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Examining the S in SMSF

One of the great misnomers in the Australian investment scene is that self-managed super funds are actually self-managed.

           

 

The simple reality is that there is an entire advice industry built around SMSFs – be they traditional accountants, financial advisers, lawyers or one of several SMSF administration platforms.

This makes the provision of quality advice to those Australians who have an SMSF – or those considering setting one up – absolutely critical, if the more than one million SMSF trustees are to achieve the best possible outcome when they retire.

Last month ASIC released a comprehensive report on the quality of advice and member experiences in the SMSF sector.

The 120 page report* will make uncomfortable reading for many in the industry because it calls out a high level of non-compliance with the best interests duty and, in a review of 250 client files by an independent expert, 10% of the files reviewed risked being significantly worse off as a result of the advice they received to set up an SMSF.

A healthy and vibrant SMSF sector is a vital part of our compulsory superannuation system. It provides a competitive alternative to the institutional APRA funds and gives super fund members an effective choice and alternative.

ASIC says that in the right hands “SMSFs can be very effective retirement savings vehicles. In the wrong hands, however, SMSFs can be a high-risk option”.

ASIC's focus was on funds set up in the past five years – so the research sample is skewed to relative newcomers to the sector – and while there are some strong messages for the advice industry on where it needs to lift standards, there are also some red flags that both existing SMSF trustees and those thinking about establishing an SMSF should pay attention to.

ASIC found common issues with the files reviewed centred on the disclosure of costs and risks about the set up and running of an SMSF, advisers not properly considering the client's circumstances or existing super fund and not prioritising the needs of the client.

So there is plenty for the advice industry to work on to improve outcomes for SMSF members and the overall professionalism of the advice industry.

While the reaction to the ASIC report has naturally been on the negative findings about advisers, the report provides balance by also highlighting case studies where good advice has been both given and acted on by the investor.

It also effectively holds up a mirror to trustees, or would-be trustees, with what perhaps is a challenging reality check around the personal responsibility that comes with the decision to set up an SMSF.

In some of the case studies provided by ASIC, financial literacy among trustees is clearly an issue with some trustees not aware of how their fund is performing, what it costs to operate or even if it has an investment strategy.

The bottom line is that an SMSF is not for everyone. Even someone who has good levels of financial literacy and resources may not be suited to an SMSF and ASIC cites the example of an investor with more than $2 million in super but no time or interest in running their own fund.

That level of personal self-awareness was clearly lacking among some of the SMSF trustees participating in ASIC's research. This raises the question of whether some base level of financial literacy needs to be demonstrated before the keys to an SMSF are handed over.

The stark example in the ASIC research is that 55% of the SMSFs in the research sample had more than half their money invested in one asset type. That level of portfolio concentration risk, ASIC says, means those members may face greater risk in reaching their retirement goals.

Nowhere is the issue of financial literacy more pointed in the SMSF world than on the issue of borrowing to buy property. What ASIC's online and face to face interviews showed is that for some an SMSF has become a happy marriage of convenience between those wanting to access the residential property market and using their super savings to do it.

Now Australian investors' love affair with property is beyond dispute. And the property market has generally been kind, to the point that ASIC found that the surge in prices in recent years particularly in Sydney and Melbourne markets had “created a sense of urgency driven by a fear of missing out”.

But perhaps this is a case of where love of the property market is making investors blind to risks and costs.

The fear of being locked out of the market is clearly playing into the hands of so-called “one-stop property shops”. ASIC's research showed that trustees who had used a property one-stop shop had quite different experiences to those using a financial adviser or accountant.

“After members had made a decision to set up an SMSF with a property one-stop shop they were introduced to related parties such as mortgage brokers, lawyers, insurance brokers, property management companies and property developers,” the ASIC report says.

What was surprising was not how the one-stop shops were operating but rather that the members seemed unconcerned about the potential conflicts of interest, and some even saw that as an advantage.

What is obvious from reading some of the case studies cited by ASIC was that some members didn't know if commissions or kickbacks had been paid to related parties, indeed they were vague about what the total cost of setting up the SMSF and the loan facility had been.

