Elephants in the Room Released: SMSF Roundtable - part 1

While a change in government has yet to reveal any impact for the SMSF sector, there is optimism around adjustments to contribution rules, the potential for a non-arm's-length expenditure solution and a definitive ruling on binding death benefit nominations. The selfmanagedsuper SMSF annual roundtable for 2022 asked four leading lights in the industry to dig into the importance of these and other key issues for the months and years ahead.

This first part of the roundtable covers the federal election; NALE reform; changes to the work test; and Hill v Zuda.

Participants

Graeme Colley (GC) - SuperConcepts technical and private wealth executive manager.

Meg Heffron (MH) - Heffron managing director.

Claire Mackay (CM) - Quantum Financial principal adviser and director.

Peter Burgess (PB) - SMSF Association deputy chief executive and policy and education director.

Moderators

Darin Tyson-Chan (DTC) - selfmanagedsuper editor.

Jason Spits (JS) - selfmanagedsuper senior journalist.

The federal election

DTC: Can we expect to see anything significant changing for SMSFs following the result of this year’s federal election?

PB: It’s early days, but we’re not expecting to see any specific measures targeting SMSFs. When we’ve gone to Canberra and had discussions with the government, as well as the opposition, it’s very clear to us they understand the importance of the SMSF sector and they understand the importance of members having choice when it comes to retirement savings. There are a few measures left over from the previous government – the legacy pension measure, and the residency rule changes – which were announced in the budget last year. We would like to see those measures proceed, but there has been no mention of that. It’s fair to say that for a new Labor government those measures are not high on their agenda, so we’re going to have to be patient.

MH: Peter, when asked what you thought the about the new government and SMSFs, you immediately spoke in terms of being targeted, which shows the mindset we have about governments and SMSFs. We are more concerned about negative outcomes than we are excited about positive ones. The Labor Party has not historically been a great friend to SMSFs, but I don’t think they are antagonistic, either. They are realistic and have bigger fish to fry at the moment than doing something to disrupt a sector that looks after a third of Australia’s retirement savings. I’m optimistic they will leave it alone.

JS: There has been chatter about the government watering down the Your Future, Your Super legislation from a transparency perspective. Is this indicative the new government is more focused on the industry funds sector, maybe to the detriment of other sectors?

PB: That seems to be a stand-alone issue. There’s been no suggestion based on our discussions with the new government that it’s looking to do anything specific around SMSFs, so we have no reason to be concerned at this stage. It is very clear that we won’t see a return to the franking credit policy it took to the previous election.

GC: While the politicians might water down the MySuper rules, I don’t think that shows they’re going to move towards SMSFs and attack them in a specific way. They’ve got other bigger fish to fry mainly on the revenue side of things. SMSFs are not going to be exempt from those sort of mega changes because they’re going to affect income tax and revenue, which are the items the government wants to use to help make up the deficit resulting from the last few years of COVID-19 disruption.

CM: There is going to be pressure on budget repair, to look for areas of either savings or revenue and every time superannuation becomes that big box people want to crack open. The other thing is that it’s not just what the government wants to do, it may be the will of the people who are in their ears. The industry funds have their own agenda, which may or may not impact SMSFs. So we can’t control the political stuff, but can control how we navigate through it.

DTC: Assistant Treasurer and Financial Services Minister Stephen Jones has made comments about channelling superannuation into a particular area, to help the economy, to help build things like infrastructure. What can they use to potentially do this?

CM: There is a liquidity issue that restricts SMSFs where the balances are much smaller. Larger funds have a greater flexibility given the amount of money they’ve got, but they still have to meet their liquidity requirements. If you start looking at the age demographics of particular funds that have an average lower age, they can be more flexible in taking on longer-term investment projects because they can look at their member base and say, subject to unfortunate events, liquidity is not going to necessarily be as high a priority unless people are switching.

MH: I think it would be incredibly hard for any kind of government mandate for an investment in infrastructure. Maybe there would be incentives to invest in infrastructure or in something else which is more liquid, but I just can’t see us ending up at a spot where funds are forced to invest in something that creates a liquidity problem.

PB: Mandating a certain percentage of assets to be invested anywhere always raises questions about what that does to the overall return of a fund. Will it have a negative impact on what someone’s retirement savings might be worth when they retire? Those things would need to be worked through and no doubt will come up if those type of proposals get floated.

GC: We will probably see some encouragement to invest in a particular sector rather than mandating it. If funds want to invest in start-up companies even now, they can invest in infrastructure-type investments. I think it’d be done through encouragement rather than what we would regard as discouragement and the problems with cash flow if it was mandated.

