First Home Saver Accounts – Can they make a difference?

First Home Saver Accounts – Can they make a difference?

By Jenny Willcocks | March 2008 Area of Expertise | Insurance & Financial Services, Life Insurance, Superannuation & Collective Investments

Summary The Federal Government released an outline of its proposed arrangements for the new first home saver accounts (FHOA’s) in February 2008. The introduction of these new accounts was previously announced by the Government as a means of assisting people to purchase their first home. The release of the proposal paper (the Paper) is timely given that it coincides with further increases in interest rates.

The Government is consulting closely with the financial services industry and all aspects of how FHOA’s are to operate is open to discussion.

The Paper contains some surprises for superannuation trustees, including the fundamental requirement that superannuation funds can only offer FHOA’s through a separate trust.

Who Does This Impact?

This impacts Trustees of Public Offer superannuation funds, life insurers (including friendly societies), banks, credit unions and building societies.

What Action Should Be Taken?

Those eligible to offer FHOA’s should familiarise themselves with what is proposed in the Paper and actively participate in consultation with Government.

Who can offer these accounts?

The following entities will be permitted to offer FHOA’s: •

Trustees of registrable superannuation entities with a public offer or extended public offer RSE licence (Public Offer Licensees) through a separate trust subject to being authorised by APRA.

•

Life Insurers (including friendly societies), banks, building societies and credit unions can offer the accounts under their existing structures and APRA authorisation.

Why only Public Offer Superannuation Funds?

The reason given as to why only Public Offer Licensees, and not all RSE licensees of superannuation funds, can offer FHOA’s is that Public Offer Licensees are subject to higher levels of prudential regulation than non-public offer RSE licensees. This includes minimum capital requirements. The Paper indicates that as these higher standards of prudential regulation are closer to the standards imposed on authorised deposit-taking institutions and life insurers; this ensures Public Offer Licensees will be well placed to deal with operational risks associated with the shorter term nature of FHOA’s.

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Proposed First Home Saver Accounts – Can they make a difference? by Jenny Willcocks

This limitation may come as a surprise to many trustees of non-public offer superannuation funds which have successfully managed billions of dollars in superannuation money for many years, including in a fund choice environment when membership can be short term.

These accounts will operate on a similar basis to a superannuation accumulation account. Presumably the non-public offer part of the superannuation industry will put its own case to have this restriction removed.

Why have a separate trust?

The most unexpected element of the Paper is the requirement for Public Offer Licensees to offer these accounts through a separate trust from the superannuation fund they administer. This will necessitate: •

A separate trust deed appointing the trustee and meeting the requirements concerning eligibility, establishment and administration of FHOA’s.

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This separate trust will be subject to prudential regulation of APRA “similar to existing regulation under the Superannuation Industry (Superannuation) Act 1993” .

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Separate accounts must be maintained for the FHOA Trust and a separate tax return.

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Assets of the FHOA must be separate from the assets of the superannuation fund.

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Separate disclosure obligations will apply.

It appears this separate trust structure may be to avoid issues relating to the sole purpose test under section 62 of the Superannuation Industry (Supervision) Act 1993 (SIS) as it is not a requirement imposed on the other entities entitled to offer FHOA’s.

It is possible for SIS to be amended to incorporate FHOA’s as an ancillary purpose under section 62 with an appropriate condition of release.

However, this may be seen as undermining the sanctity of the sole purpose test.

Requiring a separate trust to be established and administered by Public Offer Licensees will add to the cost of offering this product through a superannuation fund. This may make it impossible to offer the product at a competitive price, placing Public Offer Licensees at a disadvantage.

Life insurers, banks, building societies and credit unions Life insurers are registered with APRA under the Life Insurance Act 1995 and are subject to prudential standards under that legislation. This includes requirements to comply with minimum capital, insolvency risk management and governance standards. Similarly, banks, building societies and credit unions are regulated by APRA under the Banking Act 1959 according to prudential standards under that Act which include strict capital adequacy, liquidity and governance standards.

Under the proposal in the Paper, life insurers will offer FHOA’s as life insurance policies, which may be investment linked. Banks, building societies and credit unions will offer them as a deposit account. Accordingly, this group will be able to offer FHOA’s through their existing structures.

