The Times They Are A-Changin': SMSF Roundtable - Part 2

Six-member funds, indexation, a legacy pension amnesty and auditor independence standards are issues that grabbed the attention of the SMSF sector in 2021 and will have an ongoing impact into the future.

Selfmanagedsuper’s SMSF roundtable unpacked what these mean in a year when many changes are likely to do more good than harm to practitioners, trustees and members.

This second part of the roundtable covers six-member funds; Your Future, Your Super; COVID-19 legacy; and what lies ahead.

Participants:

Meg Heffron (MH) - Managing director of Heffron.

Peter Burgess (PB) - Deputy chief executive and policy and education director at the SMSF Association.

Philip La Greca (PLG) - SMSF technical and strategic solutions executive manager at SuperConcepts.

Aaron Dunn (AD) - Chief executive of Smarter SMSF.

Moderators:

Jason Spits (JS) - Senior journalist at selfmanagedsuper.

Darin Tyson-Chan (DTC) - Editor of selfmanagedsuper.

Six-member funds

JS: The concept of six-member SMSFs has been discussed for a long time. Now it has become law, are you expecting it to make a real difference?

MH: I am amazed at how many conversations I’ve already had with trustees who want to bring their adult children into their super fund because of this six-member fund thing. I think I totally got that wrong. I thought this was something surely nobody’s going to want to do anyway. We’ve had four-member funds and people with two kids don’t have them in their funds, so why would a sixmember fund suddenly make it different other than to open it up to more families? I have been amazed at how many trustees have phoned and wanted to talk through the pros and cons of doing it. For lots of them when you talk to them about things like control, they get less keen about it, but I think one thing I’m learning is how, and probably I’m seeing this in my own family and then maybe seeing it played out in others as well, is how many parents in their 70s or 80s, with kids in their 40s and 50s, are having serious conversations about intergenerational wealth transfer and the parents are being very transparent about finances.

I was on the phone to a trustee yesterday who was saying: “I’ve got a large accumulation account I’m never going to use. My kids live in Sydney, they’re mortgaged up to the eyeballs and they’re never going to contribute to their super above the super guarantee levy. So what I’m going to start doing is taking out $110,000 per child each year, giving it to the kids and saying if they want to put that money back into super, then put it into my SMSF and we can all belong to the same fund.” They’re genuinely not trying to do anything dodgy, they’re actually saying this is how I can best support my children to grow their retirement wealth because they’re not going to have the cash to do it and I’m in the fortunate position of having an enormous super fund. A number are also taking quite an interesting parent-like view of the world, expressing an interest in educating their 30 and 40-year-old children about investing. That’s fascinating to me because their children are adults, they’ve got children of their own and yet their parents are still thinking about how they can help them focus on investing. I’ve been flabbergasted at how many conversations I’ve had along those lines.

AD: I’ve definitely had a number of conversations on the subject. From a service provider’s perspective we’ve had to make significant changes to accommodate the member increase and it’s likely to be disproportionate to the number of people who will take advantage of the change. But there are people actively having those discussions and, Meg, I’ve had a couple of similar conversations with advisers and accountants asking about the pros and cons. It has also got me thinking about how we look at documentation from this point in time and how deeds can be drafted with regard to voting rights. This may have been triggered based on the increase from four to six members, but in reality I think it’s going to be relevant for two-member funds as well. So it’s not just about having members from the next generation in the SMSF, it’s also about contemplating how to make decisions regarding the holding of assets and the payment of income streams in general.

MH: Aaron, I wonder if it’s because the maximum member limit change is bumping into a demographic change. Like 10 to 15 years ago, people in their mid-80s to mid-90s didn’t have large SMSFs. But today’s 85 and 95 year olds more often do, so we’ve got wealthy old people bumping into the problem of thinking “I’m not going to be able to look after my SMSF indefinitely.”

