Finding the right balance for SMSFs

The findings of the Cooper Review have given self-managed superannuation funds increased legitimacy but, as Damon Taylor writes, people are still questioning the way SMSFs are being treated for regulatory purposes.

Self-managed superannuation funds (SMSFs) represent the fastest-growing segment of the industry, accounting for almost a third of assets — suggesting to many that the time has come for the Government and regulators to treat them accordingly.

SMSFs can no longer be called a cottage industry, and for Sharyn Long, chair of the Self-Managed Superannuation Fund Professionals’ Association of Australia (SPAA), the developments of 2010 have only served to reinforce that fact.

"The last 12 months have been a period where we’ve been particularly active and I think our voice has been heard to an extent that it hasn’t previously," she says.

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"Our representation and involvement with the Cooper Review, our involvement in the hand-down of the Henry Review and also of the Federal Budget, the fact that we were able to influence the Minister [Chris Bowen, former Minister for Financial Services, Superannuation and Corporate Law] and have an outcome as far as the Minister’s final decision on collectibles and the recommendations of Cooper."

"All of these things demonstrate that the SPAA has a real and significant voice, as does the SMSF sector," she adds.

Graeme Colley, technical manager of SMSF administrator SuperConcepts, says that the Cooper Review’s recognition of SMSFs and the important role they now play in Australia’s wider superannuation industry has been a particularly dynamic change.

"Prior to that, people were treating self-managed fund [trustees] as someone they didn’t want to talk to," he says.

"And obviously that should never have been the case. The reality is that they’ve been one third of the industry for a long, long time and if you look at the stats that are coming out from the ATO [Australian Taxation Office] that presence only seems to be increasing."

"At this point, the next key change is largely dependent on whether the Cooper Review will actually be implemented either in part or in full," Colley continues.

"A lot of the change that’s been flagged has to do with competency standards and one of the criticisms coming from the bigger parts of the industry have been that people in the self-managed fund space are relatively incompetent because things like RG146 (Regulatory Guide 146) certainly don’t require that you have expertise or knowledge of SMSFs to go out and talk about them.

"So if that sort of change comes in and those criticisms are deflected, that’s definitely another space to watch."

Echoing Colley’s view regarding negative perceptions of SMSFs from the ‘bigger end of town’, Long says that for many industry participants, SMSFs have been considered a nuisance.

"But I think that’s changed now and Jeremy Cooper [Chair of the Super System Review] and the Minister [Bill Shorten, Minister for Financial Services and Superannuation] and everyone who’s influential has basically said that while SMSFs are not there for everyone, they are a valid part of the sector and they do suit a certain demographic of people who want to have control," she says.

"There’s always going to be further to go when it comes to increasing the profile of SMSFs but one of the fundamental things we see in superannuation is constant change."

"It undermines credibility and people become nervous as a consequence. The one thing that people say to me most often is ‘Well, that’s all well and good now but what will be the rules when I do retire?’ and ‘If I put my money in now, is it still going to be tax free in 10 years time when I’m ready to retire?’" continues Long.

"So stability and consistency is key here. We all acknowledge that there’s still some way to go in terms of the Cooper recommendations that haven’t been endorsed or those that the Government hasn’t commented on and we’ve still got the Financial Service Reform happening as well.

"So there’s no doubt that we still have a way to go but what we’re saying is that things aren’t broken, we’re tweaking the edges a little here and there but we do need to restore consumer confidence right across the sector," she adds.

Indeed, given the significant strides made by the self-managed sector of the super industry to this point, one of the more interesting questions to be posed is whether they are now a concern for industry and retail fund trustees.

To date, their growth has not slowed meaningfully at any point and according to John McIlroy, CEO of Multiport, their attraction to superannuants has been a concern for mainstream funds for some time.

"Certainly for the retail sector, when you look at the money that’s going out of retail-based funds and wraps, significant parts of that are going into SMSFs," he says.

"Some institutions actually identified it a while ago and have looked to put offers or arrangements in place so that they don’t necessarily completely lose the money."

"In our own situation, being a subsidiary of AXA since the middle of last year, they identified three or four years ago that they wanted to be a player in this market and that was not only because they thought it was going to be an area of growth, but because they were losing money to the sector," McIlroy continues.

"And I think it’s a similar story for most institutions. You’ve now seen companies like SuperConcepts becoming part of ANZ, Multiport being a part of AXA, Perpetual owning SmartSuper, so you’ve seen evidence of it occurring already.

"So from retail funds’ point of view, it’s obviously a pretty significant issue for them and I’m sure we’ll see more organisations do things in this area."

For Long, the reality of an increasingly competitive market means that retaining members has to be a core concern for all funds.

"And my personal view is that SMSFs possibly have a lot to gain from the MySuper product," she says.

"It's still to be decided what final form that will take but my understanding of how its proposed right now is that every APRA-regulated [Australian Prudential Regulation Authority] fund in Australia is going to have to offer a MySuper product which is going to be a low-cost, no bells and whistles type of product which will suit the 60 to 70 per cent of members who are disengaged.

