Top ten problems with our super system, and how we can fix them

In the May 2009 edition of SuperGuide, I promised you a list of what I believed to be the top ten problems with Australia’s super system. My motivation for promising this list was the federal government’s announcement of yet another review (details at bottom of this article) relating to the superannuation system, and the appointment of an advisory panel with no consumer representation or SMSF trustee representation.

The superannuation system looks after more than $1 trillion dollars in savings on behalf of millions of Australians, and those Australians are not directly represented in this super review.

Before I highlight the problems with Australia’s super system, a constructive approach is to first explain what I believe is good about our super system.

The good bits about super

Apart from its complexity, Australia’s Retirement Incomes Policy (RIP) is an innovative and cohesive policy that provides a safety net for those in need, and incentives for those seeking to take responsibility for their financial future. RIP has four limbs that collectively provide a sound base for Australians saving for retirement:

• Age Pension. The Federal Government provides a basic Age Pension, which is a safety net for those who are unable to fully provide for themselves in retirement. Note that 80% of retirees receive a part or full Age Pension.
• Superannuation Guarantee (SG). SG stands for compulsory super contributions made by employers on behalf of employees. Even when an Australian is showing no interest in super, he or she has a super account accumulating retirement savings. Australian employers have contributed the maximum 9 per cent SG contribution only since 1 July 2002, which means many Australians will need to kick in voluntary contributions to accumulate a decent super nest egg.
• Tax concessions for voluntary super savings. The Government provides tax incentives (tax deductions for super contributions, lower tax on super fund earnings, tax-free super for over-60s, tax-free earnings on fund assets in pension phase) to encourage you to make voluntary super savings, and to take an income stream in retirement.
• Co-contribution scheme. The Government puts extra tax-free money in your super account, known as a co-contribution, if you make after-tax super contributions and your income is below a certain threshold.

The Government’s decision to leave the running of the broader super system to the private sector, notwithstanding the compulsory nature of SG contributions, means that Australians can choose the type of fund they want to use for their retirement savings. Unfortunately, due to the compulsory nature of superannuation, not many Australians have taken advantage of this opportunity.

Super’s major flaw

The major flaw with Australia’s super system, which is linked to the key limb of work-related compulsory super, is that for the system to have the best chance of working properly you need to possess ALL of the following characteristics:

• You’re male.
• Your work continuously for 35 years.
• You never change jobs.
• You make voluntary super contributions regularly throughout your working life, rather than playing catch-up after you’ve educated your kids and nearly paid off your mortgage.
• You know a lot about super, tax management and investing.
• You pay more than 15 cents in the dollar tax on your personal income.
• You haven’t divorced.
• You haven’t suffered illness.
• You haven’t relied on a financial adviser who receives commissions for putting you in a super fund that charges high fees.
• You believe the super rules aren’t going to change too much in the future, and they in fact don’t change too much.

If the bullet list above doesn’t reflect your circumstances, or your beliefs, then the superannuation system is unlikely to meet your needs, unless you take a very active interest in your retirement savings.

The top ten – big and small

No system is perfect, and most universal policies, including superannuation policies, are designed to help the most number of people, most of the time, but our super system was designed around a working life of 35 years, and for individuals who pay more than 15 cents in the dollar income tax. Significantly, the basis of our compulsory super system and super tax incentives totally ignores the fact that parents (mainly women) take time out of the workforce to rear children.

As a starting point, I have created a list of the top ten problems with our super system, but you may wish to add your own suggestions to the list (feel free to add your comments in the comments section at the bottom of this article).

1. It’s all too hard: Complexity and constant change
2. Hello! It’s all about the member (lack of consumer representation)
3. Let’s ignore 30% of the market: Lack of SMSF trustee representation
4. Oops! We forgot about the other 50% of the population (women)
5. Do we really have to know about tax, and retirement?
6. They’re baaack! Kill commissions now, before they kill the industry
7. Is the search for independent advice, super’s needle in the haystack?
8. A little knowledge is very dangerous
9. Co-contribution for all
10. Relying on the goodwill of employers: salary sacrific

1 It’s all too hard: Complexity and constant change

Complexity and constant changes to the super rules leads to a lack of confidence in super by the Australian public, and often unjust outcomes for individuals who have relied on rules that were in place years before.

How to fix it: If the Government creates superannuation and retirement policy in line with its Retirement Incomes Policy (refer earlier in the article) there is absolutely no reason to make radical changes to the super rules. And if the Government do need to make changes, due to budgetary concerns or to improve the working of the system, then the Government should be honest about the reasons for those changes, rather than making spurious claims that rich gits are rorting the super rules. For making these comments, Prime Minister Kevin Rudd and Treasurer Wayne Swan owe an apology to any Australian taking responsibility for their retirement by making additional super contributions.