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Proposed First Home Saver Accounts – Can they make a difference? by Jenny Willcocks

Portability FHOA’s must be able to be transferred between providers within 30 days of the request from the account holder.

Information must be provided to the new account provider to keep track of eligibility criteria including how long the FHOA has existed, contributions made and earnings. The Australian Taxation Office (ATO) must be informed that the account has been transferred to a new provider but only at the end of the year.

It is proposed that a standard transfer form will be developed. The Paper indicates that the prudential framework to support FHOA’s will allow for bulk transfer of assets from an account provider on it ceasing to provide this type of product or where the account holder fails to choose an alternative provider.

The banks, building societies and life insurers’ arrangements would be as per their existing legislation. However, arrangements for Public Offer Licensees will be similar to those applying to superannuation funds under SIS. No further detail of what this would entail is given. For example, transfers by consent or some kind of successor fund transfer mechanism to apply to these accounts.

If an individual is transferring their balance from one FHOA provider to another they will be permitted to hold two accounts but only on a temporary basis. The transfer to the new account must be completed within 30 days of it being opened. If this does not occur, the provider of the new account will be required to close it. This is because a person cannot have more than one FHOA. Obviously the timeframes and processes for the transfers of these accounts will need to operate with this in mind.

ELIGIBILITY CRITERIA The criteria used by the States to assess eligibility for the First Home Owner Grant (FHOG) will be adopted for FHOA’s. However, unlike the FHOG, eligibility is determined on an individual basis. That is, a person’s eligibility is not affected by the eligibility of their partner. The FHOG arrangements remain the same.

Eligibility criteria proposed are as follows:

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The person must be aged 18 and over and under 65 years.

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The account must be opened for their own benefit except in the case of incapacity where a legal personal representative may open the account on their behalf.

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They must be an Australian resident for income taxation purposes.

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They must never have previously purchased or built a first home in Australia to live in.

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They must provide their tax file number and meet the standard proof of identity requirements.

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They must confirm they do not already have or previously have had a FHOA.

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They must make a minimum $1,000 upfront contribution to the account.

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The Paper includes the following statement: “The ATO will undertake compliance work to ensure that individuals who open an account are eligible and that only one account is opened per individual. Penalties will apply for breaching the eligibility requirements, including criminal penalties if applicable.”

Therefore determining a person’s eligibility will be the responsibility of the ATO as will be penalising those who do not comply with the requirements. However, to do this the account providers are going to have to provide the necessary data on these accounts to the ATO.

PROVISION OF TAX FILE NUMBERS As with the government co-contribution to be eligible to receive the Government’s contribution to a FHOA, the account holder must provide their tax file number.

As with the provision of tax file numbers in other circumstances obligations relating to collection, use and disclosure of private information must be complied with and would need to be addressed on any application form to open a FHOA. In most cases FHOA’s will be provided to a person with whom the account provider has an existing relationship. It is therefore preferable to avoid a situation where the account provider has to go through the process of collecting a tax file number for an FHOA when it is already holding that tax file number for another purpose e.g. to provide superannuation, a bank account etc. If the person applying for a FHOA has already provided their TFN for Superannuation purposes (or are deemed to have done so) they could be deemed to have also provided it for the purpose of a FHOA. Hopefully this will be the case to avoid unnecessary administration.

Process for opening an account The following process for opening an account will apply; •

disclosure by the account provider of key information (see below);

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provision of information by the applicant using a standard form to provide information to establish eligibility including their tax file number, the standard proof of identity documents required under the Anti-Money Laundering and Counter-Terrorism Legislation; and

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a declaration that they meet the eligibility criteria referred to above.

The account provider must report to the ATO that a FHOA has been opened as soon as practicable after opening it, but in any event within 30 days. This means reporting on an ongoing basis rather than annually. Reports will be provided in electronic form to the ATO who will then undertake compliance work to ensure that the account holder is eligible. In the report to the ATO the account provider must include the account holder’s tax file number, name, date of birth and address, certain account details including the account number and the date it was opened.

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Contributions WHO CAN CONTRIBUTE? There are no restrictions on who can make a contribution to a FHOA once it is opened. An employer will be able to submit post-tax contributions on behalf of its employees to these accounts. Parents or other relatives will be able to contribute on behalf of children who are saving for their first home to assist them in obtaining the government co-contribution.