One Sydney case study – Luke – provided a hard-earned lesson for others to heed. He set up an SMSF to buy a property in Queensland after a cold call from an adviser and a related accountant. He found costs of buying the property were higher than he anticipated and costs of running the SMSF higher than he expected. He is now attempting to sell the Queensland townhouse for $22,000 less than he paid for it and his overall loss will be around $70,000.

In retrospect Luke admitted he should have done a lot more research.

Perhaps the only consolation for Luke is that judging by the ASIC research he sadly is not alone.

And while the financial advice industry has much to do to improve its level of professionalism, the trustees of SMSFs have to also take personal responsibility for both the decision to set up the fund, and for its investment decisions.

You certainly do not have to manage everything to do with an SMSF yourself, but if you are not prepared to spend the time understanding the costs of running an SMSF, setting an investment strategy and monitoring its performance, then you should seriously question whether an SMSF is the right retirement savings vehicle for you.

* Report 575 SMSFs: Improving the quality of advice and member experiences.

This article originally appeared in Cuffelinks on 26 July 2018
 

Written by Robin Bowerman
Head of Corporate Affairs at Vanguard.
01 August 2018
vanguardinvestments.com.au

Living expenses for retirees on the rise

The latest Association of Superannuation Funds of Australia (ASFA) statistics into retirement lifestyles has shown a jump in the cost for retirees during the June 2018 quarter, driven mainly by clothing, transport and health services.

         

 

The ASFA Retirement Standard figures for the quarter revealed couples aged around 65 had to spend $60,604 per year to enjoy a comfortable lifestyle, while a single person needed to spend $42,953 to achieve the same result. These amounts represent an increase of around 0.5 per cent compared to the previous quarter.

In addition, the standard showed achieving a modest lifestyle in retirement would require couples to spend $39,442 annually and singles $27,425, also a jump of about 0.2 per cent from the March 2018 quarter.

With regard to retirees aged 85 and over, their total budget for a comfortable lifestyle rose by 0.4 per cent and by 0.3 per cent for a modest lifestyle over the quarter.

Commenting on the result, ASFA chief executive Martin Fahy said: “The cost of retirement over the most recent quarter only increased by a relatively small amount and that is welcome news but many retirees will still find it difficult to achieve a comfortable standard of living in retirement.”

He singled out health care costs as a significant contributing factor.

“Health care costs are a significant burden for many retiree households. Health care costs in the budgets rose by over 2.2 per cent in the quarter, largely driven by the 4 per cent increase on average in private health insurance premiums,” Fahy explained.

While the overall cost of living increased over the quarter for retirees, the standard showed certain areas such as food-related expenses fell by 0.4 per cent.

The statistics also revealed the costs associated with leisure activities also dropped over the period mainly due to a 2.7 per cent reduction in the price of domestic travel.

 

 

Darin Tyson-Chan
August 23, 2018
smsmagazine.com.au

Still a long and bumpy road to travel on the way to a U.S.-China deal

Headlines about trade wars between the U.S. and other nations have been moving global financial markets this year.

         

 

In spite of talks toward free-trade agreements in other regions, trade frictions between the U.S. and China, the two largest economies in the world, have intensified recently. The increased frictions follow several rounds of cooperation, negotiation, retaliation, and escalation. So far, there has been limited progress on cooperation and negotiation. Instead, there has been another round of tit-for-tat tariffs on imports. The U.S. also has announced an additional tariff list that could take effect in the fall, if implemented. This has pushed us much closer to a trade war.

In disputes such as these, there are two final scenarios: win-win and lose-lose. Given the greater temptation not to cooperate, an ending in which both players lose is quite likely. Hence, it is understandable that the markets are highly concerned about an eventual trade war, especially since the risk of miscalculation and miscommunication between the U.S. and China is quite high, given numerous social, political, and cultural differences between the two countries.

The silver lining is that this is not a one-shot game. The U.S. and China could go for several rounds before they eventually settle into a more stable relationship, for better or worse. It is true that neither side is willing to let the other win easily and that each is still trying to test the other's limit at this moment. However, when the pain of the trade war becomes unbearable, the players may decide to back off, get back to the negotiation table, and restart. For the U.S., it may take a sharp decline in the financial markets and a significant deterioration in the labor market. For China, it could be the risk of a sharp deceleration of economic growth to below 6.3%, the pace necessary to achieve China's goal of doubling its 2010 GDP by 2020. Obviously, we are not there yet.

