REFILLING THE COVID CRATER

The impact of COVID-19 has rippled throughout Australian society and did not spare the superannuation system, with balances taking a hit from reduced returns and members taking advantage of the early access provisions. Jason Spits examines what measures are in place to repair that impact and how the superannuation agenda has shifted.

The rapid arrival of the coronavirus into Australia and its ongoing impact on society has become a source of constant background noise for many, and particularly for the federal government, which has had to wrestle with the sudden economic impact on the nation and millions of individuals within it.

Given the $2.9 trillion currently stored in superannuation, it was only natural some of that would be tapped to dig the government and populace out of the financial hardship that developed quickly in the middle of 2020.

Early release of superannuation (ERS) provisions were repurposed to fit the COVID-19 downturn and up to $20,000 of people’s own money was available to them following an application to the ATO.

The most recent figures released by the Australian Prudential Regulation Authority (APRA) at the end of January 2021 indicate $36.4 billion of payments have been made from 3.5 million initial applications and 1.4 million second applications, with an average payment of $7638. Within those figures, $377 million has been released as a result of 39,000 applications from 20,000 SMSFs, as at 1 November 2020, according to data supplied by the ATO to selfmanagedsuper.

This latter figure is consistent with the experience of Verante director Liam Shorte and SuperConcepts SMSF technical support executive manager Nick Ali, who both report SMSF trustees and members were aware of the ERS provisions, but had their focus on other issues related to superannuation and retirement.

Ali says the typical higher net worth demographic of SMSF members meant they were less likely to have to rely on superannuation and Shorte points out low interest rates, poor market returns and reduced rental income were probably of greater concern to some SMSFs than easy access to the $10,000 tranches allowed by the ATO.

SMSF Association deputy chief executive and director of policy and education Peter Burgess says feedback from members indicated SMSFs were generally better placed to handle COVID-19 than retail and industry superannuation funds.

“Based on discussions with members, it appears SMSFs have recovered from the initial impact and for those in the drawdown phase, which is about 40 per cent of funds, the government played its part with the 50 per cent reduction of the minimum pension drawdown, which means balances will be able to recover,” Burgess says.

However, SMSF Association technical manager Mary Simmons says for some SMSFs it does not matter how their balances were depleted if they are staring down the barrel of a reduced balance or pension income now or in the near future.

“Some are asking whether they have enough time to ride out the impacts of COVID-19 before the recovery comes or will they have to make a decision sooner about what to do with their fund and their retirement income plans,” Simmons says.

A political solution

The impact on superannuation balances from low interest rates and poor market returns is hard to sheet home to any one party, but critics of the early release scheme were quick to point out the damage it would do to low-balance and low-income fund members.

While supporters of the ERS have been pointing out its utility in helping people meet their financial obligations, and as critics continue to point out the impact on current balances and future retirement balances, there has been minimal discussion about letting people backfill those withdrawals in the short term.

Only a handful of pre-budget submissions have broached the topic, with the Australian Institute of Superannuation Trustees suggesting the government provide a $5000 one-off contribution for low-income earners who accessed their super, as well as increasing the co-contribution rate from 50 cents to $1.50 for every dollar voluntarily contributed.

In its submission, CPA Australia also proposed using the co-contribution scheme, higher contribution limits and an increased total super balance (TSB) threshold for those who accessed superannuation and wanted to use carry-forward provisions to make up the difference. At the same time, The Tax Institute proposed a new cap over and above existing limits to allow for a maximum total contribution of $50,000 to be made within five years.

This latter proposal is similar to an amendment put forward by Pauline Hanson’s One Nation to the Treasury Laws Amendment (More Flexible Superannuation) Bill 2020, which would allow superannuation fund members to recontribute their ERS amount, in part or full, in any year until 2030.

At present, however, there is limited interest in this approach from the government, according to Superannuation, Financial Services and the Digital Economy Minister Jane Hume.

Following an address to the industry in late January, Hume says current contribution measures should be sufficient when selfmanagedsuper questioned her on the issue.

“Understand that early release of superannuation was in fact an existing measure. You could always take out superannuation on the basis of hardship. All we did was build some integrity measures around it and changed the definition of hardship temporarily to acknowledge COVID-19,” she says.