PLG: I think you’re right. The six-member rule is going to trigger this issue, but it’s really about the control and decisionmaking. We’ve never really had that much of an issue in funds with four or fewer members because it has always reverted back to the fundamental principle that if you’re dealing with majority rules, you generally can’t have too many people unhappy in a four-member SMSF. That’s because with two members everybody had to agree to make a decision, with three members it’s two out of three, four members it’s three out of four to get a decision. The problem now is when we move to five and six members it has to be three out of five individuals or four out of six to achieve a majority. This is where the concept of whether a simple majority is adequate for certain decisions becomes more critical.

MH: And what do you think people will do with things like shareholding in the corporate trustee? I’m wondering whether they’ll have directors and members and if the parents hang on to the shares in the corporate trustee.

PLG: I would imagine there may well still be some of that and then the shares actually become an actual asset in the estate.

AD: I often talk to people who do deed upgrades through us and whether they’ve actually done any sort of constitution upgrade to make sure there’s absolute alignment between the company constitution and the deed. That’s because as soon as you do start to get disconnects between these documents, it’s going to get to a point where it’s going to absolutely blow up on you. So yes, it is something that is becoming more and more important to be talking to people about as they work through these things.

JS: Is this desire for founders of an SMSF to have their children and grandchildren to now play a bigger part in running the fund having an effect on fund longevity and the ability to retain more money in the tax-effective superannuation environment?

MH: The issue of death benefits is probably a bit overplayed because the tax and super rules will still force the money out once both parents have died, generally. What will allow them to keep money in super is if the parents are doing this take money out, give it to the kids, and have the kids put it back into the SMSF strategy, but there’s a limit to how much that’s going to be possible for some of these really large funds. What I’m finding really interesting about this, is when we as practitioners talk about the pros and cons, we actively tell clients to be careful about loss of control when you bring your kids into the SMSF. Yet what I’m hearing, and what I’m actually experiencing in my own family, is the ageing parents are saying they’re not worried about losing control and they actually want to hand over some responsibility to the children in a legitimate fashion. They don’t want to have their kids managing the SMSF informally. They want them to be part of it as they take on more responsibility for the fund they’ve been members for a number of years and had some skin in the game.

PLG: I think a lot of it’s coming down to the issue we’ve always had with SMSFs about capacity. What happens to people as they start to wonder whether they’ve got the mental capacity to run their own super fund and if their capacity is at the right level? And then if they start to become more disengaged by having children in the SMSF, at least it gives them a mechanism where there’s someone who can run the fund. It’s one of the big risks we haven’t really dealt with well, when people start to lose mental capacity and so this sentiment is perhaps starting to answer those questions.

MH: And I used to think the perfect model at very old age was transferring to a small APRA fund (SAF), but we’ve never had a vibrant SAF market that can marry the professional trustee with significant flexibility and other characteristics of an SMSF.

PLG: So your kids become your SAF.

AD: But then the challenge is making sure elder abuse does not happen as well. There are steps that can be taken and that again comes back to decision-making. It may require some other fund guardian role or something like that because naturally there will be circumstances of elder abuse where people’s money will be taken when it shouldn’t have been. So there will need to be a balance.

JS: Does the surfacing of these elements mean we’re witnessing the official birth of the family super fund concept and if so, is the concept taking off more quickly than we could have anticipated?

PLG: Well the discussions are certainly taking off more quickly. I think everyone thought “oh, six-member funds are here and we might have somebody ask us about it”. But I think what’s happening is we’re seeing more questions about it and more expansive use of it as a concept. The actual conversion from conversation to an actual six-member fund – that’s still I think a little bit away.

MH: As I was saying before, I didn’t predict this, but I think it’s almost an idea whose time is right. Twenty years ago it would have been useless because the people who had SMSFs, and who were elderly in this position, were the trendsetters of their time. Many people didn’t run their own super fund. Now it’s a pretty mainstream thing for a 75-year-old to have an SMSF, and they’re also the people who tend to have the most money. They’re thinking: “I am going to have wealth to pass on to the next generation, how is that best done seeing a lot of my assets are in my SMSF?” So a six-member fund would have been irrelevant 10 or 20 years ago because it would not have been the kind of thing you would imagine your kids to be a part of. You did it for a particular reason and you were slightly unusual, but why would your kids do it? Whereas now you certainly would imagine your kids also wanting an SMSF.