Higher chance of ending up with the lose-lose scenario

As the U.S. midterm elections approach, there is a decent chance of further escalation in the near term. Hence, we have revised the chance of a “trade wars” scenario from 30%–40% in May to 40%–50%. A trade war would lower growth in both the U.S. and China. The direct impact on growth in both countries would be manageable. Obviously, both are major players in the global economy; combined, they produce 38% of the world's GDP. However, their international trade, as large as it is, represents only 1.8% of total world trade and about 2% of their combined GDP. China's exports to the U.S. represent about 4% of Chinese GDP and U.S. exports to China represent about 1% of U.S. GDP.

Nonetheless, the indirect impact could be felt through the effect on the labor market and consumption, or via the effect on financial markets and business confidence.

This won't lead to a hard landing, but it does pose some downside risk to China's 6.5% growth target this year. In fact, Chinese policymakers have paused their deleveraging campaign and started to ease monetary and fiscal stimulus to cushion the potential negative impact from trade frictions. Our U.S. economists believe that in this scenario, the U.S. economy could face a modest reduction of 10–15 basis points given China's retaliation. In fact, since the second-order effects would be the more important negative driver, the U.S. administration will keep a close eye on financial market developments.

There will be a spillover effect on the rest of the world, too. From a value-added perspective, more than one-third of the goods exported from China are actually made somewhere else. This is particularly true for China's electronic and machinery exports, which have been the target products in the U.S. government's investigation into China's trade practices. For every dollar of goods that China is exporting, 20 cents comes from Asia and 7 cents from Europe. Certain Asian markets would be particularly vulnerable, such as Japan, South Korea, and Taiwan, given how integrated they are into the regional supply chain. Nonetheless, as long as the trade war is strictly limited to tariffs and protectionist measures, the global economy may not collapse into a deeper recession.

We see a 10% chance of ultimate “isolationism,” which would involve damaged diplomatic ties between China and the U.S. on multiple fronts—economic, political, and cultural. If major retaliatory measures are involved—such as a broad-based sanction against China and China's dumping U.S. Treasury bills in return—it could result in significant financial market disruption and eventually a global recession. Luckily, the chance is very low in our view since the outcome would be extremely negative for both China and the U.S., as well as for the rest of the world.

Not yet at the point of no return

Despite a higher chance of a trade war, there is still hope for eventual peace. Both countries understand that a trade war would be a lose-lose situation. As such, we continue to believe there is room for negotiation, especially when the pain becomes unbearable. We assign a 40%–50% chance to a “protectionist” scenario, with modest implementation of trade tariffs/retaliation and an ultimate negotiation on a comprehensive trade and investment agreement between China and the U.S. Even so, the path to that eventual deal is likely to be bumpy. While this scenario will have only a marginal impact on the global economy and inflation, it will translate into volatility in the market.

Trade frictions to get worse before getting better

Select U.S. tariffs likely to be used to gain leverage in future trade negotiations.

Source: Vanguard Investment Strategy Group as of July 2018

U.S. and China frictions over the long haul

Disagreements on bilateral trade represent only the first of two conflicts between China and the U.S. The other conflict is over longer-term issues and will be much more strategic and prolonged. It will focus on issues fundamental to the structure of the Chinese economy. The U.S. is pressuring China to live up to its promise to the World Trade Organization by further opening markets and pushing forward market-oriented reforms. Hence, although a comprehensive trade and investment agreement could be reached eventually, the bumpy path of negotiation on other issues will continue.

On this front, China has shown willingness to cooperate as this would ultimately benefit its long-term development through more efficient capital allocation. That in turn will eventually lead to higher productivity and growth potential. Indeed, President Xi announced at April's Boao Forum that China is planning to further open the domestic financial market, relax the foreign ownership limit in the auto and financial industries, enhance the investment environment, strengthen protection of intellectual property rights, and ensure a level playing field. However, the pace and scope of any such opening and reforms are at the core of the second conflict, especially regarding government subsidies to high-tech industries and state-owned enterprises.

What should investors do?

