Why compulsory annuities won't suit SMSFs

A considerable number of voices believe it’s one of the last great reforms needed to get Australia’s superannuation system up to world’s best.

Compulsory annuities: When you hit retirement age – or some defined qualifying age – you are then required to use some, or all, of your superannuation to purchase an income stream.

The most recent call came last week, via the latest Melbourne Mercer Global Pension Index report (the contents of which I’ll come back to). The report’s authors claim that Australia needs to start moving to a compulsory annuity style arrangement and should start planning for it now.

Under the compulsory annuity outline proffered in the MMGPI’s 2013 report, Australian super members would get limited access to super lump sums at retirement and limited access to capital after retirement.

The architecture would have to be flexible enough to continue to allow phased retirements, as we do now with transition to retirement rules.

Early on, MMGPI would like to see an income product that came with “some constraints and/or guarantees”, before a second phase, which would have “a pooled insurance-type product to provide longevity protection for the later years that could be a deferred annuity or pooled product provided by the pension plan or insurer”.

Members should be forced to put at least two-thirds of their super into these products.

Problems? Well, there’s a few.

Won’t like the fees

Any sort of guaranteed annuity product requires the management of the money by a life insurance company, and there would be associated fees for the provision of that management. One of the biggest reasons people start SMSFs is because they don’t want to pay fund managers to do the investing.

Won’t like the loss of control

If you’re forced to hand over a wad of cash to an external manager to provide you with an annuity income stream, by definition you will no longer control the investments and their performance.

But I don’t want to sell

What if you are approaching or hit that defined time when you are forced to start your externally managed annuity? You might not want to sell a given asset for a number of reasons, including it not being a good time to sell? SMSFs are a loved vehicle because you can control buying and selling to a time that suits the members.

Geared property forced sale

What if you’ve got a geared property that you are still deriving tax benefits for the fund? Or if property has gone into a bit of a slump – which you would otherwise be prepared to wait out, but for the fact that you are now being forced to start an annuity?

Commercial property

Many SMSFs purchase the property out of which their business operates so that they have control over the property and the business pays rent to the super fund rather than a nameless landlord. Would hitting a determined age require the SMSF to be a forced seller of the commercial property to fund the required pension, even if the business was still operating from the property?

Distort investment decisions – liquidity

If you know that you are going to have to start a pension on your 65^th birthday (or whatever age is decided), SMSF trustees might have to sell an investment months, or years, before they would otherwise, because of potential liquidity issues for the asset on sale. Growth investments (shares and property) would have to be weighed up as to whether to sell now or closer to the date, meaning several years of investment returns could be missed.

Distort investment decisions – exclusion

Similarly, but in reverse, many SMSF trustees would essentially be excluded from buying certain assets because of the time left until they would have to sell up to purchase their annuity. If the annuity had to start at age 65, would the SMSF trustee purchase a property at age 60? Highly unlikely. Under current rules, they might well buy a property at age 60, with the intention of holding it into their 80s.

Exceptions for SMSF funds?

It doesn’t even feel that the report’s authors have really considered SMSFs.

The suggestions and recommendations appear to be based around APRA funds, where the transition from a managed fund in super to a managed fund in an annuity is not a big stretch.

But it would require a massive rethink of entire investment strategies for all SMSFs. That this hasn’t really been considered by proponents of compulsory annuities before seems quite odd.

There is just one sentence that suggests that MMGPI has considered SMSFs: “If you can’t force an annuity for at least part of the benefit, tax rules should provide a carrot and stick to encourage the right outcomes.”

Could you then make an exception and exclude SMSFs from having to take a compulsory annuity?

No. The number of SMSFs would double almost instantly. Anyone who was thinking about it would rush to it.

The Melbourne Mercer Global Pension Index 2013 Report is, actually, about ranking global super schemes.

It’s in its fifth year and it found that Australia’s super scheme is the third best (again) in a universe of 20 countries surveyed.

Australia improved during the year, largely as a result of the “Stronger Super” reforms introduced by the previous government.

Australia, with a B , sits behind Denmark (A) and The Netherlands (B ), but ahead of countries including Switzerland, Sweden, Canada, Singapore and the UK.

Sneaking in with a pass has countries including Germany, the US, France and Brazil. Fails included China, Japan, Korea, India and Indonesia.

Apart from forcing Australians into compulsory annuities, the report said the other ways the nation could improve its system would be by increasing labour force participation among older workers, introducing a mechanism to increase the pension age as life expectancy increases, and improving laws to allow for the provision of better retirement income products.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is a licensed financial adviser and mortgage broker with Castellan Financial Consulting and Castellan Lending, and is the author of four property investment books. E: bruce@castellanfinancial.com.au

• Online lender loans.com.au has launched a new SMSF-only home loan at 4.99%, undercutting the major banks amid warnings from the Reserve Bank for lenders to remain prudent with their lending standards. “SMSF Trustees may well ask their lenders why they are paying so much money to buy residential property when loans.com.au is able to offer similar loans at significantly reduced rates and much lower fees,” said managing director Marie Mortimer. “Banks give SMSF loans a different capital weighting because they consider them to be commercial loans,” she said. “We don’t have a capital weighting on SMSF loans so it’s a normal mortgage deal with the risk spread across our mortgage portfolio rather than a riskier commercial portfolio,’’ she added.
• Independent platform group Wealthtrac has launched a mobile application designed to deliver news and information to anyone interested in self-managed super. “Our cloud-based SMSF platform brings together all SMSF administration and reporting needs into one centralised hub,” said Wealthtrac managing director, Matthew Johnson. He added that the app provides users with SMSF news, access to SMSF education documents and allows trustees to find their nearest adviser. Users will also be able to set up an SMSF, Johnson said.
• The self-managed super fund (SMSF) sector is beginning to embrace technology beyond compliance and accounting services, according to Darren Stevens, director of strategy for Bravura Solutions. “The last 18 months have seen marked improvement,” he reportedly said. But one of the problems with the SMSF sector is how disparate and fragmented it is, he added. “You don’t have many large scale administration organisations, you have lots of smaller trustee funds with their suburban accountant, and they tend to opt for different solutions.”