reporting, to enable accountants and advisers to provide advice and guidance that meets the needs of their clients.

The most significant changes in recent years have been the 2017 changes introducing the $1.6 million transfer balance cap and the $1.6 million total superannuation balance limit, beyond which non-concessional contributions are no longer permitted. Of course these changes applied to the whole superannuation system, in conjunction with other changes such as “putting members interests first” and “protecting your super”.

We also had a very interesting federal election last year, where several proposals including changes to the refundability of franking credits were proposed by the Opposition that could have had a severely negative impact on the SMSF sector.

More recently, we have extensive recommendations from the Royal Commission and the Productivity Commission that will impact upon the whole financial system and upon the SMSF sector to some degree.

One of the distinguishing features between the SMSF sector and the rest of the superannuation system is the exposure to both commercial and residential property, often via limited recourse borrowing arrangements. The SMSF sector’s exposure to these asset classes is reviewed regularly by the Council of Financial Regulators and their most recent report in 2019 indicated that there was no need to restrict such activities based on concerns about potential systemic risk, due to the low overall potential impact on the property sectors.

Turning to the present day, the SMSF sector represent a major part of Australia’s overall superannuation system, which is regarded very highly on a global basis, as evidenced by the Mercer global pension index and other reports that indicate Australia is much better prepared to deal with its demographic challenges from an ageing population compared to most other countries. The SMSF sector is unique on a global basis and demonstrates the willingness of consumers to make large voluntary contributions to the superannuation system, if they are engaged and have confidence in their ability to manage and control their own retirement savings. Of course, it is also dependent upon the overall incentives from the taxation and social security systems to be adequate to encourage consumers to make voluntary contributions to their retirement savings.

Some interesting statistics on the SMSF sector demonstrate how successful it has been building retirement savings for over 1 million Australians and how the vast bulk of those savings are being used to provide retirement income for those who have entered the retirement phase.

All of the settings of our superannuation system will be examined this year by the Retirement Income Review. Before the review was called, the SMSF Association encouraged the Treasurer to include six questions in the terms of reference. These were:

  • What overarching objective or set of guiding principles for Australia’s retirement income system would foster greater certainty and stability across the retirement income system?
  • What does an efficient drawdown of retirement savings look like and how should preservation and utilisation of capital interact with this concept?
  • What is an adequate level of retirement income to ensure individuals are able to reasonably maintain their pre-retirement standard of living throughout their retirement?
  • What optimal level of Superannuation Guarantee should be included in an efficient and effective retirement income system?
  • What type and level of incentives to encourage individuals to save for their retirement should be included in the retirement income system without producing an excessive impact on public finances?
  • What is the role and interaction of each part of the superannuation system in the retirement income system? This should include recognition that SMSFs comprise almost one third of the entire superannuation system’s assets and are an appropriate structure for many Australians.

We are also still waiting to learn what the government will do with some of its proposals in the 2018 budget, including the increase in the maximum number of members from 4 to 6 and the proposal to shift the frequency of audits of some SMSFs from annual to 3 yearly. We expect the number of members issue to be re-introduced to Parliament in the near future while we expect the audit changes not to proceed given the substantial concerns raised by many submissions including from the SMSF Association.

Another key area of concern relates to the manner in which FASEA is executing its mandate, especially in relation to the code of ethics which came into force earlier this month. We fully support the goals contained in FASEA’s mandate to lift standards of education and ethics, however we would encourage them to undertake more effective consultation with all interested stakeholders to enable smooth implementation of very significant changes.

Other issues of concern were the SMSF fact sheet published by ASIC last year and distributed to all new SMSFs during November on a pilot basis, following a Productivity Commission recommendation to ensure greater visibility of the red flags that new SMSF members should consider. We took issue with some of the figures that ASIC included in the fact sheet because they were unbalanced and inappropriate. The average expense figure represented a questionable use of ATO statistics as a more appropriate figure would relate to the median operational and investment costs of funds under $500,000 which is under $5,000 per annum compared to the figure of almost $14,000 used by ASIC.

The ATO also wrote to about 18,000 SMSFs encouraging them to review their investment strategy where they had a high exposure to a single asset class, especially geared property. We support compliance with all regulations, including investment strategy requirements and corresponding investment decisions. However, we have encouraged the ATO to be clear in its communication to ensure that all trustees are not frightened unnecessarily when the concern relates to a small component of the whole sector.

The marketplace for the whole superannuation system and for financial advice and SMSFs is very dynamic at the moment. All of the major banks have announced or commenced movement away from directly providing wealth management activities and owning major dealer groups. This will lead to an increased reliance on smaller dealer groups and self- licensed advisers to meet advice needs across the whole financial sector.

Only a few major groups, including AMP and IOOF, remain committed to the provision of financial advice as part of their overall offering to customers. There is much interest in how successful the future strategies of these groups will be, as other parts of the financial system step up to fill the gaps that have been created.

One interesting move is the offer by industry funds, such as Hostplus, to SMSFs to use some of their investment options without needing to become members. We support the continued expansion of investment options, especially in the infrastructure and alternative investment categories, to SMSFs. We are strong believers in choice and competition and believe the whole superannuation system will benefit from continued expansion in choice in competition.

