Tuesday 22 September 2015
SMSFs vs Super Wraps: A super heavy-weight bout?
Introduction: The super heavy-weights?
The self managed superannuation fund (SMSF) sector has experienced extraordinary growth over the last 15 years. In March 2000 assets in small funds (those with less than five members, including small APRA funds) amounted to $68.7 billion. By March 2015 assets in SMSFs had grown to $594.8 billion,1 representing an average growth rate in excess of 15 per cent per annum over 15 years.
Over the same period retail superannuation funds grew at a more modest 10.3 per cent per annum, from $126.8 billion to $550.8 billion. But within the retail sector over a similar period we have seen the birth and rapid growth of sophisticated wrap-style superannuation funds, referred to here as ‘Super Wraps’, which comprised approximately $254 billion by December 2014.2
The primary motivations for establishing an SMSF is typically the desire for investment control and to reduce fees.3
There is no question that an SMSF can offer a wide range of investment options and control. And they can be cost effective, depending on the level of funds held, the willingness and ability of trustees to perform some of the functions of the fund themselves and the cost of services out-sourced to relevant SMSF industry professionals.
But SMSFs are not for everyone. They can be complex to run and require a requisite level of financial literacy of the members of the fund. The Australian Securities and Investments Commission (ASIC) has commented that it does not want to see “an influx of trustees who are ill-equipped to cope with the responsibilities and obligations inherent in running an SMSF”.4
The growth and evolution of Super Wraps has narrowed the features gap between SMSFs and what’s available to clients in the retail superannuation fund sector
The growth and evolution of Super Wraps has narrowed the features gap between SMSFs and what’s available to clients in the retail superannuation fund sector. Most Super Wraps now offer access to ASX 300 or ASX 500 stocks and a wide range of managed funds. Some also offer access to stocks listed on other exchanges. Super Wraps can be cost competitive when an objective comparison is made between the actual costs of running an SMSF. Furthermore many Super Wraps offer tax benefits like individual account based tax accounting and anti-detriment payments, and a high level of estate planning certainty with binding death benefit or non-lapsing nominations and arms-length trustees.
So it is timely and worthwhile to compare and contrast the features of SMSFs and Super Wraps. Our aim is to present an objective comparison, without necessarily drawing an overall conclusion that either is better than the other. That conclusion will typically be made on a client-by-client basis, based on the individual circumstances and requirements of each client - it is expected that an SMSF may suit certain clients, and a Super Wrap may suit other clients. The challenge is to identify which clients are best suited to each option.
The issues to consider are numerous, too numerous to cover in a single article. We intend to publish a series of articles, dealing with the issues individually. Table 1 below provides a brief introduction to some of the issues worthy of further analysis in the SMSF vs Super Wrap debate.
Table 1: SMSF and Super Wrap product features
|Regulated by||Australian Taxation Office (ATO)||Australian Prudential Regulation Authority (APRA)|
|Minimum balance||A starting balance of $200,000 or below is unlikely to be in the clients's best interests5||Varies, typically $20,000 to $50,000|
|Investment choice||Potentially any investments allowed by superannuation law, including real property, collectibles, certain personal use assets, privately owned companies||Generally limited to ASX-listed stocks, stocks listed on some foreign exchanges, managed funds, term deposits and cash. Trustees may impose additional investment limitations.|
|Trustee responsibilities||Members bear the responsibilities of a trustee||Members have no trustee responsibilities, but do have certain responsibilities as members|
|Tax efficiency||SMSF are generally tax efficient, as tax benefits ultimately benefit the members||Many Super Wraps report at the account level, ensuring tax benefits are attributed to individual members||Larger funds may have greater capacity to provide credits for CGT losses in the year they are incurred|
|Pension payment issues||Trustee must ensure liquidity and minimum pension payment standards are met||Usually an automated process within the Super Wrap platform|
||May be complex, potentially involving contingent nominations||Generally nominate only dependants or Legal Personal Representative|
||Surviving members/trustees may have incentives to thwart a deceased member’s estate planning arrangements||Arms-length trustee controls the fund, so valid death benefit nominations are generally effective||Refer to article, Supreme challenges in SMSF estate planning|
|Winding up the arrangement||Winding up an SMSF can be complicated and may take many months||Usually it is possible to close a Super Wrap account within a few days|
|Dispute resolution and compensation||Only formal means of resolving conflict is via courts. Generally compensation available under the superannuation law does not apply to SMSF members||Funds must have formal dispute resolution procedures. Members may also have recourse to the Superannuation Complaints Tribunal|
Round 1: anti-detriment payments
The MAStech team is often questioned by financial services professionals about SMSFs making anti-detriment payments in relation to lump sum death benefit payments.