Along with the long and bump path of negotiation between the U.S. and China, volatility in global financial markets is likely to persist. Despite the up and downs, we advise investors, first, to maintain a diversified portfolio given the heightened uncertainties in the current environment and, second, stick to their long-term investment portfolio. That should give investors a better chance to weather the short-term volatilities and achieve long-term investment success.

 

By Qian Wang, PhD
Managing Director and Chief Economist, Asia-Pacific
14 August 2018
vanguardinvestments.com.au

Smart spouse investing

Spouses have clear motivations to at least consider the potential benefits of taking a co-ordinated approach to savings and investing – as well as in dealing with their day-to-day budgeting.

         

 

The motivations for couples to think about a harmonised approach to family finances are rising. This is, in part, because of the lowering of super contribution caps, the new $1.6 million pension transfer cap and a proposal to increase the maximum number of members in a self-managed super fund (SMSF).

Wealth management

Whether a joint approach to money works in the interest of both spouses much depends, of course, on personal circumstances.

In a few words, the potential benefits of such an approach are that couples are working together to achieve mutually set financial and personal goals.

By contrast, spouses with an uncoordinated approach may be unintentionally pulling in different directions. They may not be making the most of opportunities to save and invest, and perhaps have no realistic impression of how far their savings will stretch in retirement.

Consider making a list of at least the fundamental ways that you and your spouse can harmonise your finances and then perhaps discuss the list with an adviser.

Your list may include: budgeting together, setting shared long-term goals, co-ordinating investment and saving strategies to achieve those goals, and setting appropriate asset allocations and diversification for portfolios held jointly and individually.

Other critical matters to add to your list include: deciding whether your family has enough life, disability, income-protection and medical insurance; minimising investment costs that handicap investment success; and undertaking co-ordinated estate planning.

An estimated two-thirds of Australian couples are in a marital relationship at typical retirement ages. As actuaries Rice Warner comments in a research paper, it “simply makes sense” for them to take a synchronised stance to managing their wealth.

Age pension eligibility and payments are based, of course, on “singles” or “couples”, adding to the case for couples to take a co-ordinated approach.

Raising a family

Couples with a co-ordinated stance to managing their money typically improve their chances of catching up on their super contributions while one takes a few years off work to raise children. For instance, the partner remaining in the workforce could increase their super contributions if possible or split their contributions with a spouse taking time out of the workforce.

Super caps

The lowering of the contribution caps and the introduction of the $1.6 million pension transfer cap provide a further incentive for a couple to combine and co-ordinate their savings efforts.

The indexed $1.6 million pension transfer cap is the maximum transferrable from an accumulation to a pension super account from 1 July 2017. Further, members with total super balances (in accumulation and pension accounts) greater or equal to the transfer cap can no longer make non-concessional (after-tax) contributions without overshooting the contributions cap.

SMSFs

Rice Warner has observed in the past that most SMSFs are set up by spouses who then mostly “co-mingle the assets” in what is “effectively a joint superannuation account with each partner's share identified”.

From July next year, the Government proposes to increase the maximum number of members in an SMSF from four to six. As the Australian Superannuation Handbook 2018-19, published by Thomson Reuters, comments, the proposal seeks to provide greater flexibility for large families to jointly manage their super.

Finally, a core benefit for spouses taking a joint approach to family finances is that both should gain a better understanding of family finances.

 

By Robin Bowerman
Head of Corporate Affairs at Vanguard
27 August 2018
vanguardinvestments.com.au

What the ATO will be keeping an eye on in FY19

The ATO has outlined key risk factors, behavioural triggers and paper trails that will draw its attention to your client’s SMSF this financial year.

         

 

For the tax office, the SMSF sector has been largely compliant since its birth in the 1990s. However, there are new and ongoing areas marked for surveillance each financial year, which acting assistant commissioner Tara McLachlan ran through earlier this month.

SMSF set-up 

The ATO has found some taxpayers continue to see SMSFs as vehicle for early access to their superannuation funds for short-term gain, such as to pay bills or purchase a car. They are often spurred on by promoters who prey on vulnerable pockets of taxpayers.

“These individuals never had any intention of managing their own super and established an SMSF to gain illegal early access to their benefits,” said Ms McLachlan.