We strongly believe that SMSFs are an appropriate vehicle for a large number of Australians but not for everyone. Hence, we should make it as easy as possible for those who wish to use an SMSF, where it is appropriate, to do so. We should also make it as easy as possible for those who choose to shift from their SMSF to a large superannuation fund to do so.

One of the major initiatives underway to enable this to happen is the full inclusion of the SMSF sector into superstream, which will enable electronic rollovers in both directions. Currently, this can take any weeks for rollovers to be processed which does not meet community expectations compared to other financial transactions. Of course, we need to be concerned about risks of identity fraud, the illegal early release of super funds and cybercrime. However, these concerns apply right across the financial system and hence need to be managed in a holistic and comprehensive manner. One of the risk factors for the SMSF sector, is that the size of rollover transactions can be very large and hence they could be more of a target for cyber criminals.

My final comment on the present situation for the SMSF sector, is that many elements of technology used to support all aspects of SMSF activity, including establishment, administration, financial advice documentation and investment activities is continuing to develop rapidly and is likely to underpin increased efficiency and greater member engagement.

Now moving to the most interesting aspect of this topic which is the future of the SMSF sector. Looking at projections for the whole superannuation system, such as those prepared by Deloitte, it is very likely that the SMSF sector will continue to grow strongly in absolute terms over the next decade or two but its share of overall system assets may reduce, as many existing SMSFs are in the drawdown phase and the overall age of SMSF members is significantly higher than for large super funds.

We do not subscribe to the view that there is a contest between different parts of the superannuation system to be the largest part. Our aim is to ensure that the SMSF sector remains attractive for those Australians who seek greater control of their own financial destiny in conjunction with their advisers or via their own management of their SMSF. We do not seek a particular market share, that is the outcome of people exercising their choice in a competitive market. Our role is to help encourage the SMSF sector to maintain high integrity, high levels of efficiency and strong professional standards, so that the choice of an SMSF remains an attractive and viable choice for many Australians.

Many of the issues that are now facing the SMSF sector, with a high proportion of members in the drawdown phase, will be faced by large superannuation fund members over the decades ahead. These issues include estate planning, dealing with cognitive decline, managing low real rates of return on defensive assets and dealing with longevity risk. To date, most large funds are focused on optimising their operations during the accumulation phase. There will need to be a shift towards optimising how the funds operate in the drawdown phase for the members.

Many ongoing impacts of the Royal Commission recommendations and the Productivity Commission recommendations will take several years to work through the system.

The impact of the Retirement Income Review will be very important but is more uncertain, given the nature of the review to develop a fact base, rather than a list of recommendations.

The Review Panel has put a long list of very important questions in front of the Australian community. Many of these questions have been asked from time to time over the past 30 years and we are still grappling as a community to provide answers to such basic questions as what is the goal of the retirement income system, including superannuation, age pension and voluntary saving, including my home ownership.

We are hopeful that the Review will deal with these important questions, by gathering an evidence base and providing projections, illustrations and options that will lead to a more informed community debate on important issues once the Review has been completed. We look forward to fully engaging during the Review and most importantly after the Review has been completed.

We believe that one of the most important concerns is the level of unmet financial advice that will make it much more difficult for people to plan for their retirement and to execute those plans with a degree of confidence. The level of complexity in the system and the continued volatility in investment markets where most of the risk sits with the individual member produces much stress for retirees. Some longevity protection is provided by the age pension for those with modest assets at retirement or at older ages but for many retirees it is very difficult to share or manage their retirement risks.

The future role of financial advice regulation is crucial. We believe that a more customer centric advice framework is needed, where consumers can receive trusted and professional advice. Consumers really want affordable advice, delivered with the help of sophisticated technology, via a system of open superannuation similar to the open banking environment with clear consumer data rights. Important thinking is underway via the Senate select committee on fin-tech and reg-tech, chaired by Andrew Bragg, and many interesting ideas have already been put to the committee in the first round of submissions.

We expect market dynamics will continue to evolve and that the financial advice profession will gradually look more like a medical profession, where regular health checks can be undertaken using real-time data that is readily available for consumers and can be shared with their advisers. Efficient initial advice could be more like a half hour discussion with the doctor reviewing the results of general blood tests and measurements of height, weight, blood pressure, family history, rather than requiring extensive manual data gathering and days of manual analysis and report preparation that is primarily focused on risk mitigation for advisers, rather than value adding for consumers.

Of course, we do not want to reduce any of the consumer protections provided by the existing regulatory frameworks. However, we believe more effective regulation can be developed in practice and can be much better by focusing on what consumers really want and need. Mechanisms are needed whereby most Australians can have access to affordable advice with significant trust in the system.

This will require continued advancements in technology, rebuilding in trust from all participants in the financial system and from focusing on what is in the best interest of the consumer in reality rather than in theory. Protecting retirement savings and financial health of all Australians is at the forefront regardless of which forms of retirement savings are chosen.