CM: If the underlying investment is worth it, there will be money that flows to it, but in the SMSF space there are only a handful of funds that can really play in that space. The majority of families are focusing on their retirement savings and a 25-year infrastructure plan for most members is not really going to be high on their agenda.

NALE reform

DTC: Are we confident the government and Stephen Jones are committed to reviewing the nonarm’s-length expenditure (NALE) provisions and will find a workable solution in a suitable timeframe?

GC: It is good the big superannuation funds have seen the issue and how the rules will impact them because it has highlighted to the new government that it’s not just small funds having a whinge about the way the laws are being interpreted by the ATO on some of these general expenses. The announcement by former superannuation, financial services and the digital economy minister Jane Hume that the rules need to be reviewed has alerted the current government to some things that need to be done as well.

DTC: Some of the contribution rules regarding in-specie contributions are being shaped to accommodate the NALE provisions. Is this a sign this issue is continuing to head in the wrong direction?

PB: One of the changes we did see made to Taxation Ruling 2010/1 – which is still in draft format – was to accommodate the introduction of the NALE rules where a fund acquires a property at less than market value. What the ATO have said in the changes to the ruling is you can’t record the difference as an in-specie contribution, which is a common thing we’ve seen in the past. The ATO is now saying in this draft ruling this will be a NALE situation. It means the asset in question will always be tainted and the income the fund receives will need to be taxed as non-arm’s-length income. It’s not clear in the draft ruling whether it could be made retrospective. We have not yet made any formal comments on that draft ruling as we need to see where we land with the NALE rules before we turn our mind to some of those changes that have been proposed. We remain very optimistic we will see a law change. The only way to solve this issue is a complete rewrite of those provisions, not a band-aid fix, to ensure we don’t end up in situations where all of the fund’s income is taxed at 45 per cent because it didn’t incur an admin fee on an arm’s-length terms, or the fund doesn’t end up paying 45 per cent on all the income from a specific investment because the fund didn’t incur an expense in relation to that investment at arm’s-length terms. Options being considered is for the ATO to have discretion to apply these rules and to have some criteria in place before it would take action, and having to consider the financial impact on the fund and whether it was actually an inadvertent mistake. If that’s not possible, the other option would be looking to break that link between the non-arm’slength expenditure and the income related to that, because that’s where we get the disproportionate outcomes as the penalty is applied to all the income that’s linked to that non-arm’slength expenditure. We need to break that link and identify what we call the shortfall amount and treat it as an excess contribution.

JS: Is it possible we may just see the legislation continuing as is, but applied in line with the original intent rather than seeing a complete rewriting of it?

PB: Yes, from a government perspective, if they’re looking for the simplest solution. But in our view we don’t think you can solve this problem unless you do the complete rewrite. If you do something other than that, you’re probably not going to solve all the issues associated with these provisions.

GC: It depends on the pressure from the lobby groups, big and small super funds, and also whether the government considers that what’s in place now is the end of that policy matter. If that’s the case, then it will only be minor changes to those rules. Often, big slabs of legislation come in and the government is only prepared, irrespective of which party is in power, to make minor changes at that point.

JS: Are individual SMSF trustees aware of the NALE rules and what it might mean for them?

CM: The clients that are aware of it are the ones who need to be aware of it and, as advisers, our job is to bring it to their attention if they weren’t aware of it, or to identify this might be an issue, given what we know about our members, their jobs and what they own in their SMSF. The problem here is this issue has been unresolved for so long. For years, we’ve been hearing from the ATO that when honest or inadvertent mistakes are made they don’t want Australians to lose sizeable chunks of their retirement savings through penalty taxes. Yet the application of these rules seems a little bit contradictory, so proportionality is important. As an industry, you want the law to be straightforward, but not at the detriment of undermining the whole superannuation sector as well.

MH: The risk here is out of proportion to the offence and it seems crazy that an inappropriate administration fee or advice fee threatens a massive tax be imposed on all of the fund’s income. However, it is also the sector’s focus on it that is out of proportion to the problem. When Claire and I say the clients of ours who are affected are aware of it, that number I suspect is very small. To that end, it’s a shame we’ve spent so much time and effort on an issue which is relevant for very few clients. But if the ATO ends up doing what it initially wanted to do, it would be massively out of proportion to the action of these clients in the first place. It’s not a storm in a teacup, because the storm is very definitely here, but it does seem out of proportion to the extent of the crime.

