Rice Warner actuaries have recently highlighted three key areas where self-managed superannuation funds (SMSFs) have distinct advantages over larger APRA regulated super funds.
Half of the baby-boomer generation has already retired, and the majority did so without receiving any formal financial advice. In addition, very few have built a longevity product into their retirement portfolio to prevent them outliving their retirement savings. Most large superannuation funds still run simple account-based pensions where all risks are borne by members.
Learning from SMSFs
Well over half of all Australia’s retirement assets are held within SMSFs, as it is structured sensibly to allow retirees to manage their finances with great control whether they do so alone or in conjunction with their financial adviser.
Despite their small size compared to the behemoth industry and retail superannuation funds, SMSFs have advantages in three key areas:
- Administration including fund and tax structure
- Financial advice
The key advantage of SMSFs is that they enable pooling of family superannuation. More than 85% of these funds have been set up for couples. A couple at retirement often have at least four underlying accounts within their SMSF, being an accumulation and a pension account for each partner.
Even when retired, an accumulation account is needed to take future contributions from any ongoing part-time work, or to hold assets exceeding the $1.6m Pension Transfer Balance cap. Moving from accumulation phase to pension phase does involve some paperwork, however the pooled investments of an SMSF don’t change so there is a relatively smooth transition.
This contrasts to APRA funds where the partners may not in the same fund, and where their accounts cannot be linked due to outdated administration platforms. Further, shifting from a MySuper accumulation product into a retirement product can be tedious with cumbersome paperwork.
As APRA funds look to provide advice to their members, they are hampered by holding only a part of a member’s financial assets, so any intra-fund advice does not capture enough information to do more than recommend moving out of accumulation into pension phase.
Some APRA funds provide comprehensive financial advice, they can struggle. It was no surprise to see QSuper withdraw from providing comprehensive financial advice recently. The problem facing big superannuation funds is the cost of delivery of this service and the heavy compliance risks. These costs usually exceed any revenue from the service which means they are subsidised by other members.
Even where a full pre-retirement plan is prepared for a couple, the member is simply moved into an account-based pension, but the partner is often left in their current fund’s retirement product. One of the reasons for this is the compliance cost of comparing the partner’s fund with the member’s fund – and the embarrassment if the partners existing superannuation fund is rated better or is more cost effective. However, leaving the members in separate funds does makes it more complex to review strategies in future years.
Holding the superannuation assets of a couple within the same fund, such as an SMSF, materially improves the ability to facilitate the delivery of better financial advice through a broader range of options available.
Most APRA funds have a single diversified (balanced) fund shaped around MySuper.
Some funds have introduced lifecycle investments and/or bucketing solutions to help members to manage sequencing risk, including sudden downturns in investment markets leading into and during retirement. However, the absence of longevity products means that members still take on the risk of living beyond life expectancy (running out of money) as well as taking all investment market risks.
A balanced fund is ideal for those saving for retirement, but it is not optimum for retirement where people need several accounts for different purposes. For example, this could include one account for making regular pension payments, a diversified fund to cater for the longer-term spending needs, and a separate allocation for longevity protection.
Once again, this is easier to structure for a couple with all their pension assets held in one place. It is also easier to manage the tax situation. It is well known that moving from accumulation to pension phase is not considered to be a CGT event, so deferred tax liabilities are released on retirement. Some APRA funds now pay a pension transfer bonus to partly compensate their members, but it is not as efficient as an SMSF.
Many SMSFs also benefit heavily from franking credits and from company buy-backs. Many SMSFs have a higher after-tax than pre-tax investment return.
Like APRA funds, SMSFs may generally lack longevity protection, apart from the safety net of the Age Pension for those who spend all their retirement benefits before they die. SMSFs can offset longevity risk by incorporating annuity products into their investment strategies.
This article is an abridged version of “What APRA funds can learn from SMSFs in building a retirement solution” posted on the Rice Warner actuaries website 10 July 2020.
SMSFs are not for everybody and the information contained in this article should not be construed as personal advice.
This information does not take into account any particular person’s objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of this information having regard to your personal objectives, financial situation or needs. We strongly recommend you obtain financial advice specific to your situation before making any financial investment or insurance decision.
If you have any questions in relation to this article please contact us.