PLG: COVID I think has also changed how people suddenly started to think about mortality. If you are elderly now, the coronavirus is actually bringing mortality to top of mind. We’ve had COVID issues, we’ve seen how it’s affected older people, we’ve seen the impact it’s had on agedcare facilities. All these elements are prompting people to think “Well hang on, if I’m in that age group and age bracket, I really need to start thinking a little bit more seriously about death and incapacity”. So if you combine these sorts of little things, you get this domino effect that leads to the conclusion that maybe a six-member SMSF is a good idea.

DTC: If we add the stapling measure contained in the Your Future, Your Super legislation to the mix, will this further strengthen the case for sixmember family SMSFs?

AD: I’ve seen evidence of that three times already in the last two-and-a-half weeks, where a 16 or 17-year-old is starting a part-time job and are included in an SMSF. They wouldn’t know the first thing about stapling, but the decision was made by their parents that it will be easier to stick them in the fund. Then the parents feel they can police what’s going on and control other aspects often seen in public offer funds such as default insurance and whatever else that is probably not really relevant to them at this point in time. Further, the thought process is if they want to stick with the fund in the future, it will be up to them once they’re 18 years of age. But it is something that I have seen on a few occasions already. I have twins about to turn 16 who are looking for jobs and I’m considering implementing this very strategy.

MH: That’s all right for you at the moment, Aaron, because they’re 16, but what happens when they turn 18 and will have to be trustees of the SMSF? Will you be happy for them to be trustees of your super fund?

AD: That’s written into the trust deed and becomes the big issue in that you say they actually have to understand the responsibilities that come with being a trustee, as well as signing the paperwork, they’re responsible for annual return lodgement is on time, SIS (Superannuation Industry (Supervision)) compliance and that sort of thing. When faced with all of that they may decide, “Well no thanks, Dad, not on my life am I going do that”. So then you actually need to push them out. I guess there are pros and cons that come with this scenario, but Darin, to your point about the stapling it does get the issue definitely front of mind with someone in my position.

PLG: Peter and I have actually seen a situation where a colleague of ours wanted to bring his child into his SMSF and he couldn’t because of the way the current industrial relations laws operated, so the stapling provision will actually allow that to happen now.

PB: I guess a big question is whether six members is enough.

PLG: Well it’s always a question about how many kids you want in the fund. I mean even with a maximum of four members it was always a matter of which kid to leave out.

MH: Getting back to the cases I’ve had which have been around older parents and wanting to include their middle aged children who also have their own children. I’m wondering how they feel about excluding the spouses because your financial planning or management when you’re in your 40s and 50s is all about you as a nuclear family with your spouse and your children. It’s not about your parents. So I’m wondering how the personal dynamics work there where, yes the child is in the parent’s super fund and merrily building up their balance, but that deliberately excludes their spouse from any involvement in a very significant part of that nuclear family’s wealth.

PLG: The spouse may still receive some benefit from these arrangements. If you are going to give those children amounts from your super, you’re making that decision in a sense really for the family. If they use it to pay off their mortgage, the spouse is effectively getting some benefit and if it goes into super, they are probably the beneficiary anyway. And in the event of divorce they are going to get half of it.

MH: It’s not so much that, Phil. I’m not really thinking about can they get their hands on it. I’m more thinking, what the psychology of this arrangement is. I mean: “Here’s a very significant part of our family wealth. I’m choosing to manage that with my parents, not with my spouse.”

PLG: But it’s your parents who are asking you to be a part of their SMSF rather than you making that specific decision. So it’s really you helping your parents in that situation.

Your Future, Your Super

DTC: Speaking of the Your Future, Your Super legislation, it introduced the trustee duty of acting in the best financial interest of fund members. What sort of impact might this have on SMSFs?

