It has been a few weeks since my last article as I was down in Melbourne at the annual conference for the SMSF Association. While it was very technically minded to please the auditors, accountants and math magicians in the room; it also had more meaty topics on what I love and that is Behavioural Finance (BF). Behavioural finance understands the phycology behind investment markets and human behaviour. It analyses the role money plays in human lives and how our brains unconsciously lead to both rational and irrational decisions.
This article however is not on Behavioural Finance but on a comment that I was left pondering on the Thursday evening after a panel session involving Peter Kell (Chairman of ASIC), Chris Jordan (Commissioner of ATO) and Rob Heferen (Executive Director of Revenue Group).
Revenue Group provides advice to the government on revenue and taxation policy matters. Mr. Rob Heferen went through thousands of numbers; most of which explained the boom of SMSF funds over the previous decade. He did however mention one set of numbers that made my jaw drop.
Apparently in Australia there are 5 SMSFs with over $100,000,000 in assets. Yes you read that right $100 million.
There are also over 1,500 funds in Australia with over $10 million.
My mind began to think through the tax breaks these funds are getting. They are unmistakingly huge. The larger funds would be saving $1millions/year in income tax alone as well as any tax-free capital gains. I ended up with a feeling that these funds had taken advantage of the system to the nth degree and questioning the ridiculous financial rewards they are receiving.
It's important however to put these amounts in to context.
To get over $10-50million in to an SMSF; the owners must have had to do a few things
Achieve unbelievable investment returns
Contribute huge amounts for a very long time
Before I continue, I applaud the investors who achieved this through unbelievable investments returns and borrowing heavily....as it sure did pay off. I understand that no return is free of relative risk however so I sincerely doubt their skills in picking these assets led to these ridiculous returns.
I suggest if this was part of it that they knew that the assets they were purchasing were at bargain prices through having market knowledge, professional contacts and the ability of a huge super fund to purchase very large assets. I would say it is impossible for everyday investors to purchase these types of assets at these prices and the returns through investing in Residential Property and Direct Shares would not have achieved this.
So if I am right to rule out returns and borrowing, I suggest the final way is through making contributions and making very large ones for a very long time.
As you can see below the Superannuation System has not always looked the way it does today
There were periods when contributions and earnings were tax-free in 1980s and there was a period when income was taxed at marginal rates in 1980s. This is vastly different to the world we live in today when income is taxed at 15% and contributions are taxed at 15% unless you are over the age of 55.
I believe in 2007, the government made a raft of changes to superannuation as they knew they had a huge problem on their hands. Superannuation members on higher income and with significant wealth were powering every dollar they could in to superannuation. Tax concessional super contributions limits were in their $100,000s per year and even back in 2007 you could put $1mil in to your superannuation fund as a one off. A huge amount!
Not that 2007 would have been perfect time to invest in shares as it was just before the GFC.
Now there is a point to this article and it is not to bore you with statistics about the rules in the past but to clearly explain that these are not the rules we are blessed with today. The government however knew that these rules were too relaxed and had to do something about it.
So what is the problem?
A huge part of the work i do is helping people save for their retirement and make the most of their superannuation. Unfortunately however the ability for members to do so has significantly reduced over the past eight years. The government has reduced the contribution limits to a point now where I believe the limits are too low for Australians to build up adequate wealth for their retirement especially if they are starting to pick up the pace in their 50s.
Two years ago the government spoke about introducing a tax on Superannuation once they earned over $100,000 in pension phase. This income would still be taxed at a lower rate of 15% instead of current marginal rates of 17-47% but much higher than the 0% Tax Free Status pensions receive. The rule however never came in but at the time, I was against every financial adviser, media commentator and industry professional as I was actually against the tax free incomes I knew these very large funds were receiving in their retirement.
I have personally seen funds with over $10mil in pension phase getting a $600,000 tax free income. While I know they have built this amount of wealth legally and wisely with the help of financial advice, they also benefitted from rules which on reflection were far too relaxed to be fair.
By reducing the limits to avoid these investors continuing to benefit, the vast majority of people who need to get advice today, do not get the same opportunity to contribute as the ones who had the opportunity in the 1980s, 90s and early 00s.
I believe the purpose of Super should be to provide a fair and safe way to build wealth in a lower tax environment for your retirement. At the moment is can be a safe and low tax way but If we would like to make it a fairer super system, I believe taxing these very large balance funds is not unfair due to ridiculous tax breaks they have received in the past and are still receiving.
I do believe that the amount they can receive tax free needs to be a significant and perhaps over $5mil in assets or $200,000/yr as they have made conscious decisions to save and should be rewarded for that.
I am a big believer in Superannuation being the right not the only way to build wealth for your retirement. It will play a huge role in removing the burden from the government in the coming century and beyond.
I do however feel and fear that a change like this is around the corner. The government may make a change along these lines in the coming years and if it is it might be to make the system fairer for all.
What do you think?
Is it fair and is it morally right that these funds are getting these huge tax breaks?
Where is the line.