A time of change: maximising SMSF investments and reform

With a slew of reforms coming into effect this year, advisers and planners with self-managed superannuation fund (SMSF) clients may need to reconsider fund trustees’ investment choices. Add to this ongoing advice needs as members enter retirement and changing asset allocation preferences, and those in the SMSF space are in for a big year.

Cracking down on concessions

Changes to both concessional and non-concessional contributions and the introduction of a Transfer Balance Cap (TBC) have impacted both how much SMSF investors can put into funds and what benefits they receive for doing so.

SMSF Association head of policy, Jordan George, warned that SMSF trustees aged over 50 would be the most affected by the changes to contribution limits. Advisers and planners would need to bear this in mind when guiding trustees.

According to Rice Warner, many trustees plan to make contributions to their SMSFs once they hit 50. Their disposable income increases as mortgages are paid off and children leave home. They also tend to feel a more immediate connection with their super balances as retirement approaches, so they’re more likely to prioritise growing them.

While once the tax benefits of concessional contributions made this a sensible approach, George cautioned that investors would need advice on whether this was still a suitable strategy for them in light of the changes.

However, that does not mean all hope of building a substantial balance after 50 is lost.

SuperConcepts general manager, technical services and education, Peter Burgess, believed that, although it would now be harder to make concessional contributions, the ability to make catch-up payments would lessen the reforms’ impact.

As most people would not contribute to their balance every year, he said that they would be carrying forward contribution space to future years.

That means that by the time they get to a stage, perhaps when they’re over 50, where they can contribute more than $25,000 a year, they would probably be able to do so through catch-up contributions.

The introduction of a $1.6 million TBC would also change the advice SMSF clients would need.

George said that this may not necessarily be negative, with the real issue instead being around ensuring compliance. Advisers would need to be sure that their clients’ assets had not reached a point where they accidentally contravened the cap.

He also pointed out that any assets over the TBC were still eligible for a 15 per cent tax rate.

“That’s still a good deal as it is still a very concessional tax rate overall,” he said.

Despite still being eligible for a relatively low tax rate, Vanguard head of market strategy and communications, Robin Bowerman, said that another response of SMSF trustees exceeding the cap could be to move funds elsewhere.

“For people either over or approaching the cap, what we will see is people perhaps, rather than putting more into super at that level, investing outside of superannuation.”

We could also see an uptake in people investing more money in their own names or discretionary trusts, according to Cooper Partners Financial Services director, Jemma Sanderson, as people try to avoid exceeding the TBC.

To report or not to report?

The introduction of event-based reporting was contested by many SMSF advocates, with a compromise being reached with the Australian Taxation Office (ATO) on both the frequency and balance threshold requirements for reporting.

Now, SMSF members would only need to report quarterly, and only if their fund balances hit $1 million.

The SMSF Association welcomed the change, saying that it would significantly lower the compliance burden on SMSF members. George said that the $1 million threshold would save 70 – 80 per cent of members in the pension phase from having to report.

He also said that quarterly reporting, as opposed to the monthly requirements originally proposed, would similarly ease compliance strain on members. While many would be well-placed to administer monthly reporting, especially those who use software, George said it would still ease the transfer to more rigorous requirements from SMSFs.

HLB Mann Judd superannuation director, Andrew Yee, warned that members likely would not be positive about the increased compliance that more frequent reporting would bring.

“They probably think the less compliance, regulation and documentation the better, as they probably don’t think there’s much benefit in the compliance side,” he said.

He said that trustees needed to get used to real-time reporting if they want to ensure compliance with other reforms, such as the introduction of the TBC.

Burgess believed that more frequent reporting was in clients’ best interests though. With more regular reporting, accidental contraventions would be less likely.

Consistency across reporting across SMSFs and Australian Prudential Regulation Authority (APRA)-regulated funds would also ensure advisers have reliable and up-to-date information, easing their compliance burden.

Currently, advisers would be under more pressure to keep records as they cannot rely on the ATO for information on SMSFs, as the reporting is not as frequent as for their APRA counterparts.

By aligning the two, advisers would have the security of knowing that the data accessible through the ATO for all funds is accurate as of the same date, allowing them to determine what clients hold across multiple accounts.

Burgess said that there was no reason SMSFs should not comply with the same reporting requirements.

While a transition period would be needed, he pointed to the rise of automated programs such as SuperConcepts as proof that daily reporting was possible and even easy.

Burgess also felt that the $1 million threshold on event-based reporting compromise was flawed, as this was another area in which alignment with APRA-regulated funds would benefit SMSF clients.

As funds with under $1 million would only be required to report yearly, Burgess said that they could accidentally contravene the law should their partner die and their balance go over the $1.6 million cap.

