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Self Managed Super Fund (SMSF) Article
Investor confidence in super system crashes

By Tony Negline.

This article may be out of date.

11th February 2009

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Over the last few months the raison d'etre for superannuation has been questioned.  This is hardly surprising.  The same happened during the 1991 recession and the 2001/2 US recession and market downturn.

This time there have been two different attacks.  One which questions the need for and structure of compulsory super.  The other has asked for additional flexibility in how super pensions are paid.

Qualitative research commissioned by the Industry Funds Network (IFN) shows that people of all ages and income scales strongly support compulsory super and that many think the age pension will disappear.

The tax concessions attaching to super therefore seek to achieve two objectives.  Firstly they compensate an investor for placing their money into a long-term investment and secondly they act as a beacon for investors searching for tax efficiency.

These super tax concessions cost quite a lot.  In 2007/08 they cost almost $29 billion – or roughly 3% of GDP – which is about 10% of the direct revenue the Federal Government raised that year.

Treasury modeling released over the years shows that superannuation assists, in a modest way, in reducing future age pension outlays.  Unless something is done, a very large government budget deficit will begin to appear in about 2017 and get progressively larger because of age pension, aged care and related health care expenditures.

The reality is that the super accounts of low income earners will reduce their age pension requirements by very little, if anything.  For anyone earning about average wages or less superannuation is not tax effective.

Arguably anyone earning less than about $25,000 per annum should be allowed to opt-out of superannuation and take those compulsory super contributions as salary.  Before compulsory super, lower income earners rarely had any spare income which could be turned into capital over the long-term.  Watching the magic of compound interest is a powerful educator which will be passed onto future generations who might have remained ignorant.

From a tax perspective superannuation is a great deal for higher income earners.  Superannuation is not an investment but investment structure with certain tax characteristics.  It holds investments, like shares and property, and for high income earnings its tax efficiency is almost unrivaled compared to other investment structures.

One of the problems with compulsory superannuation is that the super fund that receives employer contributions is often selected by the employer.  For a variety of reasons most employees fail to nominate where these contributions are made.

Some have argued that this gives many large super funds and their selected fund managers too easy a ride.  They work hard to win an employer's super business and then rest easy on the spoils.

It is true that some of the activities of super funds leave a lot to be desired but they get away with it because most investors don't seem to recognize when errors have been made and fund auditors check the fund itself not what happens at member level.

The IFN research found that investor confidence with the superannuation system is quite low.  Most people find the complexity of superannuation mind numbing, the language of superannuation confusing and the rapidity of super and tax law changes baffling.  Responsible Government Ministers, take note!

Anyone who isn't happy with their current super fund can move to another one.  If an investor chooses to run their own small super fund then they will be free to make their own investment decisions and, within the restrictions of the law, can place their super monies wherever they prefer.

There is a good argument for saying that everyone should be running their own small super fund because it would force a great level of involvement.

Lester Wills, a colleague and friend, completed a PhD on why people show such a low level of interest in retirement planning.  He found that those "who are involved in the decision making process to save for their retirement, will undertake significantly more financial preparation than those who are not".

It's not unlike the different level of interest homeowners and renters show in the house they live in.  Owner occupied houses are nearly always better kept than rented properties because the owner occupier's vested interest is palpable.

Finally some have argued that the design of super fund pensions needs to change.  For almost twenty years the minimum level of pension income paid during a year has been determined by using the market value of assets at 1 July.  A problem can arise when the market drops dramatically during a financial year and pension income payments are being made from assets valued at lower values.

Selling capital assets in a down market to pay pension income is bad news.  Some have suggested that the government needs to allow the minimum pension to be re-determined if the market value of assets has fallen by a certain percentage.

The problem often arises because the pension assets haven't really been structured to generate income.  Ideally super fund trustees and their advisers should carefully determine their fund's future cashflow requirements and plan accordingly.  This process actually forms part of the legal requirement to create and implement an investment strategy.

Unfortunately many pensions are invested into managed funds which give a total return that don't differentiate between capital and income returns.  It's worth pointing out that during the 2008 calendar year the S&P ASX 200 All Ordinaries Index declined by over 50%.  The dollar value of dividends paid by companies in the same index between calendar years 2007 and 2008 declined by 0.14%.

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