There are also schemes in the market which target taxpayers looking to enter the housing market by purchasing a property in their SMSF.

“[Those] schemes operate by pulling on the heartstrings of average Australians struggling to enter the housing market. Retirement savings are targeted by promoting the buying of the property through an SMSF, often with a complicated limited recourse borrowing attached, with no regard to the size of the SMSF or its ability to grow retirement savings,” said Ms McLachlan.

The ATO recently warned professionals and trustees alike of a scam concentrated in Sydney’s western suburbs, targeting those with limited knowledge of the superannuation system to facilitate illegal early access to benefits.

Red flags

There are several factors which could trigger an ATO review in your client’s SMSF registration. They include the behavioural and financial history of each taxpayer, and also the history of their service providers and tax agents.

For the individual, red flags are raised in the ATO’s system where there is bankruptcy, outstanding debts, and whether the taxpayer has links with other problem funds.

As always, the ATO is also concerned by poor lodgment and compliance history, which it heralded on several occasions last financial year during a post-reform clean up.

The ATO is similarly concerned by service providers or tax agents with outstanding debts and a poor lodgment record for its client base. SMSFs associated with these problem professionals are at higher risk of surveillance and compliance activity.

 

Katarina Taurian
30 August 2018
smsfadviser.com

 

How financial advise helps create wealth.

An article based on a 16 year study by Vanguard Investments Pty Ltd. 

         

 

Last month we reported on a 16-year study by Vanguard Investments that found a financial adviser effectively adds around 3% to the value of a client’s portfolio over time.

The real significance of this is that you can have a finance professional take care of one of the most important jobs in your life (funding your retirement) for very little, if any, real cost.  This can even be the case for those with smaller portfolios.

However, for many people the main problem is getting started and the cost is often seen as too high or the adviser focus can seem a bit too much on their needs rather than the client. 

A major reason for this, unfortunately, is that increased regulation and monitoring has meant advisers have moved to a fee-based model and away from the commissions of yesteryear.  This is a good outcome but it has meant advisers have had to increase entry costs which, in turn, has led many potential clients to see these costs as too high.  A proverbial Catch 22.   

It is because of this sort of conundrum that firms like Vanguard Investments have undertaken long term studies.  The outcome from their work is that a WIN/WIN opportunity exists for all. 

However, this benefit isn’t just from better investing, though that will often be the case.  It’s the more holistic approach that wins the day.  Vanguard Investments identify the following areas as those that will generate this positive outcome:

  • Suitable asset allocation
  • Cost-effective implementation (expense ratios)
  • Rebalancing
  • Behavioural coaching (Vanguard Investments found this to be the most significant contributor because there are some tasks people struggle with such as budgeting and expense management.  Behavioural coaching addresses this issue).
  • Tax efficiency (An example here is where an investor with a modest portfolio lost more than $250,000 in value over a 10-12 year period because they thought the three stock brokers they used were looking after tax related issues.  They weren’t!  If the planner had been involved sooner the outcomes would have been significantly different.)
  • Total returns versus income investing.

 

Finally, the concerns many potential clients have over the cost of financial planning means they delay getting help early enough which, in turn, threatens the retirement outcomes they want to achieve. 

 

Peter Graham
PlannerWeb / AcctWeb

  

ATO issues alert on super, tax scams

Beware identify theft scams.

       

 

The ATO expects to see another spike in scams this tax time, including those that aim to obtain personal data in order to access bank accounts and superannuation.

ATO assistant commissioner Kath Anderson said last year more than 37,000 scam attempts were reported to the ATO during tax time.

“While many people were alert and didn’t fall for the scams, hundreds handed over a total of more than $630,000 and thousands handed over their personal details,” said Ms Anderson.

Ms Anderson said organised crime groups use a range of tactics to trick taxpayers that include asking them to click on a link to divulge their login, personal or financial information or to download a file or open an attachment which enables them to access data.

“Once they have your data, they can either sell it or use it to impersonate you for financial gain,” she said.

“Besides selling it to organised crime groups, identity thieves can use your data to do things like getting a loan or commit fraud in your name, access your bank account and shop using your credit card, access your myGov account, steal your superannuation or sell your house.”

