self managed super funds warning

Guillotine hangs over self-managed fund growth as laws face big shake-up

Allan Fels and Fred Brenchley
March 22, 2008
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THE boom times in self-managed super funds — in which SMSFs have attracted about a quarter of the total $1.2 trillion super pot — are about to end.

Prime Minister Kevin Rudd's Superannuation Minister, Nick Sherry (Australia's first minister for super), is quietly working on measures that will likely curtail SMSFs, with a $200,000 minimum entry level and their trustees governed by tighter regulation and new penalties. Any idea of expanding the pull of SMSFs by increasing the number of trustees from four to 10 to attract larger families and younger people — as proposed by a parliamentary inquiry last year — has been canned.

SMSFs have literally exploded in recent years, driven by the perception of cheaper costs, the attraction of direct control and generous in-house asset-test rules. Accountants, seeing a fee stream, have pushed them to small-business clients. From 97,000 in 1995, SMSFs grew to 370,000 by last December. The sector holds about $300 billion of superannuation assets.

With a guillotine hanging over future growth, the SMSF sector is deeply suspicious of Sherry's "reforms", which are seen as only aiding the big industry and retail funds. The fact Sherry was a founder of the Hostplus industry super fund only fuels suspicions.

But Sherry says he intends to crack the governance whip across all three levels of funds. His interest in SMSFs stems from a damaging survey by the Australian Taxation Office, which regulates the sector.

The ATO survey found that 21% of participating SMSF trustees had a "low to medium" or "low" knowledge of their obligations. Thirty per cent of new trustees could not explain the sole purpose test (the sole objective is supposedly retirement benefits), more than 15% did not have an investment strategy while 25% were unaware of the restrictions on assets that can be acquired from related parties.

Sherry also cites the finding that many SMSFs held more than 35% of their investments in cash or liquid securities. While this was beyond the norm in the booming sharemarket at the time of the survey, it would be seen as the mark of a savvy investor in today's market turbulence. But most damning are separate ATO figures revealing the high ratio of operating expenses to total assets for smaller SMSFs. These range up to a whopping 10.5% for a fund with just $50,000.

According to the AT0, 30% of SMSFs have less than $200,000 in assets. If Sherry introduces a $200,000 threshold, that could cull almost a third of SMSFs, although transitional arrangements will undoubtedly apply.


Page 2 of 2
THE boom times in self-managed super funds — in which SMSFs have attracted about a quarter of the total $1.2 trillion super pot — are about to end.

Prime Minister Kevin Rudd's Superannuation Minister, Nick Sherry (Australia's first minister for super), is quietly working on measures that will likely curtail SMSFs, with a $200,000 minimum entry level and their trustees governed by tighter regulation and new penalties. Any idea of expanding the pull of SMSFs by increasing the number of trustees from four to 10 to attract larger families and younger people — as proposed by a parliamentary inquiry last year — has been canned.

SMSFs have literally exploded in recent years, driven by the perception of cheaper costs, the attraction of direct control and generous in-house asset-test rules. Accountants, seeing a fee stream, have pushed them to small-business clients. From 97,000 in 1995, SMSFs grew to 370,000 by last December. The sector holds about $300 billion of superannuation assets.

With a guillotine hanging over future growth, the SMSF sector is deeply suspicious of Sherry's "reforms", which are seen as only aiding the big industry and retail funds. The fact Sherry was a founder of the Hostplus industry super fund only fuels suspicions.

But Sherry says he intends to crack the governance whip across all three levels of funds. His interest in SMSFs stems from a damaging survey by the Australian Taxation Office, which regulates the sector.

The ATO survey found that 21% of participating SMSF trustees had a "low to medium" or "low" knowledge of their obligations. Thirty per cent of new trustees could not explain the sole purpose test (the sole objective is supposedly retirement benefits), more than 15% did not have an investment strategy while 25% were unaware of the restrictions on assets that can be acquired from related parties.

Sherry also cites the finding that many SMSFs held more than 35% of their investments in cash or liquid securities. While this was beyond the norm in the booming sharemarket at the time of the survey, it would be seen as the mark of a savvy investor in today's market turbulence. But most damning are separate ATO figures revealing the high ratio of operating expenses to total assets for smaller SMSFs. These range up to a whopping 10.5% for a fund with just $50,000.

According to the AT0, 30% of SMSFs have less than $200,000 in assets. If Sherry introduces a $200,000 threshold, that could cull almost a third of SMSFs, although transitional arrangements will undoubtedly apply.

So what is Sherry planning? He has created an advisory group stacked with industry members (there are no consumers or employers), invited wider industry comments, and aims to reveal detailed reforms by the end of next month. Apart from talking up a minimum $200,000 threshold, Sherry is angling for tighter governance, possibly bringing SMSF trustees under similar Super Safety disclosure and reporting rules that apply to bigger retail and industry funds.

That will likely push many SMSFs into subplans of bank and industry funds.

Penalties would also be broadened. The only sanction now available to the Tax Office is to remove tax concession status. Sherry will probably introduce a range of penalties for various breaches.

There is pressure from within the Labor Party for Sherry to restore the privileged position that the big union-controlled industry funds enjoyed under Paul Keating's initial super initiatives. John Howard's super reforms and his anti-union bent swung the balance to SMSFs at the expense of industry funds.

Sherry rejects the notion that he is about to cut the SMSF sector off at the knees. His worry, he says, is the minority of SMSFs with lax governance.

"The Government is currently taking industry submissions on the best way forward — after which I am confident we will still have a thriving SMSF sector," he says.

Maybe. But Sherry should tread warily. Some 700,000 Australians have their super in those 370,000 SMSFs, many of them Howard battlers who decided to give Rudd Labor a chance. Whacking their super funds could be political stupidity.

Clearly, some smaller SMSFs suffer exorbitant operating expenses and rules now enable some trustees to sail close to the wind on investments.

But in any rebalancing, Sherry needs to be careful not to give union and retail fund competitors a free kick at the expense of well managed smaller SMSFs.

Allan Fels is dean of the Australia New Zealand School of Government. Fred Brenchley is a former editor of The Australian Financial Review.