Time for a rethink

Instances of individuals looking to access their retirement savings assets early both legally and illegally are on the rise. The SMSF Association head of technical Mary Simmons suggests the trend indicates the time is right for a review of the rules applicable to these actions.

In the midst of a cost-of-living crisis and evolving societal needs, the debate over early release of superannuation on compassionate grounds is gaining renewed attention.

Leaving aside the extraordinary circumstances caused by COVID, allowing temporary limited access to superannuation benefits, the rules governing the early release of super on compassionate grounds have largely remained unchanged since 1997.

But evidence is mounting these guidelines may no longer be fit for purpose.

There can be no arguing with the ATO figures. Since becoming the approver of all compassionate release requests from 1 July 2018, the regulator’s data shows early release is increasing. Application numbers increased 40 per cent from 53,800 in 2018/19 to 75,600 in 2022/23 and, in dollars terms, withdrawals rose from $456 million to $762 million for the same periods. Where there hasn’t been much movement is in the number of applications approved, dipping slightly from 58 per cent in 2018/19 to 55 per cent in 2022/23.

Where the raw data gets even more interesting over this five-year period is the fall in what have traditionally been expenses leading individuals to request early release, being the forced sale of the family home (down from $35 million to $10 million with less than 6 per cent of applications approved in 2022/23), palliative care, funerals and disability.

In contrast, there has been a notable spike in approvals relating to medical expenses. On the dental front, the cost for approved applications has increased almost fivefold, from $66.4 million in 2018/19 to $313 million in 2022/23. Weight loss, too, is another category that has seen a 20 per cent increase in benefits approved from $207 million to $249 million over this timeframe, although the number of applications has remained steady.

In the face of these numbers, perhaps the primary focus should be on reforming Medicare and funding of our health system to better support the provision of necessary treatments, rather than shifting the financial burden onto individuals’ retirement savings.

Nonetheless, while we wait for reform to our health system, we are left with no choice but to question the principles underpinning the release of superannuation on compassionate grounds to ensure we maintain the integrity of the super system.

With detailed data from the ATO on the specific reasons for early release applications, it is hard to avoid questioning whether some of these medical treatments would fall, at the very least, outside the spirit of the law relating to early release.

Let’s take dental work as an example to highlight just two significant consequences.

Firstly, it sacrifices the compounding effect of super. Withdrawing $20,000 now for dental work will have a long-term impact on how much individuals have in retirement. Using the Australian Securities and Investments Commission’s Moneysmart calculator, with an average 5 per cent annual return, a 30-year-old withdrawing $20,000 today will have about $110,000 less in their accumulation account when they retire at age 65.

Secondly, Private Healthcare Australia argues allowing thousands of Australians to drain their superannuation for dental care is driving up the cost of dentistry for all consumers. It wants the federal government to tighten rules for early access to super so it is only used for terminal and life-threatening medical conditions.

It concludes: “The benefits of compulsory superannuation in providing a retirement income for millions of Australians are significant. The government must consider what egregious billing is doing to all Australian consumers trying to access healthcare during a cost-of-living crisis.”

The SMSF Association has sympathy with these assertions. At the very least it certainly suggests some of these expenses are out of alignment with the policy intent of the compassionate early-release regime, which is based on the principle of last resort.

None of this is to suggest the ATO should be stripped of its discretionary powers to approve applications for the early release of super. A level of flexibility should remain a policy feature to ensure genuine compassionate grounds can be recognised.

This was well illustrated by a recent matter before the Inspector-General of Taxation (IGOT), highlighting how the ATO’s discretion can be used without undermining the integrity of the compassionate early-release regime.

In 2023, the IGOT intervened in a dispute between a complainant and the ATO over the early release of superannuation on compassionate grounds. The complainant had borrowed money from a family friend to pay for urgent surgery and medical expenses, intending to repay the loan by accessing their super.

The ATO initially rejected the application, stating only unpaid expenses were eligible for compassionate release, but the IGOT found the regulator could use its discretion to approve the release in certain limited circumstances, such as when the applicant had difficulties repaying the loan. This resulted in the ATO changing its policy and approving the complainant’s request after obtaining the relevant evidence from them.

But the problem remains that ambiguity still pervades early release. This was recognised as far back as 2017 by then revenue and financial services minister Kelly O’Dwyer when announcing a review of the current framework for the early release of superannuation benefits.

There was no shortage of submissions, with the SMSF Association being one of many participants. We argued in favour of reform, stating money released early from superannuation should be for genuine claims only. To quote: “We have focused our solution on ensuring that the financial capacity aspect of the legislation is tighter and applied correctly rather than including safeguards or limits on specific releases.