Anti-detriment payments are conceptually a compensation for contributions and earnings taxes paid since 1 July 1988
Anti-detriment payments are conceptually a compensation for contributions and earnings taxes paid since 1 July 1988. For a more detailed description of anti-detriment payments, access the MAStech Fastfacts sheet Anti-detriment payment upon death.
The amount payable is approximately 17.6% of the taxable component of a lump sum death benefit accrued since 1 July 1988.
Some retail superannuation funds, including Super Wraps, pay this additional benefit automatically (subject to certain criteria) when paying lump sum death benefits to eligible beneficiaries. But not all retail funds do so, and a July 2013 decision6 of the Superannuation Complaints Tribunal (SCT) demonstrates that a beneficiary may not be successful in demanding an anti-detriment payment from a superannuation trustee. However, in an earlier decision7 the SCT did make comment in relation to anti-detriment payments that:
The Trustee has a duty to act in the best interests of beneficiaries of the trust, which, in this case, includes the Spouse. Whilst the legislation does not oblige the Trustee to claim the anti-detriment amount and pay that amount to the beneficiary of a death benefit, to not do so may not be in the best interests of beneficiaries
The problems with an SMSF making an anti-detriment payment are more fundamental. Although it is not entirely impossible, in practice paying an anti-detriment benefit is very difficult for SMSFs.
Firstly, an SMSF will need assets to be available to make the anti-detriment payment in the first place. The SMSF must make the payment at the same time as the death benefit lump sum amount is paid, prior to ‘recouping’ the payment from Australian Taxation Office (ATO) as a tax deduction.
In a simple example, consider a single member SMSF, with the member’s account balance amounting to $500,000. Upon death, $500,000 would be potentially payable as a lump sum death benefit to the beneficiaries. The anti-detriment payment could be as much as an additional $88,000. But how can the SMSF fund a payment of $588,000 (account balance plus anti-detriment payment)?
Conceptually, the anti-detriment benefit may be funded from current year provisions for tax payable (for example contributions and earnings tax), or from fund reserves. But not all SMSFs will have sufficient current year provisions and/or reserves to fund an anti-detriment payment, and distributions from reserves may have implications for concessional contribution assessment purposes.
If a solution to the funding problem does exist, then the benefit of an anti-detriment payment is effectively claimed back from the ATO via additional tax deductions (the amount of the anti-detriment payment divided by fifteen per cent) to offset assessable income.
In the example above, the tax deduction available to the SMSF would be approximately $88,000 / 15%, or $586,667. In the case of a single member SMSF where the member has passed away, that tax deduction may have no benefit as there could be no assessable income to offset.
New members would need to be admitted to the fund to generate assessable income against which this very large tax deduction could be offset. It could take many years before the tax deduction is completely used.
This large tax deduction may result in carry forward tax losses for the SMSF. The carry forward losses have an intrinsic value, and can potentially be recorded as an asset on the SMSF’s balance sheet as a ‘future income tax benefit’ (FITB), although the recording is dependent on a number of factors, including the likelihood of the realisation of the tax benefit.8
Impacting on the ability of an SMSF to claw back the amount paid as an anti-detriment payment is the ATO’s view on how carry forward losses should be applied if an SMSF has exempt current pension income (ECPI). See the ATO guidance on this here. Broadly, the ATO’s view is that carry forward losses should be used to offset ECPI firstly, which results in no tax benefit to the SMSF for the amount of carry forward losses used to offset ECPI. This may have a significant impact on the likelihood of an SMSF realising the tax benefit, and its ability to record the benefit as an asset.
...SMSFs may have a range of practical difficulties in paying and benefitting from an anti-detriment payment
The above analysis illustrates that SMSFs may have a range of practical difficulties in paying and benefitting from an anti-detriment payment. Clients’ beneficiaries may have greater certainty in relation to the receipt of an anti-detriment payment through membership of a Super Wrap.
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