As their balance on the ATO site would not be accurate, advisers could struggle to give reliable estate-planning advice, or guidance following the death of a partner.

I’ve retired, what now?

Advisers and planners need to bear in mind the age of SMSF trustees and offer investment advice accordingly to meet their differing needs.

For people under 35-years-old, Sanderson said that advisers need to remember that young people need to balance contributions to super with the fact that they cannot access that money for a long time.

“You don’t want to say to a 30-year-old to start putting contributions up to their limit when, if they desire access to funds they can’t get at for thirty years, it’s not necessarily an appropriate strategy for them to fit into,” she said.

Rather, young people should consider issues such as insurance when making their SMSF decisions. Young people tend to be cashflow-poor, so it could be beneficial to them to have their super fund paying their insurance premiums.

Sanderson said that as people move into the 45 – 55 age bracket, they should reconsider their insurance needs. Advisers should suggest ramping up super contributions as much as possible.

The age demographic that potentially sees the most change in investment strategy is the final one, of SMSF members over 55 who are in either a full or partial pension phase.

According to the ATO, this group accounted for 47.1 per cent of all SMSF trustees in 2016. This would only increase as the baby boomer bubble moves further into retirement.

While some people may not change their asset allocation at all going into retirement – Bowerman said that perhaps “they’re happy with the dividend yield coming off the portfolio so they’re prepared to leave it” – many do need to consider changing it.

Bowerman believed that trustees in that phase need to get advice on de-risking their portfolio. Once you’re not working, you can’t really top the portfolio up.

This would make it harder to take a downturn and then replenish it with extra contributions, or to survive exposure to capital loss should another global financial crisis come along.

Bowerman said, however, that, from talking to advisers, it seemed like not enough people were seeking advice on changing their asset allocation as they headed into the retirement phase.

He suggested that trustees could do so gradually. They could, for instance, start with a strong growth portfolio that is predominately in equities, and then over time scale it back so that it is 50/50 between growth and being defensive as retirement draws nearer.

Bowerman said that this could suit people who need to prepare for retirement, but still wanted to take advantage of current market trends that shy away from pension phase-friendly allocations.

“When interest rates are at historic lows, people look at fixed income investments and the return number and go, well that’s really low. So then they go, I like the idea of being more defensive but I’m not willing to give up the yield I might have on a share portfolio,” he said.

By easing their way into a retirement-suitable investment allocation, investors could take advantage of such yield while still preparing for the pension phase.

Show me the money

The asset allocation  of SMSFs are, according to Bowerman, “probably the most important decision an SMSF trustee makes, as it pretty much dictates the risk and return they are going to get out of their portfolio.”

It is also the aspect of managing their own fund that SMSF members find hardest, with Investment Trends finding in their 2017 SMSF Investor Report that investors struggled most with identifying individual investments for their fund.

There is potential then, for planners and advisers to tap into SMSF demand in this space due to the trend toward increased fund allocation into managed investments by SMSFs.

He said that while SMSF investors had looked to invest in blue chip, high yield, small cap and international shares going forward, in 2017 they had signalled a desire to put more in managed accounts.

Investors had been turning to cash, exchange traded funds (ETFs) and managed investments rather than direct shares, with the allocation of SMSF funds invested in the latter reducing from 45 per cent in 2013 to 37 per cent in 2017.

Investment Trends senior analyst, King Loong Choi, said that the investment allocation changes had been driven both by a desire for diversification and ease.

Bowerman said that SMSFs in general had been early and strong adopters of ETFs, which had “unlocked a world of investing from an SMSF point of view.”

This easy access opened up international markets for SMSFs.

While it was difficult for SMSFs and individual investors to buy overseas shares a decade ago, as they had to rely on international share funds in an unlisted fund structure, the rise of ETFs allowed people to add thousands of international companies to their portfolio at a low cost in just two or three trades.

“This is a good thing in that it gets away from the home country bias that as Australian investors we all have, as we start to diversify into other markets,” Bowerman said.

He pointed to the strength of the US market last year, saying that ETFs had allowed SMSF investors to take advantage of its performance.

While in 2016 they invested just five per cent of SMSF funds in managed accounts, for example, in 2017 this doubled to ten per cent.

Financial planners have also been investing SMSF clients’ funds in ETFs, managed funds and indexed funds in greater numbers, according to Investment Trends’ 2017 SMSF Planner Study.

Not all funds ordinarily invested in direct shares are going to managed funds or ETFs though. Of the $180 billion kept in cash by SMSFs, $53 billion would previously have been kept in the market.

Investment Trends found that trustees were holding the funds in cash while they worked out where to invest it. SMSF members also reported that they had 277,000 unmet advice needs last year, about a third of which related to investment advice.

For planners or advisers with experience in ETFs and managed funds, this could be an alluring space to try and engage new clients in.