The FHOA provider will need to request basic identifying information from the person contributing to these accounts to enable excess contributions to be returned (see below).

POST-TAX CONTRIBUTIONS ONLY Contributions to FHOA’s must be post-tax contributions so they will not involve salary sacrifice arrangements. The government contribution to these accounts is based on an individual’s marginal tax rate and appears to be structured to overcome any inequity caused by some people having access to salary sacrifice arrangements, while others do not.

NO MINIMUM CONTRIBUTION While an initial minimum contribution of $1,000 is required to open an account, no minimum annual contribution will be set. However, amounts can only be withdrawn from an FHOA where contributions of at least $1,000 have been made over 4 years. The Paper does not indicate whether this 4 year period needs to be consecutive.

CONTRIBUTION LIMITS Contributions to FHOA’s will be limited to $10,000 (indexed) per annum excluding the government contribution and any earnings on the FHOA. The Paper includes an option for an overall contribution limit of $50,000 (indexed).

The Paper states that the account provider will not be able to accept contributions that exceed the annual cap of $10,000 p.a. The account provider will have to keep track of contributions to identify when this limit is reached. The $10,000 limit will be maintained at double the $5,000 government contribution threshold and will be indexed to average weekly ordinary time earnings in $500 increments.

RETURN CONTRIBUTIONS The Paper includes a process for account providers to return excess contributions above the annual limit of $10,000 within 28 days of receipt, and to notify the account holder if they are not the person who made the contribution. Penalties will be imposed on the account provider if they fail to meet this requirement. No penalty will apply to the person who contributed the excess contribution or to the holder of the account.

For an account provider to be able to comply with this requirement, they must have the name and address of the contributor. This puts in question whether they can accept contributions electronically from contributors who have not already provided this information.

The need to monitor the $10,000 limit and to return excess contributions imposes an unacceptable administrative burden on the account provider. This would be increased if there is an overall limit of $50,000 imposed as well. If the policy is to encourage savings, any limit

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should relate to the amount on which the Government contribution is based. This would greatly simplify the administration and ensure the account provider’s role is to accept contributions and manage the account without becoming involved in eligibility issues.

Government contribution and taxation The government contribution to these accounts will operate as follows: •

Savings of up to $5,000 per year (indexed) will be eligible for the government contribution which will be paid directly to the FHOA.

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The Government contribution will be at least 15% increasing to 30% based on the marginal income tax rate of the account holder (See below).

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If the account holder does not pay tax or is subject to the 15% marginal income tax rate, a minimum government contribution of 15% will apply.

The intention is that the government contribution will provide a similar outcome to salary sacrifice arrangements which were part of the original proposal for these accounts. This responds to the fact that salary sacrifice is not available to all.

Based on the current marginal tax scales, the Government will contribute the following percentage to contributions paid by the account holder: Marginal Income Tax Rate

Percentage of $5,000

0, 15 or 30%

15%

40%

25%

45%

30%

Accordingly, the more you earn the more tax you pay, the higher the amount of the government contribution. Obviously there are equity issues which will need to be considered.

Small account protection The paper requires similar arrangement to member protection for small accounts within superannuation funds to apply to FHOA’s. Account providers can set their own contribution limits to minimise any administrative costs relating to small account balances. Therefore an account provider could require a minimum contribution of $5,000 or other amount it deems appropriate to avoid an excess number of small accounts which will be protected from administration costs exceeding the returns. However, this approach could put access to this product out of the reach of some of the people that need it the most.

It is questionable how this type of protection can apply in the context of these accounts. The fundamental question is who pays for this protection? It can only be the other account holders who bear this burden adding to the cost.

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When does the FHOA cease?

The account must be closed when; •

the whole balance is withdrawn to purchase or build a first home;

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the account holder reaches age 65; or

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the balance of the account is contributed to superannuation (see below).

If the FHOA is closed because the account holder reaches age 65, the balance must be transferred into superannuation within 30 days. The account holder must satisfy the work test before contributing money to superannuation. To allow for the transfer to superannuation, it is proposed that the work test will be suspended for 30 days following a person reaching age 65 to allow the transfer to occur without the necessity of meeting the work test.

It assumes that the account provider is able to locate the account holder at this time in order to obtain authority to pay a specified superannuation fund in which the account holder is a member.