“One change we made that may have flown under the radar was that we made the withdrawal tax free, which normally in the case of financial hardship withdrawals aren’t tax free, so there was a tax benefit on the way out.

“One of the things One Nation is talking about is a tax-free or tax concession on the way back in and that is already in place because the concessional cap is $25,000 per year, so if you are putting in your 9.5 per cent [superannuation guarantee contribution] and it’s less than $25,000 a year, there is already a tax concession up to that cap.

“We also have a catch-up contribution and if you have not put in the full $25,000 in previous years, you can roll those years’ concessional caps over, so there are already opportunities to put more money back into superannuation to make up the difference, tax concessionally, and you can do it at a time that suits you.”

Practical considerations

With this in mind, Simmons says the best way to approach the issue of back-filling balances is to consider whether an SMSF, and its members, are in accumulation or pension phase or a combination of both, and use the options currently available.

“Those in accumulation phase have got time to wait for the market to recover, but in the meantime if they’ve got access to capital, the focus should be on maximising their contributions, especially non-concessional contributions, because there are no more work or age tests for anyone under 65,” she says.

Reduced individual balances will also create a reduced TSB, providing an opportunity to access the maximum $300,000 non-concessional contribution allowed under bring-forward rules, she notes.

“It is a good time for individuals to have a look at what the reduced member balance does for their TSB and apply that before 30 June and see if they qualify for the bring-forward provisions.”

The concessional cap of $25,000 also remains in play for all super fund members and Simmons says that for younger members who are more likely to have accessed funds under the ERS model, they can also access catch-up contributions.

“The concessional contribution offers a tax deduction and the bonus on top is that if a member has a TSB less than $500,000, they can access the catch-up concessional contributions that have been in place since the 1st of July 2018,” she says.

Adding to these, Shorte says there are a number of other options for people with lower balances or reduced ability to make large contributions.

“The spouse contribution allows $540 to be added to a fund and the co-contribution still attracts $500 for every $1000 contributed, while salary sacrifice can save 24 cents on the dollar,”he explains.

Some are asking whether they have enough time to ride out the impacts of COVID-19 before the recovery comes or will they have to make a decision sooner about what to do with their fund and their retirement income plans.- Mary Simmons, SMSF Association

“For those with some extra cash, there are still some choices about where they can make contributions for the best earnings.”

Heffron managing director Meg Heffron observes salary splitting, via salary sacrifice, has waned in popularity, but it is a suitable long-term strategy to equalise balances between two people.

“If there are two members in an SMSF with large incomes, salary sacrifice makes sense and it can be used to boost the balance of one or both members,” Heffron says.

“If there is an age difference between them, splitting between the older and younger members also gives the ability to access those funds earlier.”

For those straddling the accumulation and pension phases, Simmons acknowledges being aware of the various tax components of the TSB is useful because investment returns can be allocated to the tax-free component.

“With a TSB there is a tax-free and taxable component and when you take a super benefit, either as a lump sum or pension, it has to be split based on a proportion rule,” she says.

“The tax-free component is based on this formula while you are in accumulation phase and whatever is left over, which includes all your investment returns, makes up your taxable component.

“Negative returns reduce that taxable component until it is exhausted and they start eating into the tax-free component – but only notionally – and there is a temporary reduction in the dollar value of a member’s tax-free component.

“This means there are some opportunities to restore that tax-free component through investment returns, which would ordinarily be a taxable component, but because the level of the tax-free component has yet to be restored to the notionally reduced level, they automatically become tax free.”

Extending this thinking to those in pension mode, she says SMSF members who are already receiving a pension with a high taxfree component should leave it and allow the earnings to recover and remain tax free.

“If they do need additional capital, then they should be taking that out as a partial commutation so that they don’t impact on those tax proportions but still retain them in the fund, but if they have a pension with a high taxable component, this might be an opportunity to commute the pension and pull everything back into the fund and start a new pension with a better tax-free component.”

A rocky recovery

While the strategies outlined above can apply to all superannuants, there are elements of the superannuation landscape unique to SMSFs, including limited recourse borrowing arrangements (LRBA).