PB: I’m not convinced it’s going to be a big issue for the SMSF sector. When you look at the rule with the self-purpose test, it’s already there now. There are a lot of other rules around which govern what SMSF trustees can do and can’t do, particularly when it comes to related entities. So whether it will have an impact, I don’t think so is my view.

PLG: I had some interesting conversations about this between an auditor and a large fund administrator-cum-trustee about expenditure. It’s going to be interesting because if it’s financial duty, the question becomes how much should I spend on things. So one of the big arguments that they were talking about was, and particularly with regard to the SMSF space, around valuation costs and where the auditor insists the trustee gets a full-blown valuation. But is it actually worthwhile to do every year? This is an interesting sort of dynamic because the logic could be the trustee says, “Well, hang on, why should I spend $3000 a year on audit and valuation costs when I can get a cheaper valuation more regularly and only get the expensive one every couple of years?”

DTC: Will the legislation affect what could be classified as speculative investments and will a timeframe be implemented to determine the merit of deciding to invest in the said asset?

PLG: The investment one I’m less concerned about because that should already be wrapped up within the investment strategy. If you’re making speculative investments, or implementing long-term strategies, time frames would be included as part of the diversification component. For example, the trustee could say, “I’ve got safe-bet assets that give me a certain level of income and I’ve got other assets that are a little bit riskier but might have a longer pay-off, and I’m allowed to do that within my investment strategy.” It’s about the enunciation of the strategy, which remember is what the ATO spoke about when it said not only do you need to talk about your asset allocation, but also about the whys, and that’s really what the whys are. So the trustee needs to confirm I’m buying these speculative stocks for a short or long play. They have to communicate that decision when they make that call.

AD: Phil, I think you’ve hit the nail on the head where if there’s a disconnect between the investment strategy and the action taken by the trustee, that’s where the issue would arise.

DTC: Do you think the way investment strategies work at the moment, there is that sort of descriptive and prospective nature?

AD: Well there’s certainly been a heightened level of interest in the last 12 to 18 months. So are trustees now approaching this with more seriousness than they have before? You’d like to hope so. I think there’s been a lot of effort and energy put into investment strategies over the last 12 months with the view that hopefully now the fallback position of practitioners is not going back to set and forget. We need to remember the regulation requires regular review and that includes the documentation set around the review and what auditors are going to be seeking. This will go beyond declaring the trustees have considered all aspects of the investment strategy and from that have satisfied the auditors the review was proper. I’m going to be interested to see what happens over the course of the next 12,18, 24 months around the expectation of review. In particular the COVID period has seen a number of events that would force a trustee to have to consider the review of the investment strategy that goes above and beyond adding members and starting pensions.

PLG: I think that’s right because the discussions we’ve been having with auditors, the original focus, if you think back to that ATO letter, was those SMSFs that had 90 per cent of the portfolio allocated to one asset. The auditors are now talking about a significant investment in particular asset classes, whatever the hell that means. We’re talking beyond property and cash. There are a whole lot of other asset classes and investments you do now need to ask questions about. For example, someone buys shares in a private company, how does that fit within the investment strategy with respect to liquidity, diversification and cash flow? It’s all about why I’m making this transaction in the greater scheme of things. And that probably leads into the other issue from the Your Future, Your Super legislation SMSFs haven’t yet had to deal with, which is performance. The APRA funds, at least the MySuper funds, will be benchmarked by the regulator, effectively putting a floor under what returns people will expect their super funds to produce. From an SMSF perspective the implication for trustees could be: “If I can’t outperform a MySuper fund, why have I got an SMSF?”

MH: Have you ever had an SMSF trustee admit that they’ve underperformed a MySuper fund?

PLG: Well it’s going to be interesting because if I’m an adviser I have a best interest duty which says I’ve got to make sure you are in an adequately performing fund. So how do I recommend you keep your SMSF, or put you into an SMSF if I don’t think your performance is going to outstrip that MySuper fund?