Other circumstances in which account can be released How an FHOA will be dealt with varies in the following circumstances: •

Death of the account holder – balance to be transferred to superannuation and treated as part of the superannuation benefit.

•

Bankruptcy of the account holder – balance to be treated the same way as if it was an ordinary savings account.

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Relationship breakdown -In the event of a relationship breakdown (presumably separation, divorce) the account is treated in the same way as superannuation.

There is no apparent reason for this inconsistency. Treating the balance on death or divorce in the same was as superannuation is not consistent with the requirement for Public Offer Licensees to maintain these accounts under a separate trust.

Withdrawals The following requirements apply to withdrawal of monies from an FHOA;

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withdrawals can only be for the purpose of purchasing or building a first home in Australia to live in;

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the whole amount must be withdrawn and the account closed;

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withdrawal on this basis is only possible if contributions of at least $1,000 have been made in each of at least 4 years;

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the full amount of the FHOA can be contributed to superannuation at any time and the account closed; or

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the account must be closed and the balance transferred to superannuation within 30 days of the account holder reaching age 65.

The balance transferred into superannuation can be accessed under the SIS early release provisions for severe financial hardship, compassionate grounds or terminal illness.

The purpose of FHOA’s is to encourage saving either for a first home or for retirement, hence the provision that the balance can be moved across to superannuation at any time.

PURPOSE OF WITHDRAWAL The purpose of the withdrawal must be to purchase a first home. This includes payment of a deposit and where a home is being built, the instalment due on signing of the contract to build.

If the account holder is purchasing land only, it must be a condition of the land purchase that a building contract be entered into within 6 months. It is difficult to see how this requirement could possibly be met. With whom would this contract be made? Clearly it will be of no interest to the vendor of the land whether or not the person acquiring it builds in 6 months or not.

TIMING OF WITHDRAWALS A standard form will be introduced to facilitate withdrawals. There are critical time requirements which must be met and which add complexity to this process.

The withdrawal must occur before the sale or contract to build a first home is “finalised”. Presumably this does not mean the date the contract is signed but in the case of a purchase, the date of settlement or in the case of a building contract, when the final progress payment is made.

If the first home has already been purchased or built, the amount cannot be withdrawn. The Paper indicates they are still trying to deal with the issue of purchasing at auction.

This part of the Paper presents a number of practical problems and it is difficult to understand why someone would forfeit their opportunity to withdraw the account balance just because they have completed the purchase or building of the home. In many ways it is preferable for that process to have been completed before withdrawal occurs. For example if you can withdraw before you settle what happens if the purchase falls through?

Obviously many of those who will be attracted to this product will be looking to save their deposit. Therefore being able to access it before the sale is completed is essential, and in the case of the auction they will be required to pay on the day of the auction.

What happens if you do not use the FHOA to purchase first home?

If the account holder fails to purchase a first home with the funds saved, the balance will be transferred into superannuation. Superannuation funds will be receiving these transfers as non-concessional contributions which will count towards the non-concessional contributions cap but not for the co-contribution. They will also be accepting these transfers/rollovers from outside of the superannuation industry. Some amendments to SIS will be needed to accommodate these “transfers”.

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Joint Owners Where the purchase of the first home is being made by the account holder with another person or persons, the balance of their FHOA may be released even if the four year condition has not been met, provided the account provider is satisfied the other person or persons involved in the purchase meets the condition in relation to their own FHOA. The Paper does not indicate how the account provider would do this, but acknowledges that a process will need to be developed to allow providers to transfer this information.

This provision is likely to be very cumbersome and possibly time consuming and will impose a burden on those providing FHOA’s and add to the cost of administration.

Prior home ownership There are some anomalies in the Paper concerning the prohibition on prior home ownership.

The account holder must not have previously bought or built a first home to live in but remarkably will still be eligible if they have previously purchased an investment property or block of land! The prohibition applies only to property in Australia so you can own a property overseas and still be eligible.

Conditions applicable after withdrawal Conditions will be imposed to ensure the purchase of the home is for the account holder to live in and not for other purposes such as use as an investment property.

The account holder must live in the home for a continuous period of 6 months commencing within 12 months of settlement or completion of construction. On this basis a home could be acquired, rented out as an investment property for 12 months, occupied by the account holder as their residence after that period for 6 months and they would meet the criteria.