Rent and loan payment relief measures introduced in mid-2020 for commercial property arrangements have also applied to LRBAs, but Burgess and Ali see the road ahead remaining bumpy for LRBAs for the foreseeable future.

Burgess says investment guidance from the ATO to SMSFs requires investments to be able to deliver sufficient cash flow, provide retirement income funds and be diversified where the fund is in retirement phase.

“SMSFs must have a cash flow for pension payments and if the balance falls, that will need to be factored into an investment review and ensure the investments, including the LRBA, are fit for purpose,” he says.

For Ali though, the sudden decline in rental income and pressure on LRBAs echoes recent warnings and predictions related to the arrangements.

“Rental income is down, but those funds will have to repay those loans, even without rent and the ATO was right – they needed to diversity if that was their only or major asset,” he says.

“COVID-19 has also made people nervous about using an LRBA and the virus may have achieved what regulators could not, and that is the end of LRBAs within the SMSF sector.”

Despite this possible dark spot, Shorte and Heffron believe SMSFs are uniquely placed to recover faster and better serve the need of their members than their retail and industry fund counterparts.

“The fact is SMSF trustees and members are more engaged and use the superannuation and tax systems to find the best place for their money,” Shorte points out.

“The transparency of their investments also provides more confidence to stick with a strategy compared with some of the more fixed and illiquid positions taken during the market scare of 2020.”

Building on that, Heffron says the individual nature of SMSFs is their strength during times when investments, returns and income are under pressure.

“The real benefit of SMSFs is they focus on the needs of two people, typically. This does not mean they are necessarily better than retail or industry funds in creating returns, but they have the freedom to focus just on those members and so can be ideally positioned to recover from anything,” she says.

People are looking at SMSFs again for their flexibility and COVID-19, like the global financial crisis, has shown how nimble they can be.- Nick Ali, SuperConcepts

Ali notes the impact of COVID-19 became the backdrop for the release of the Retirement Income Review (RIR) in November 2020 and a rolling discussion about the future level of the superannuation guarantee contribution, and has reconnected people to super and SMSFs.

“People are looking at SMSFs again for their flexibility and COVID-19, like the global financial crisis, has shown how nimble they can be,” he says.

“They are more critical of the role and performance of their superannuation and they want to be sure their superannuation meets their circumstances.”

Resetting retirement

With the focus on back-filling the negative impact on super balances caused or exacerbated by the virus, is it time to also encourage fund members to see their balances as retirement income and not as a boon for the next generation?

The final report of the RIR suggested retirees should be spending more of their savings instead of holding on to them and smoothing their spending and consumption between their working and retired lives, but Shorte says this does not factor in an unknown future.

“People are more worried about their own longevity than leaving something for their kids. They are seeing their own parents live longer and considering they may have 35 years in which to fund themselves,” he notes.

“In some cases they are taking care of themselves, their parents and their kids and are doing that outside of superannuation, but their fund is for their old age so they can stay at home and not be totally dependent on the pension system.”

Ali, however, sees this focus on an unknown future and the calls by the RIR to reexamine super as an essential discussion that involves the next generations of retirees, who are unlikely to be able to build large balances and maintain them over time.

“There will be a shift from the idea that superannuation is a nest egg that you slowly run down to seeing it as an annuity vehicle and that change in the narrative has been backed by the findings of the RIR,” he says.

“Concerns about outliving your money and about capital preservation are part of a discussion about the future, but they will be legacy issues because superannuation for the next generation will be amortised over their life expectancy instead of being set up as an estate planning tool.”

How and when that discussion will take place depends on the government’s actions towards super, but it is clear COVID-19 and the early release of superannuation have started the ball rolling, a fact even Hume admits.

“COVID-19 provided a rare opening. The economic ramifications of the pandemic, alongside measures such as the early release of super, prompted many Australians to reassess their finances, engage with their superannuation and incorporate their retirement savings into their personal balance sheets,” she says during her address.

“The RIR final report observed ‘many superannuation funds have reported spikes in member engagement, including members switching to more conservative investment strategies’.

“While the full effects of COVID-19 remain to be seen, 2021 presents an opportunity to build on increased levels of engagement while continuing to maximise the retirement savings of all Australians.”