While the most common scam continues to be the ‘fake tax debt’ phone scam, she said, the ATO is seeing an increase in fake refund or refund-for-a-fee scams, and email and SMS scams enticing people to click a hyperlink, download a file or open an attachment.

“While handing over money is a concern, we are just as concerned about people handing over personal or financial information,” she said.

 

Miranda Brownlee
19 July 2018
www.smsfadviser.com

 

Estate planning in the new environment

The introduction of the transfer balance cap (TBC) on 1 July 2017 has had a severe impact on estate plans that include superannuation savings. 

         

 

Whereas it was previously possible that significantly greater amounts could be retained in the super system after death or disability (and SMSFs could be used as family “dynasty” vehicles), an important aspect of the purpose of the reforms to the law was to reduce “the extent that superannuation is used for tax minimisation and estate planning purposes” (see Treasurer Scott Morrison’s media release dated 3 May 2016).

What changed?

Among numerous changes, perhaps the most significant element of the reforms was that a cap of $1.6 million for the total amount of an individual’s super savings that could be transferred into the tax-free retirement phase. Although this measure immediately impacts on the retirement plans of individuals during their lifetime, it will also impact on the estate plans of individuals who have total super balances that exceed $1.6 million at the time of their death (whether in retirement or accumulation phase), or whose beneficiaries do (whether in their own right, or in combination with their inheritance).

Super death benefits may be paid as: a single lump sum, an interim and then a final lump sum, one or more retirement phase pensions, or combinations of all of the above. It’s a common wish of individuals that their super pension be paid to their beneficiaries in the same form after their death, for reasons such as asset protection and tax. Of course, this is only possible where it’s permitted and in accordance with the relevant trust deed, pension document and death benefit nomination. Importantly the recipient of such a pension must be a tax law dependant of the deceased.

What’s the problem?

Where these conditions have been satisfied, the maximum death benefit that can be retained by the new pensioner (whether as a reversionary or new pension) will be equivalent to their general TBC (which will ordinarily be $1.6 million). However, this outcome assumes that the new pensioner has no other retirement phase pension interests when they receive the death benefits. Where they do have other such interests, then they will already have an amount standing to the credit of their transfer balance account equivalent to the value of the assets supporting those interests (as at the previous 30 June). The consequence is that any additional amounts transferred to the retirement phase for that individual (in any super fund) must not result in their TBC being exceeded. Such excess transfers may result in the imposition of penalty taxes and interest, where they aren’t rectified within certain periods.

Is there a fix?

Fortunately, the reforms allow such rectification to occur within a period of up to one year from the date of death, but only where the new pensioner receives a reversionary pension. In addition, the existing law also permits the trustee of a super fund to pay a death benefit (without jeopardising its status as a death benefit) within a “reasonably practicable” period. As a result, there is an obvious opportunity for the new pensioner to re-arrange their affairs in anticipation of receiving the death benefit (or even after they’ve received it), in order to ensure that they don’t exceed their TBC. In particular, this action involves the new pensioner reducing their credit value of their TBA to nil (in cases where they have not yet received the death benefit) or to $1.6 million (in cases where they have). As a result, it is possible to ensure that an additional amount of up to $1.6 million is retained in the super system.

Of course, employing the above strategy has potential tax benefits. This means it is always possible that commissioner of taxation could successfully strike it down under the general anti-avoidance provisions of the income tax laws. Notably, such an outcome may not ensue, where the taxpayer’s purpose for entering into the strategy was predominantly for some other reason. It is the author’s experience the majority of individuals who seek to employ such arrangements do so because of family dynamics that are peculiar to them (for example because super death benefits were earmarked to be received by a particular family member), or for asset protection reasons.

What should I do?

Ultimately this aspect of the reforms means many individuals will need to revisit their estate plans to take into account how their situation may now have changed. A common perception is that this measure will not affect many individuals as the current balance of their super savings (or those of their beneficiaries) doesn’t exceed or near $1.6 million and is unlikely to do so. Unfortunately this analysis ignores the possibility of growth in those savings over many years and, very importantly, the fact most super interests include life insurance policies, the payment value of which will frequently cause balances to exceed or be around this threshold.

 

Chris Balalovski
​Partner, business services at BDO Australia.
July 25, 2018
smsmagazine.com.au

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