The Paper indicates that the intention is that the account holder will reside in Australia after purchasing the house, at least within the restricted requirements indicated.

If an account holder fails to meet these requirements they are liable to repay any government contributions and penalties (including criminal penalties) may apply. Exceptions may apply where the home has not been occupied due to extenuating circumstances such as divorce or military deployment overseas.

Transfer to Super at any time To address the fact that a person’s circumstances can change, the fall back position will be where the account is not used for the original purpose (i.e. acquiring or building a first home) it can instead be contributed to superannuation at any point in time. The whole balance must be contributed and the account is then closed. Those that take up this option will cease to be eligible to open another FHOA.

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Powers of ATO ATO can direct an account provider to make an account inactive or to close it in certain circumstances. The examples given in the Paper are where the ATO identifies the account holder as being ineligible to open an account. If an account is closed in these circumstances, the account holder is liable to repay any government contributions received and penalties including criminal penalties.

It is not clear whether the ATO would seek to recover these amounts from the account balance which presumably would be required to be transferred into superannuation.

Regulation of the accounts The ATO will be responsible for administering the government contribution which will be paid directly to individuals’ accounts. As with the government superannuation co-contribution application is required, the ATO will determine a person’s eligibility for the payment based on the details provided by the account providers together with income details for the individual, based on their tax return. Payments will be made as soon as practicable after the end of the financial year. Those who do not lodge income tax returns will be dealt with by the ATO developing a separate administrative arrangement to facilitate payment.

Taxation Contributions to an account are not subject to tax as they must be made from post-tax income. The Government contribution is also tax free.

Earnings on these accounts will be included in the account provider’s assessable income and taxed at the rate of 15% and not their marginal income tax rate. Therefore the tax is payable by the account provider on the contribution of the income earned after taking into account deductions, tax offsets such as refundable imputation credits, or capital gains tax discount. Therefore the taxation arrangements are the same as those for earnings in a superannuation fund or retirement savings account.

Segregation of Assets Banks, Building Societies and Credit Unions must segregate FHOA activities from normal banking business for taxation purposes. Life insurers will need to segregate these accounts from their ordinary business and Public Offer Licensees must segregate them in a separate trust.

Investment Options The Paper states that FHOA’s will be offered by banks, building societies and credit unions as capital guaranteed deposit products and will carry different risks to those offered by Public Offer Licensees and life insurers on an investment linked basis.

The following comment appears on page 30 of the proposal paper: “Given these differences, there will need to be some limits on the investment strategies associated with accounts offered by public offer licensees and life insurers, requiring the investments to be appropriate for the nature of the accounts and to consider liquidity

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requirements. In addition there may be some asset classes that are not appropriate investments given the nature of the accounts.

These requirements will be detailed, where appropriate, in APRA’s prudential standards governing the operation of the accounts. These requirements will also have implications for the choice of investment strategies offered to account holders under investment linked accounts offered by public offer licensees and life insurers.”

It is not clear whether the Government intends restricting the investment options that can be offered by Public Offer Licensees and life insurers so they are more in line with those offered by banks, building societies and credit unions. Alternatively the intention may be to allow the product provider to determine what investment options are “appropriate for the nature of the accounts” and to consider liquidity requirements.

If these accounts are to be limited to capital guaranteed investment products, the advantage of investing them on a similar basis to that offered by superannuation funds is lost as it will not be possible to take advantage of possible higher rates of return that growth investment options would offer.

Despite the fact that Public Offer Licensees must offer these accounts through a separate trust, the Paper indicates that the restrictions on superannuation fund investments under SIS will also apply.

FINANCIAL SERVICES AND LICENSING REQUIREMENTS These accounts will be “financial products” as defined under the Corporations Act 2001; therefore the licensing requirements and conduct provisions of the Corporations Act will apply.

Accounts providers will “generally” be required to hold an Australian Financial Services Licence (AFSL) in order to offer these accounts and provide advice on them subject to any exemptions under the Corporations Act. An account provider who already holds an AFSL may need to adjust licence conditions to provide these accounts.