2 Hello! It’s all about the member (lack of consumer representation)

The retail fund industry is warring with the industry fund sector over which type of fund is the cheapest, which has the best returns, and how often unlisted assets are valued. The financial advisers are defending their market share by reluctantly relinquishing commissions sometime in the future, but quietly retaining the commission structure on existing products and on platforms (wraps).

The industry association, ASFA, is claiming that many SMSF trustees are incapable of looking after their own super interests, and should be licensed, while the entire industry and Government seem to be ignoring the important role accountants play in the lives of Australians saving for their retirement.

And, shouldn’t these discussions be about the member – you know, the consumer?

The Government has set up an industry advisory group with no representation from accountants, or consumer groups, or incredibly SMSF trustees (see article: Another super review: Who’s looking out for consumers?)

And the ivory tower soars even higher with the composition of the expert panel appointed to run the super review looking into the superannuation system. Although the chair of the panel, Jeremy Cooper, and the five part-time panel members, have excellent credentials and years of industry experience, again there is no representation on that panel from consumer groups, or from organisations representing SMSF trustees.

How to fix it: Appoint one or more of the following organisations and associations to its industry advisory group, or a leading consumer advocate to its expert panel, to better represent consumers:

• Australian Investors’ Association
• CPA Australia and Institute of Chartered Accountants
• A representative from one of the financial counselling associations
• Choice (formerly Australian Consumers’ Association)
• One of the ‘seniors’ associations
• Any other representative consumer group

3 Let’s ignore 30% of the market: Lack of SMSF trustee representation

See discussion under Problem 2.

4 Oops! We forgot about the other 50% of the population (women)

If you don’t work continuously for 35 years, then the rationale behind the compulsory super system (you need to be working) and the reduced contributions caps for voluntary contributions (you need to save regularly throughout your working life) will mean that saving for your retirement will be a continual struggle. A major segment of the population affected by lengthy breaks from the workforce is… women. Hey, that’s discriminatory policy isn’t it?

How to fix it: Well, this may sound tokenistic, but come on guys (Mr Bowen, Mr Rudd and Mr Cooper), do you think that having a female on your expert panel, may assist you to appreciate the issues of 50% of the population that seem to be ignored year in year out. And perhaps we need to be more creative about the assumptions we make about the working lives of Australians. Perhaps my argument may be more compelling, if I remind you that women are not the only Australians who have breaks from the workforce.

5 Do we really have to know about tax, and retirement?

If you look closely at the industry associations who have the ears and hearts of government (yes, politicians and government officials do have hearts), they are predominantly focused on the accumulation phase of superannuation accounts. If the government, and the super industry want to know why SMSFs have become so popular, they simply have to ask the following questions:

a Do the non-DIY super funds manage the tax implications of transactions when investing?

b Do the non-DIY super funds offer fund members an effective transition into retirement, which minimises the implications of tax and enables fund members to enter retirement with some certainty?

The super industry is relatively young, and due to the relatively small account balances of fund members has not devoted sufficient energy to maximising retirement benefits through tax management, and has relied on one-size-fits-all investment strategies.

Until recently (circa 2005), most large super funds had simply ignored the fact the members retire and need retirement products, or assistance with any lump sums payable.

How to fix it: The super review needs to put the superannuation industry on notice about the management of tax within a super fund, and the availability of suitable pension products. If the super industry isn’t up to it, and the government doesn’t want half of the population moving into SMSFs in retirement (as predicted by Deloitte), then the government may have to seriously consider offering an alternative pension product financed by a special self-funding pension vehicle. Also, see problem 7.

6 They’re baaack! Kill commissions now, before they kill the industry

Despite the touchy feely noises from the FPA and IFSA, commission-based advice and commission-based products are going to be with us for a few years yet. And my understanding is that commissions are to remain on administration offerings, commonly known as wraps or platforms.

The debate about commissions and fees seems to be centred around whether the charging of fees is a suitable alternative remuneration arrangement, when the greater issue is: conflicts of interest!

The simple fact is that advisers who are paid via commissions from financial organisations must sell investments from those financial organisations to earn a living. More generally, such advisers are unlikely to encourage direct investment in shares, or to consider direct property as a suitable investment, or to recommend products that don’t pay the adviser a commission.

If an individual simply seeks strategic advice, for example, choosing the right level of super contributions, then the real difficulty becomes seeing how commission-based advisers can provide this advice, unless they plan to do this for free, or… for a fee!

The next question then becomes, if a financial adviser charges a fee for advice that involves financial products, is that advice independent? See Problem 7.

How to fix it: Immediately remove commissions on any compulsory superannuation products where the individual member didn’t receive direct financial advice (employer received the advice). Immediately cease all commissions on superannuation products unless the financial adviser obtains a signed one-page document confirming that the fund member understands that the financial adviser receives contribution fees (if any) and a trailing commission. And obviously, eventually remove all commissions from all investment-related products.

