Planning's Big Opportunity

Rumours of the death of financial planning have been greatly exaggerated. Rather than mark the demise of financial planning as many uninformed commentators, pundits and politicians have posited, this year’s budget is a professional financial planner’s dream come true.

The 2006 budget may be remembered as the one that created the financial planning profession. Many look to the 1983 introduction of lump-sum taxes as the watershed event that was the genesis of the financial planning industry, but in the future historians will refer to this year’s budget as the Tsunami that wiped away many of the indifferent practitioners and practices of the past.

The only financial planners who will lose out are the few who rely on new retirees as their primary source of fees and new clients, and who run indifferent, commission-based businesses.

The new super rules, as they are presently articulated, provide a host of opportunities for both retirees and their families that make the regulatory arbitrages available until now simply pale into insignificance by comparison.

In the broadest terms, super is now the anointed wealth management vehicle for all those Australians prepared to suspend their cynicism.

The pairing of super with the tax and social security assets and income test exemptions for the family home, produces a coupling that dwarfs all other forms of investments for sheltered returns. And now, with the ability to access equity in the family home through first and second-generation home equity release offerings, income generation has never been easier. (To read Eureka Report's recent report on home equity release click here).

Case study

A simple example serves to illustrate the point: Jane is over 70. She has a substantial family home and a solid amount invested in the family self-managed super fund (or DIY fund).

She has two sons, David and Michael. Both in their fifties, working and grossing $50,000 each. Currently after tax and super guarantee, they have ample to meet their needs and a little for savings.

In the post-budget world, David and Michael salary sacrifice all their income beyond the new personal tax threshold (of 15%) to their family SMSF.

At the same time, Jane draws down tax-free from the family SMSF sufficient money to meet her sons’ living needs. This drawdown should meet the new minimum pension requirements.

Jane can create her own tax-free income in one of at least four ways:

• a further tax-free regular or lump sum withdrawal from the SMSF;
• the sale of the family home and the purchase of another at a lower price to realise a lump sum that can either be drawn down or invested;
• a drawdown from the line of credit she has organised via a reverse mortgage secured against the family home; or
• a drawdown or income from the proceeds of a part sale of the family home through a debt-free equity release [DFER].

Alternatively, she could achieve her objectives through a mixture of any of the above, as circumstances and market conditions allow.

The maximum tax on any dollar of earnings for Jane and her family is 15% and the average rate is considerably lower. It will be lower still if there is any reasonable exposure to franked dividend-paying Australian equities in the family SMSF.

The vast majority of the sons’ life insurance needs can be met through their work-based super fund. With no reasonable benefits limit and the benefits of a good group life pool in their company super, funding premium payments in a policy that meets their needs is no longer an issue.

Clearly in this new world of intergenerational sharing, collaborative planning will become standard.

Jane and her sons are responsible for the goal setting and cash flow management, and their financial planner is responsible for structuring the clients’ affairs such that they can achieve their goals with the financial risk that they choose to take.

On a regular basis, the options available to Jane and her family would need to be explored and tested. If the rising reverse mortgage balance is causing anxiety, then a lump-sum withdrawal from the SMSF '” taking the cash from the sale of particular shares that had met their performance expectations '” would provide relief and put the overall plan back into balance.

Clearly, this level of advice requires skills and knowledge well beyond that contemplated in the product-centric world of the investment sector. An understanding of residential property and all three home equity release options are required, at the very least, as well as a decent course in collaborative goal-setting and conflict resolution designed for families.

And, of course, advice in this space could not be contemplated if paid for through product commissions. The risk of conflict of interest would be impossible to argue against.

New world order

If my analysis is correct, the post-budget world of financial planning will be very different. And of course change invariably leads to winners and losers. Here are my best bets for those that get to ride on to glory and those who will ride into the sunset.

Financial planning winners will be those businesses that:

• Have a strong and sustained value proposition focusing on client needs.
• Put a strong emphasis on cash flow management.
• Have a solid understanding of home equity release, through both reverse mortgages and debt-free equity release [DFERs].
• Use a robust methodology for constructing portfolios, particularly those that include residential property as a component.
• Recognise managed funds may be costing clients upwards of 100 basis points per annum compared to the alternative “selectively managed accounts” [SMAs].
• Have a high level of technical competency, particularly in relation to SMSFs, tax and estate planning.
• Understand the role of life insurance in financial planning.

Product and service winners will be:

• SMSFs, in all of their options.
• Fund of funds, mandated portfolios and SMAs.
• Fund managers with consistent top-decile performance, particularly in Australian equities.
• Passive fund managers.
• Wraps and master funds with solid funds flow, scalability and low fees.
• Flexible life companies.
• Home equity release product suppliers, including reverse mortgages, shared appreciation mortgages and DFERs.
• Front-end planning software that delivers a meaningful advice experience to prospective and actual clients using traditional portfolio constructs and home equity release.

The inevitable losers will be:

• Financial planning businesses with inefficient portfolio management capabilities.
• Financial planning businesses that rely on rollover advice as their primary source of new business.
• Financial planning businesses that have no value proposition, or one that is poorly articulated.
• Wraps and master funds with uncertain funds flow, unscaleable systems and high fees.
• Fund managers with indifferent performance.
• Providers of margin lending products, because there will be a significantly reduced need to build assets outside super and the family home.
• Residential investment property, because there will be the opportunity to access lower risk returns through super.
• Annuity providers who will lose their assets test subsidy.

Much of the above may be obvious. The profession of financial planning will simply have no time for laggards and the demise of the old and inefficient must be done at a pace.

Are the budget changes here for the long term?

If you accept the key premise of the argument that low-tax “family” super will become the central product in every affluent family’s financial plan, then you must harbour some thoughts about it being “too good to be true”.

There will be a critical challenge to the sustainability of the budget changes brought about by the double hit to revenue through lower tax collections, higher benefits and more beneficiaries in Australia’s underfunded public pension system.

It is probably an unintended budget consequence, but there is a high likelihood of a meaningful reduction to the tax base as many older and professionally advised Australians take advantage of the intergenerational opportunities in SMSFs to reduce the overall tax payable by themselves and their families.

It is also obvious that there is a growing necessity for the family home to be in some way being included in the assets test for social security purposes. Although the “taxation” of the family home would be a difficult and unpopular political move by any government, the hard decision is getting closer. In any event, the budget’s proposed changes to the social security assets test are simply bringing this inevitability closer.

Closing reflections

I put together my first set of superannuation accounts about 35 years ago. At that time super was largely for the owners of businesses, who used the scheme as a “tontine” and skimmed all of the contributions and earnings for their staff to themselves through member-unfriendly vesting scales.

I have critically reviewed and designed products and services to match each major regulatory change since.

It was impossible to imagine at any time what we have now. In fact, it was impossible to imagine even on budget night what we have been delivered.

I wonder if we have the will and the intellectual capacity to take this opportunity to become a profession.

Paul Resnik is an investment industry consultant.