SCT not to have jurisdiction to disputes As these accounts will be “financial products” the provider must provide members with an external dispute resolution scheme approved by ASIC under the Corporations Act. The Paper specifically provides that the Superannuation Complaints Tribunal (SCT) will not be able to deal with complaints concerning these accounts. No explanation for this exclusion is given and it would mean that superannuation trustees could end up with yet another tribunal to determine complaints.

Given that the structure of these accounts is largely designed around how an accumulation account for a superannuation fund would operate, the SCT is appropriately qualified to be able to deal with complaints in relation to the accounts.

Disclosure Account providers will need to provide a financial services guide and if they are providing personal advice they will also have to provide a statement of advice. Disclosure of certain key information must be made to anyone applying to open one of these accounts including; •

the risks involved;

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the benefits;

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fees;

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dispute resolution procedures; and

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the type of investment options on offer (where relevant).

The proposal by the Government is to develop a “simplified disclosure regime” for the accounts. No detail is provided and what this will consist of will be the subject of further consideration through consultation with the industry.

Fees The Paper provides that: “The Government will work with industry to ensure that fees charged on the accounts are transparent, simple and kept to a minimum.”

In the case of Public Offer Licensees keeping fees to a minimum is going to be very difficult. It is not clear how the Government proposes fees would be kept to a minimum. Those offering FHOA’s must be able to recover the cost of setting up for them as well as ongoing administration and compliance. In the case of the retail sector they will also need to make a reasonable profit. If this is not possible the number of entities offering FHOA’s may be limited. This would reduce competition, make the product less accessible and seriously compromise the success of this initiative.

Annual Statements Account providers will be required to provide account holders with an annual statement with information including the account balance, details of contributions and return of investment. This is to be similar to the annual statement provided to an investor’s superannuation account.

Reporting to Regulators APRA In reporting to the regulator, providers of these accounts will be required to report certain information to APRA under the Financial Sector (Collection of Data) Act 2001. It is proposed that APRA will modify the existing reporting standard for ADI’s and life insurers, and create a new reporting standard for first home saver accounts offered by public offer licensees.

ATO The FHOA provider must report annually to the ATO on the amount of contributions made to each account. If superannuation funds must establish a separate trust to offer these accounts a separate report will be needed. If FHOA’s could be offered under the existing superannuation fund trust deed this information could be incorporated into existing contribution reports to the ATO.

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ANTI-MONEY LAUNDERING AND COUNTER-TERRORISM FINANCING Accounts will be subject to the requirements of the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML-CTF Act) and will be required to identify customers on opening an account.

Public Offer Licensees currently are obliged to identify customers when a member’s superannuation funds are cashed out or a pension commences. However Public Offer Licensees who offer FHOA’s will be required to meet upfront customer identification requirements.

Conclusion The attraction of offering FHOA’s accounts is the obvious appeal they will have for younger members or customers. If the success of the government’s superannuation co-contribution is anything to go by, the prospect of a contribution by the Government to these accounts and the tax concessions they provide are likely to be popular.

For account providers the advantages are increases in funds under management and possibly also member and customer retention.

Whether it will be a profitable product from the provider’s perspective will depend on the cost of establishing it and administering it and this will to a large extent be dictated by the level of regulation imposed.

For Public Offer Licensees the proposed model is unsatisfactory and likely to be rejected by the industry. Offering FHOA’s via the superannuation fund structure would be more cost effective. Given that the proposed structure is modelled on how a superannuation accumulation account functions, rather than duplicating the provisions of SIS, incorporation of the accounts within the superannuation fund will allow them to operate under the SIS legislation with minimal amendments to that Act. This is the first step in the Government’s proposal and it is early days. It is important for those eligible to offer FHOA’s to actively participate in the consultation process to ensure that the end result will provide consumers with the best and most cost effective option for these accounts.

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For more information, please contact:

Jenny Willcocks Partner T: 03 8600 5001 jenny.willcocks@turkslegal.com.au

Sydney | Level 29, Angel Place, 123 Pitt Street, Sydney, NSW 2000 | T: 02 8257 5700 | F: 02 9239 0922 Melbourne | Level 10 (North Tower) 459 Collins Street , Melbourne, VIC 3000 | T: 03 8600 5000 | F: 03 8600 5099 Business & Property | Commercial Disputes | Insurance & Financial Services | Workers Compensation | Workplace Relations

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