GC: One of the good things we’ve seen out of this issue, that might sound a bit strange, is clients are more interested in getting documents right on some of these non-arm’s-length arrangements they’ve got in place and making their rental payments on a far more regular basis than they ever had before. They are now really fastidious about those things. So, while we see the negative as everyone else does, we’re also seeing the positives that can come from it. There’s nothing worse when you’re hassling a client to provide documentation year after year after year and nothing happens and yet regulations like this come in and they’re all shocked and go into panic mode to make sure they are not going to be hit with 45 per cent tax.

Changes to the work test

JS: There have been some significant changes to the landscape around contributions, most notably to the work test. What opportunities have these changes opened up?

MH: The changes are brilliant for clients because there’s a whole demographic of people who may have missed the superannuation boat who now, even though they’re 67, can start putting money into the system. And not just $110,000 a year if they’re working, which is what they used to be able to do, but really meaningful sums. The fact they can also use the non-concessional contribution bring-forward rules during that period too is massive. In the past, if you had a 70-year-old whose 95-year-old mother died and they inherited a lot of money, you would never have thought of super as a spot for that money, but it’s a realistic option now for people who haven’t built up much super. If you overlay that with the fact the consumer price index is so high at the moment, we will certainly see an increase in the general transfer balance cap up to $1.8 million at 1 July 2023 and if inflation continues at the rate it did last quarter, we may even see it move to $1.9 million. Now there will be a whole host of clients who are 70 with less than $1.9 million in super, so non-concessional contributions will be back on the table for them. It’s enormous for people in that demographic and will change the game on contributions.

CM: If you combine it with the ability to make downsizer contributions as well, that’s helpful for people who may have changed their strategies because of concerns around COVID or job security. And so, if you look at income generation, people go through different stages where they are earning great income but have mortgages, children’s education costs and other expenses coming out in every direction, meaning they can’t add that little bit of extra money to their superannuation that is going to help fund their retirement in 20 years’ time. Helping people load up at the end when they’ve helped out their children and are feeling in a more comfortable place to dedicate some more money to their retirement savings is great as well. I’m all for meeting the rules, but sometimes the rules are a bit silly. We know people are working longer, but also know some people, because of their professions and their careers, can’t work longer and weren’t able to take advantage of the previous contribution rules.

JS: Are there some traps that practitioners need to be aware of because the work test was linked to other things and raised flags for ineligible contributions?

MH: There are a few. Take downsizer contributions and non-concessional contributions, for example, where somebody makes a contribution thinking it’s going to be a downsizer, only to discover they’ve failed to meet the rules. In the past, if they were 70 and made a downsizer contribution in error, and didn’t meet the work test, it was not treated as a non-concessional contribution and was spat out by the fund. Now, no work test is required and it becomes a perfectly legit contribution. If it fails the downsizer rules, it becomes a non-concessional contribution, which might also create a very large excess. There will also be people who think they’ve met the work test but haven’t and look to claim a deduction for a contribution. In these circumstances the contribution will suddenly become nonconcessional instead of concessional. So with any good thing there’s always a few traps to be aware of, but fundamentally I’m glad we’ve got this change.

GC: One of the really niggling traps is the fact when someone gets to age 75, the fund can still receive contributions 28 days after the month they turned 75. That’s very difficult to explain to some clients. The other trap is the total super balance applies for some nonconcessional contributions, but doesn’t apply for concessionals and other contributions you can make into the fund. The planning around that needs to be discussed because sometimes the total super balance will have an impact on what you can put into the fund and in other circumstances it won’t.

DTC: Will the ability for older Australians to make superannuation contributions help with sequencing and longevity risk?

CM: I don’t think so. Sequencing and longevity risk are what they are. If you’re someone who’s looking to retire in the next 12 months and at the moment there’s a war going on with no visible conclusion, inflation is going up around the world and there are concerns about being able to afford grocery bills due to these factors, then those risks haven’t changed. They are more pronounced when you see the news every night. These rules are giving people more flexibility when most Australians have a little bit more cash around and trying to match what’s happening in real life and encourage you to save for your superannuation. Sequencing risk and longevity risk have been around for every retiree who wants to have confidence about remaining in retirement regardless of the contribution rules. It may help people get more money into a concessionally taxed environment, but only if they have that money. The changes are not giving you a tree with more money coming in. You still need to have the money sitting around and if you’ve got so much money that you can’t get any more money into superannuation, that’s a lovely problem to have and this opens that up for you. For the majority of Australians it is an incentive to save for retirement as they get older and encouraging Australians it’s still possible to have a comfortable retirement they can self-fund to a greater degree than in the past.

DTC: A bill was recently tabled in parliament to further reduce the downsizer eligibility age from 60 to 55. If passed into law, it will mark the second downsizer age reduction in a very short period of time. Are moves like this making a simple measure more complicated than needed?