"The 30 or 40 per cent of membership that are engaged, those who want the more sophisticated products and who want better insurance options and more investment choice will potentially incur a larger cost to have those products within a larger fund that’s offering a very low cost product to the majority of members," Long adds.

"So in actual fact, those funds may be disadvantaged when that MySuper product comes in because they may not get the economies of scale that they need to be able to provide the more sophisticated products, those products with more bells and whistles for those members who want them."

According to Long, a likely response from those members with higher account balances could easily be looking to a SMSF as a better option.

"In a SMSF, they may be able to achieve what they’re looking for at a lower cost than what they would pay if they remained with an industry or retail fund," she says.

"Time will tell on this. We still have some detail to play out on how MySuper will actually look but if it goes ahead as it has been suggested, then I think if you can’t get that in one of those not-for-profit or retail funds at a reasonable cost then you are going to look for alternatives and SMSFs offer a viable alternative."

Naturally, all is not entirely rosy for SMSFs. Despite the progress that the sector has made in recent times, there are problem areas yet to be covered and for McIlroy, chief among them is compliance.

"There are a lot of funds out there that are run very well but there’s also a lot of funds that aren’t run terribly well and there is certainly room for general improvement," he says.

"The question is how do you make them improve. Obviously the ATO has increased their resources in the audit area but if they were to increase their resources a bit more, then that might improve things a bit."

"Unlike ASIC [the Australian Securities and Investment Commission], the ATO also doesn’t seem to publicise it too much when it penalises people for breaches so perhaps there’s not enough acknowledgement that if people do breach the rules, then there’s a serious consequence," McIlroy continues.

"For instance, there was a case just recently where the ATO fined a trustee $55,000 and they were on 12 months of periodic detention.

"Now if they publicised it when they are imposing more significant penalties, then it might make a few people take a bit more notice."

Alternatively, while Colley agrees that raising compliance standards is still a challenge for the SMSF sector, he says that increasing the publicity of non-compliance as a deterrent is not always possible.

"In the super industry’s current form, you’ve got APRA looking at the larger superannuation funds in that prudential way, looking at systems and the way in which the processes operate whereas with SMSFs, the ATO looks at the sector at a more micro level because that’s where the compliance issues are," he says.

"I know that [deputy Commissioner of the ATO] Niel Olesen, in one of his recent speeches, did mention there were a number of issues that are still coming up and one of his concerns is just the lodgement of returns because while it’s improved, he still isn’t absolutely happy with the percentage of returns that were being lodged for self-managed funds."

"In terms of publicising non-compliance, the Commissioner is bound by secrecy provisions," Colley continues.

"That’s the difficulty here because even though he may wish to publicise the reasons for some of the penalties that are being imposed, its only when things get to court that it becomes public information."

"Improvement here has to be a gradual process. The Commissioner already highlights those compliance areas he’s most concerned with as a general rule, so things like non-lodgement and borrowing, and they’re the things that need improvement but I think generally the regulators see that the SMSF area has made significant progress."

Yet beyond compliance, one of the more common arguments around SMSFs, and one the sector cannot seem to shake, relates to minimum account balances.

The argument has always been that an account balance of $200,000 or less is insufficient to take full toll of the advantages that SMSFs boast however, according to McIlroy, the question really comes back to cost.

"I actually used to be an adviser and my recommended entry point was probably a bit higher than $200,000, not so much because it might not be economical but because if you’re trying to get diversity through a SMSF, you’ve got to have a reasonable amount of money in there," he says.

"But if you used an example of $150,000, if I’m in a retail fund I’m probably paying around about 1.5 per cent so can I do that inside a SMSF? If the plan is to have 10 shares, a cash account, maybe a couple of managed funds, then the answer is yes, I probably can get it administered for similar amounts of money.

"I think it comes down to comparing the cost of where you are now and then, if you moved to self-managed, how are you going to invest it," adds McIlroy.

"If I was investing it all back through a wrap account, then economically it doesn’t make sense but if you’ve got a direct investment portfolio where I’m not incurring a second lot of administration fees, then it can be okay."

McIlroy says that while the sale of SMSFs to people for whom they aren’t appropriate is always a possibility, he would never be in favour of a mandated minimum account balance.

"In many ways, imposing some sort of minimum account balance barrier would be impossible because you could be starting off with $100,000 but then intend to pump it up with contributions," he says.

"Providing that the regulations ensure that there is adequate disclosure of what the costs are, then there’s no problem here."

"It really comes back to the disclosure aspect of it and making sure potential SMSF trustees understand exactly what the costs are."

Colley says that if a superannuant is going into an SMSF from a cost point of view, then between $150,000 and $200,000 is around about the break-even point.

"Now often people in the initial years won’t have $150,000 or $200,000 that will go into super but over a reasonable number of years, if they contribute full amounts, you would hope that they get up around those levels," he says.

"So if cost is the sole issue, it might be worth putting your money into another fund and then rolling it over into a SMSF later down the track.