“A principles-based approach will ensure that the superannuation system has appropriate policy settings to ensure that retirement savings are used in line with the system’s objectives while also providing flexibility for the system to change and adapt to a changing workforce and concept of retirement.”

What was notable from the submissions were concerns with the rising trend of releases for medical expenses. Two key issues emerged: doubts about whether the current eligibility criteria are sufficiently targeted and questions regarding the integrity of the medical practitioners certifying these claims, especially in determining which ‘specialist’ should be required for certification.

Unfortunately, the review came to naught. Although Treasury initiated a second round of consultations in late 2018, there was little impetus for change. O’Dwyer then left the portfolio in August 2018. From the association’s perspective, the arguments advanced then have even greater validity today.

Why? As the gap in accessible and affordable financial advice widens, allowing early access to superannuation for medical treatments raises concerns about health professionals providing financial advice. It’s essential to ensure there are no blurred lines between clinical advice and financial advice.

Health professionals should focus solely on providing medical care, avoiding any financial advisory role, which can lead to conflicts of interest and inappropriate financial guidance. Financial decisions involving superannuation require the expertise of licensed financial advisers.

This conflict of interest is magnified when third-party providers charge a fee to arrange early access to superannuation on medical grounds. Over the years there has been a strong emergence of thirdparty intermediaries who charge fees to facilitate this process, which can include the establishment of an SMSF.

This is not new news. It was highlighted as far back as 2017 in a federal Department of Health submission about early release that noted nearly all medical stakeholders approached expressed concern about the involvement of third parties, particularly if there is financial gain.

The surge of exploitative claims for early release goes hand in glove with an even more troubling trend, especially for the SMSF sector – the growth in unauthorised access to super benefits.

At our National Conference in Brisbane in February, the ATO did not mince its words explaining illegal early access is a “significant” issue with $381 million in 2019/20 and $256 million in 2020/21 going out the backdoor. As such, it’s hardly surprising the number of trustees being disqualified is at record levels, hitting 751 in 2022/23, a number likely to be exceeded in the 2024 financial year.

The fact illegal early release comes with significant consequences, such as additional tax, penalties and even disqualification, is obviously not proving a sufficient deterrent. According to the ATO, these miscreants are being motivated by various factors ranging from ignorance of the law, a perverse attitude among SMSF trustees in believing it is their money and ignoring the tax benefits that accompany superannuation, to personal issues and financial stress.

They are also being encouraged by promoters of illegal early access schemes who pander to their prejudices of believing it is their money, vulnerability such as financial stress, vanity encouraging non-essential medical treatments or simply ignorance in thinking their actions are legal.

We want to prevent a scenario where after the ATO rejects an application for the early release of super on compassionate grounds, individuals resort to setting up an SMSF to gain direct access to their funds.

We do not want these individuals to fall victim to scams that convince them what was disallowed when a member of a large fund is somehow legitimate in an SMSF, that being a trustee puts them above the law. Not only is that wrong, but the likelihood of being detected is high seeing the ATO oversees SMSFs and all early-release applications.

This is an issue requiring government attention. O’Dwyer believed early release was important enough seven years ago to initiate an inquiry and the fact there were 58 submissions would suggest the industry agreed.

Since then, as outlined above, the data shows the situation has worsened, whether it’s misusing early release for specious reasons (usually medical) or illegal early access, with no suggestion these trends are in retreat.

But we also need to urge government to extend any review of early release of superannuation to include an evaluation of the current tax regime. Right now the taxable component of monies released under compassionate grounds is generally taxed at 22 per cent for anyone under 60 years of age. For anyone over 60, the withdrawal tends to be tax-free.

While some may argue the tax rates applied act as a disincentive to withdrawing super early, the data suggests otherwise. In fact, by taxing these withdrawals, members are forced to take out more from their super to net enough to cover their eligible expenses, further exacerbating their future financial vulnerability.

If we can get the principles underpinning the compassionate release of superannuation right, surely it’s worth asking the question whether it would be more appropriate for these withdrawals to be tax-free to provide the much-needed financial relief, as intended. This would align with the tax-free treatment of withdrawals from super during the pandemic and for terminal illness conditions.

The association is certainly not suggesting this is an easy issue to resolve. But the present day provides a perfect opportunity to revisit this in light of the current economic environment and to ensure any reforms are consistent with the overarching Objective of Superannuation.

Balancing a genuine compassionate application for early release with the legitimate policy goal of having superannuation provide for retirement will always be akin to walking a tightrope. But that’s no argument for not doing so.