GC: It gets people to think about it a little bit more deeply. With the potential to make downsizer contributions at age 55, we can start to think about the time period between the sale of the house if the client is 55 or 60, and whether they’re going to subsequently buy another house and keep it for 10 years. If that is the case, it may be better to delay that contribution until as late as possible because there are no boundaries on it apart from the age qualification and the amount. So you could make a downsizer contribution, if you’re going to buy another house and you’re only age 60 or 65, when you’re aged 70, 75 or even older as that could be the right time for it. In the meantime, if there are inheritances and assets the client owns personally, they will be able to put them into super as non-concessional contributions, particularly if they have a total super balance of less than $1.7 million. It has become more complex from a planning point of view because there’s an age limit, a time limit and the question of how long you have owned your own residence.

CM: What most people will get tripped up on is the fact the downsizer contribution has to be made within 90 days from date of settlement, not 90 days from date of contract. The reality is when you’re selling a house, and also looking to where you’re going to live next, that matter is not necessarily top of mind. And sometimes clients do these things without telling us. So it’s about working through that problem and making sure the client can sign the form saying that they have met those conditions and making sure that the money’s available to be put into the super fund within the designated timeframe.

DTC: So if we see age 55 being the new qualification threshold for downsizer contributions, will people have to become more strategic about making them?

MH: If they can still make nonconcessional contributions, they will. The key there is the transfer balance cap. If it is more than $1.7 million for an individual, then they’ve got no other mechanism for getting more money into the super fund and so might have to make their downsizer contribution as soon as possible.

CM: Alternately, it can depend on whether the home you’re going to is not your last home. There’s a push now for people at age 55 to go into purpose-built places, so it ties in with the changing nature of what our homes look like as well.

MH: I have not thought about that, but you’re right. So, there is some logic to 55 as it is when people sometimes move into a different home and that might be their last home.

CM: It’s about considering what you want from your home and the sort of space you want as you get older. There are many different circumstances, but I’m loving it because it gives people options they otherwise wouldn’t have had.

PB: It’s a really interesting strategic conversation to have. When the downsizer qualification age was set at 65, you probably only had one opportunity to make that type of contribution. But seeing it’s probably coming down to age 55 means the chances are good that people will have another opportunity to use it later in life. If they only get one go at this, they need to consider whether they should do it now or later. If they do it now, does this maybe prevent them being able to make any further contributions if the downsizer money tips them over the total super balance threshold for nonconcessional contributions. This may ultimately mean they don’t get to have as much in super as they might have if they had made a non-concessional contribution earlier instead of the downsizer contribution. So it does make for a much more interesting strategic conversation with clients.

Hill v Zuda

JS: Let’s move on to the recent High Court case of Hill v Zuda. Graham, how significant has this been for SMSFs?

GC: It’s significant for those super funds with trust deeds that still import SIS (Superannuation Industry (Supervision)) regulation 6.17A into them. It’s interesting as to why the case got to the High Court because it’s a relatively simple technical matter that was considered. It probably didn’t change things from the point of view of the trustee taking charge in the running of the superannuation fund. And I think that’s what people really need to understand about it.

JS: Has it made people sharpen their focus on their death benefits?

MH: I’m not sure this case, in particular, has made people sharpen up and focus on death benefits more. Probably people have looked at it more in the last couple of years with regard to updating their deed, their binding nominations and the interaction between the two. I think as an industry we may have been a bit too laissez-faire about trust deeds and binding nominations as to whether they say the right things. So that’s probably a theme, I’d say, that has emerged over the last couple of years, rather than specifically in response to this case. It’s not a bad thing, right? Personally, I wish we as an industry would completely reject template binding death benefit nominations and have lawyers prepare them because they are so important.

CM: This case should definitely be on people’s agenda if they’re an adviser because when I read through it, I thought who is going to get sued. When there’s money, and in an SMSF there is money, it will be fought over, especially seeing how common blended families are now. With the knowledge you have as an adviser, do you back yourself to be certain that in every client situation, if they died yesterday, all of their death benefit documentation is tickety-boo given what you know about the potential beneficiaries? When I read this case I was going through each of my clients’ scenarios to consider which ones are at risk. It’s not just about fighting over the will because cracking the super open to get it into the will is so important. I think every client should have a death document that determines when a member dies who is going to be at the table and on the paperwork, who is advising them, what assets are involved, are the assets liquid, what is the applicable timeframe and the strategies around these factors. It can’t be just a matter of providing a form for the client to sign every three years. From a practical perspective it’s a big deal because you don’t want to be sued by clients where this is an issue for them.