COVID-19 legacy

JS: COVID-19 forced changes to some accepted practices, such as executing documents electronically. Will this prove to be a first step towards a more permanent move towards this type of documentation protocol?

AD: The government still has a bill that remains unresolved in the Senate that was meant to basically extend the temporary measures, brought in during the first COVID-19 lockdown, which ran from 21 March through to 21 September last year. This was designed to give the government more time to make those temporary measures into permanent measures.

So there is a commitment generally to amend the Corporations Act to enable that to occur. Aside from this, the reality is there are already changes in this area at state levels that have now become permanent. With the Electronic Transactions Act we saw exemptions get introduced last year for the signing of financial statements under section 35(b). We’ve also seen the government commit as part of a digitisation process to look at areas of the superannuation industry that can be exempted from the SIS Act and SIS Regulations. Here they looked at recordkeeping as a good example. The Treasury consultation executive memorandum examined whether we could look at the use of identification through digital signing for binding death benefit nominations rather than needing witnesses who would be required to verify and validate who those individuals are. So the government does remain committed to this and I think this is only going to be further embraced by the industry, the technology providers that work within the space as well, and the sooner we get it, the better in my view.

PB: I’d agree with that. I think it’s time for the some of those exemptions that apply to superannuation funds around the Electronic Transactions Act, which Aaron was talking about, are removed. We do have situations at the minute where SMSFs in particular are required to keep physical records of things, some of which have to be physically signed. I think it’s time for those exemptions to be removed so that they can be dealt with electronically.

What lies ahead

DTC: To conclude, could I ask each of you to make a bold prediction for the coming 12 months.

AD: I would like to see some resolution on the limited licensing framework so that we end up in a better situation than we’re in right now. The government’s obviously committed to reviewing this area. We do know that statistically numbers have fallen off a cliff in recent times. At 30 June we’ve seen a number of those limited licensed businesses and advisers in those businesses pull the pin on the use of that framework. There has been obviously a lot of discussion of that as part of Consultation Paper 332. We saw some opportunities to explore that with the COVID $10,000 early release of super and there’s been some level of universal acknowledgement around the concept of a record of advice and whether that could play a role into the future. So it might not be 12 months, it might be 24 months, but I’d like to think that we would be able to make some inroads into having some robust discussions as to what a more consumer-centric advice model might look like into the future.

PB: I’m of a similar view there. I think that’s the number one issue facing advisers and consumers right now is how do we make financial advice more accessible and more affordable. It’s particularly relevant to self-managed super fund investors. We need to make it easier for advisers to be able to provide advice to SMSF trustees. That’s single-issue advice, not necessarily comprehensive advice, but the advice that the consumer is looking for. We also need to be looking at ways to reduce the compliance burden on advisers. We’ve now seen the release of the Consultation Paper for the Compensation Scheme of Last Resort and I can see there are some additional costs there being imposed on the advice sector. We do need to look at ways by which we can reduce the compliance burden on financial advisers and a part of that is, as Aaron said, examining how we can use records of advice more so in the future. That’s a really important area not only for SMSFs, but also the broader advice community.

PLG: Advice is obviously a fairly key issue, but there is another matter that needs attention. We still have a massive education problem regarding financial literacy and that’s probably something that we need to get addressed. We can’t really have people understand super properly as it stands now. The reliance on advice and having access to advice is difficult enough. Financial literacy has to be rethought in terms of how we deliver it and do we actually have to go down to school level to start that process.

MH: Well funnily enough, I don’t have any big bold predictions. Following on from the conversation we had about the six-member funds, I think the take-up of that might surprise us all. Certainly it might surprise me. The other interesting thing about today’s conversation is we’ve barely talked about the government proposal to remove the work test and yet I think that was one of the best things in the budget. If it does come in, I think it will profoundly change how people think about saving for their retirement because they’ll have vastly more time to do it and it coincides with a time when I think vastly more people are likely to work beyond age 65 anyway, but not necessarily at the rate required to meet the work test. So I’m going to be fascinated to see whether we actually get that because I would really like it.