"And if that’s not the issue, you’ve just got to be prepared that in the earlier years that it may be relatively expensive to put your money into the SMSF," Colley continues.

"What I would point out though is that you don’t see other superannuation funds saying that from a cost point of view, there are other funds that are cheaper than the fund you’re in now. That’s something that’s certainly not being said at the larger end of town."

Pointing out that Jeremy Cooper as well as current and former Ministers for Financial Services and Superannuation have all said that they aren’t going to stipulate a minimum account balance for SMSFs, Long says that provided trustees are getting sound advice about the establishment, they should understand the consequences of what they’re doing and the costs associated with it.

"It’s true that the majority of costs associated with SMSFs are fixed costs so therefore the lower the account balance, the more you’re going to pay as a percentage of your assets," she says.

"However, trustees should be sophisticated enough to know that and advisers should be pointing that out very clearly to clients before they establish SMSFs."

"People think we need to mandate a minimum account balance because quite often SMSFs are started and then rollovers come in and they take time or they’re established with a view to putting in retirement assets and so on," Long continues.

"There could be any number of reasons for establishment and any number of reasons why you may have quite a small account balance on day one, but the bottom line is that there’s a lot of complexity around how you administer a minimum account balance to start with.

"My view is that the way to deal with that is ensure that advisers are providing the right advice and that trustees are fully informed before they establish."

"It’s obviously something that the wider industry has picked up on and it’s something that SMSFs have received criticism for, but the vast majority of funds actually have much stronger account balances than anywhere near the minimum that’s being suggested."

Of course, as with all sectors of superannuation, waiting in the wings for Australia’s SMSFs is the potential change that may result from Jeremy Cooper’s Super System Review.

Yet with respect to the SMSF changes that seem likely, Long suggests that the proposed removal of the accountants’ licensing exemption has already taken much of the focus.

"The accountants’ exemption will be a big factor in the coming period in terms of how that plays out," she says.

"The recommendations are that it will go, but what form of licensing will be required for accountants is still subject to industry consultation."

"The majority of people who establish a SMSF see their accountant in the first instance, and under the accountant’s exemption, an accountant can assist a client in establishing an SMSF," Long continues.

"If that exemption is removed then an accounting practice will need to have a licence in order to be able to provide advice on establishing a SMSF, whereas at the moment, an accountant can’t provide advice on other sectors unless they hold the appropriate licence."

Long says that as things stand, the accountant’s exemption has limitations in that they can only provide advice on one particular sector: SMSFs.

"They can’t provide it across the board; they can’t provide advice and compare products," she says.

"So obviously there are limitations in the current model and it needs to be changed, but whether we will go to full licensing which I think is what has been suggested, that has yet to play out but certainly has the potential to change the way we operate currently."

Focusing not just on the removal of the accountants’ licensing exemption but also on the combined effect of proposed changes, McIlroy says that he anticipates the changes will impact SMSF service providers rather than trustees.

"If you combine a couple of things together, one being the potential removal of the accountants’ exemption, secondly the registration of auditors and additional requirements for more education, and then additional requirements on licensed advisers giving advice in this area and having specific education in SMSFs," he says.

"If you put all of those things together, then given the thousands of service providers in this area we believe there will be a rationalisation in the number of service providers."

"I think the stats are that over half of accountants have 30 or fewer funds as clients and realistically, for a lot of them, that’s not really an economic number of funds to get registered, do training, do all of those sorts of things," McIlroy continues.

"So the demands on the practices for registration, additional education, whatever, may push some of them to say that they can’t be bothered anymore. You might see them outsourcing work, potentially doing joint ventures with financial planners or instead of doing the audit work themselves, farming it out to specialist auditors."

"We can see quite a bit of rationalisation happening which will probably compress the number of service providers in the industry and mean that those remaining will be truly specialised."

Yet irrespective of the change that may come from the Cooper Review and the areas of improvement that remain for SMSFs, the fact remains that this is a sector of superannuation that has earned its growing legitimacy and for Long, continued growth is inevitable.

"But the lifting of standards in professional advice for all service providers to the sector is critical," she says.

"Maintaining the status quo and not changing for change’s sake is also vital. We really need bipartisan support on superannuation and we need to stop fiddling with it."

"If you’re in your 40s now and you’re not going to retire for 20 or 25 years, you want to know that the rules you invest under or accumulate your savings under are going to be the same as the rules you retire under," Long continues.

"And that doesn’t only affect SMSFs, it’s just that because SMSF trustees are more engaged, they tend to be much more concerned about such issues."

"But certainly, stabilising current legislation is going to be fundamental to the strength of this sector."

According to Colley, though the sector has its fair share of challenges, it is tracking well.

"When you hear Jeremy Cooper say that SMSFs could be the fund of choice in 20 or 30 years time, that certainly seems to give it a fairly bright future," he says.

"And if we see an improvement in the competency on both the adviser and administrator side of things, then hopefully that will flow through to members and trustees.

"If that happens and we continue to see strong retirement outcomes then at the end of the day, I don’t think you can complain about SMSFs."