SMSFs versus the super industry
Robert Gottliebsen’s comments on SMSFs are spot on (see Three super challenges for Sinodinos). The super industry lobbied hard when its interests were threatened, but isn’t so enthusiastic about protecting investors with high balances. This is because they realise that most of those balances reside in SMSFs, which as you say, they hate. The SMSF sector needs a strong independent voice because the super industry will not protect them.
Art in super
I have read with interest Robert and Alan’s recent articles on SMSFs, all of which I agree with. One topic that was not mentioned under this subject was the current superannuation rules relating to the treatment of quality art within a super fund.
I read something in the lead up to the election where the Coalition indicated that they would amend the ludicrous scenario whereby a piece of art if owned by a super fund effectively had to be kept in storage and out of sight.
The art industry very much needs a “shot in the arm”, but I’ve not been able to get any clarity on this point when I contacted the offices of my local member in the electorate here in Perth. I appreciate that art and its treatment forms a very small part of a super fund portfolio, with questionable capital returns depending on your time line, but I still believe it is very relevant and should not be forgotten.
Editor’s response: Thanks for your letter. We flagged the rumours swirling around a possible change in policy back in August (see Art market hopes for a DIY breakthrough) but for now the Coalition has indicated it will be making no such changes.
I just read Brendon Lau’s article on the Uncapped 100, Uncapped 100 beats the pack. Is there an ETF for the Uncapped 100? If so, where can I get more information on prices, returns etc?
Brendon’s response: Thanks for your letter. There is no ETF for the Uncapped 100, it is ‘the universe’ of stocks I generally concentrate on at Eureka Report. Every Wednesday I publish an article devoted to one or more of these stocks. Companies in the Uncapped 100 include those that have solid business and growth prospects. For more information on the Uncapped 100, I suggest you read the introductory article featured on the website in June, Introducing the Uncapped 100 and today's article on the rebalance of the Uncapped 100, Four new stocks for the Uncapped 100.
Tax on inflation
I read Scott Francis’s article, The million dollar savings plan, and found it to be a bit simplistic. Even if an investor managed to get a 7% return, the calculations ignore tax on the earnings, in particular “tax on inflation”. For example, if inflation is 2.5%/annum over the period and the tax rate on earnings is 15%, the current dollar capital amount after 38 years is about $738,000 rather than a million.
I think Scott Francis forgot about tax on investment income in his article, The million dollar savings plan
Scott’s response: Thanks for your comments – and the chance to expand further on the issue of tax. If we assume that the model is looking into the future, someone planning for where they might be in 20, 30 or 40 years’ time, we certainly do have to think about the impact of tax. In the model I have assumed a return of 7% after inflation – which implies an investment in growth assets like shares or residential property. Cash and fixed interest investments have not provided this rate of return over long periods. In this case, let us use shares, only as their ‘liquidity’ allows them to be more easily bought on a regular basis over time by someone saving and investing regularly.
There are two types of tax that we have to be concerned about – income tax, that will be offset at least to some degree by franking credits and capital gains tax, that does not have to be paid until investments are sold and then, if investments have been held for 12 months, benefits from a 50% discount. The total of this is that there may be little tax to be paid – especially for an investment using a superannuation fund, who is likely to increase their return (because of the franking credits) after tax.=
Let us look at a practical example – using Vanguard. Vanguard (unlike many fund managers) report their after tax returns, and given that they are an index fund capturing the ‘average market return’ they provide an interesting benchmark for investors.
Over the past 3 years (to the end of August) the Vanguard Australian Share Index fund has returned 9.09% pa – before any tax considerations.
That return after tax for a super fund investor (15% tax rate) actually increases to 9.88% pa – a nice little bonus! It increases because an investor in a super fund will receive additional returns in the form of refunded franking credits. Given that most of us are most likely to use the magic of compounding interest in a super fund environment, this is good news.
For an individual on a mid-tax rate, the return falls slightly to 8.92% - but I think not significantly enough to influence the reasonableness of an assumed return of 7% after inflation.
The assumptions of a ‘7% return after taxes and inflation’ is a pretty crass estimate of returns – based on what we have seen happen in the past, and assumptions from current market earnings. I wish there was a more precise way to come up with a possible investment returns, however I am not aware of one.
Superannuation and tax
Within the pension phase the idea of taxing superannuation income within the fund in excess of $100,000 was always stupid (see Three super challenges for Sinodinos).
Firstly, returns are extremely variable. In its report on SMSF costs for ASIC, Rice Warner gives the following aggregate returns for years ending 2005 to 2011: 17.4%, 16.0%, 20.1%, -4.0%, -4.5%, 8.3%, 11.2%. So tax planning becomes a total nightmare.
Secondly, as it was apparently based on the individual’s account rather than the total fund, the tax a couple pays would depend on how well they had managed to balance their individual funds. So $2,000,000 being hardly enough to live on might only be a fib if it was all held in one partner’s account, but an exaggeration if it were split 50/50 and an obscenity if each partner had this amount.
In pension phase the real unfairness of our superannuation tax system is not within superannuation. It is that people with substantial income outside superannuation benefit disproportionately from their superannuation.
This is because the benefit is based on your marginal tax rate. If you are paying the full marginal tax on your income outside super that is the benefit you get from your tax free super income.
If you had income of $50,000 from investments of $1,000,000, whether it was from super or not, given the tax free threshold and the aged persons benefit you would pay almost no tax and get all your franking credits back, so it doesn’t matter much whether it is in super or not.
The answer is to include superannuation in taxable income and then to apply rebates to it so that no one is taxed into having to rely on the state pension system.
Running an SMSF
Robert Gottliebsen’s article, Three super challenges for Sinodinos, says that it costs about $1,000 a year to run a simple fund. With a minimum audit of $500 and an ATO levy of $321 for 2013, that doesn’t leave much for the preparation of financial statements and tax return, let alone any revised strategy or other documentation required. I’d suggest that $2,000 to $2,500 total would be closer to the actual figure for cost of running a simple SMSF.