7 Is the search for independent advice, super’s needle in the haystack?

So, an individual wants independent advice. Where does she go, and if she demands truly independent advice, will a non-independent adviser have the strength to turn her away?

Does the individual know what questions to ask? For example, can an adviser recommend any products, or only products offered by a single organisation, or products on an approved list where the product providers have paid to be on that approved list?

Under the current system, a consumer has no clear path to find an independent adviser. Even I don’t know where to go to find a list (if it exists) of all financial advisers that are truly independent of financial organisations and commission incentives, and who charge a fee.

How to fix it: Once and for all, reward the independent advisers with a special category. An adviser can use the ‘independent’ term when the adviser is not employed or aligned with a financial organisation, can be paid without having to recommend a financial product, and does not receive volume bonuses when recommendations for a certain product reach a certain level. Alternatively, we can return to the old way of giving out financial services licences, where you had advisers who provided financial adviser, and dealers who sold financial products. And then require all advisers who don’t have the ‘independent’ tag to verbally say to prospective clients: ‘I am not an independent adviser’.

8 A little knowledge is very dangerous

The super industry is professing to be looking after the retirement needs of Australians, namely consumers. I beg to differ. Certainly, they are investing super contributions and accumulating super savings, but superannuation is a concessionally taxed investment vehicle with the sole purpose of providing for an individual’s retirement.

So, we’re talking about tax, and retirement. The super industry (including the government) as a group have sidelined the one profession who knows about tax – the accountants. Accountants are also the key point of contact for Australians when considering retirement.

Besides accountants and fee-based advisers providing strategic retirement advice, very few players in the super industry understand the non-super tax rules in retirement, the Age Pension rules, and the relationship between the super rules and the Age Pension.

Rather than fighting among themselves, the super industry needs to look ahead to the next ten years for what fund members need if they want to remain relevant to super fund members.

How to fix it: The expert panel running the super review should start talking to the organisations who have the most to do with prospective retirees, including Government-funded organisations, such as NICRI and the Financial Information Service. Clearly, the accounting bodies should be involved and the associations representing retail investors and seniors as well. Also, see Problem 2.

The remaining two problems are more specific, but I have included them in the top ten list because they apply universally to Australians:

9 Co-contribution for all

The co-contribution scheme is one of the more innovative superannuation policies. The Government puts extra tax-free money in an individual’s super account if the individual makes a non-concessional (after-tax) super contribution.

The rationale behind the Government’s Co-contribution Scheme is to encourage those on lower and middle incomes to save for their retirement. Depending on how much income you earn, you can receive up to $1,000 a year (for 2009/2010) as tax-free income paid directly into your super fund when you make an after-tax contribution of up to $1,000.

Currently, full-time carers and parents rearing children full-time cannot access the scheme. A scheme, with an objective of targeting women, has failed because the women who could benefit the most are not eligible.

How to fix it: The co-contribution scheme should be available for all Australians of working age and older, and up to the age of 74 (rather than 70). Also, see problem 4.

10 Relying on the goodwill of employers: salary sacrifice

If you’re working under an industrial award, your remuneration is typically your wages plus 9 per cent super. If you negotiate a salary, your salary package amount usually includes your employer’s superannuation contribution, unless you agree otherwise. Your employer then calculates SG on the basis of the cash component of your salary, which means that because you have a salary sacrifice arrangement in place, you lose some of your SG entitlements. In some instances, an employee can negotiate that the cut in SG entitlements doesn’t occur but the employee is relying on the goodwill of the employer for this to happen,

Some industrial awards expressly require that SG contributions be calculated on your full salary, before deducting any salary-sacrificed contributions that an individual chooses to make.

How to fix it: Expressly legislate that any SG calculations are calculated on the full salary, before deducting the salary sacrificed contributions.

Details of the Government’s super review

TERMS OF REFERENCE for a Review into the governance, efficiency, structure and operation of Australia’s superannuation system

1. The Review will comprehensively examine and analyse the governance, efficiency, structure and operation of Australia’s superannuation system, including both compulsory and voluntary aspects, addressing, but not limited to, the following issues:

1.1. Governance: examining the legal and regulatory framework of the superannuation system, including issues of trustee knowledge, skills and training; and thoroughly assess the risks involved in the use of debt and leverage and the development of investment options that lead to a weakening of the diversification principle in the superannuation system;

1.2. Efficiency: ensuring the most efficient operation of the superannuation system for all members, whether active or passive members and whether making compulsory or voluntary contributions, including removing unnecessary complexities from the system and ensuring, in light of its compulsory nature, that it operates in the most cost effective manner and in the best interests of members;

1.3. Structure: promoting effective competition in the superannuation system that leads to downward pressure on system costs, examining current add-on features of the superannuation system; and, examining other structural legacy features of the system; and

1.4. Operation: maximising returns to members, including through minimising costs, covering both passive defaulting members, who should receive maximum returns and value for money through soundly regulated default products, and active selecting members, who should not be negatively impacted by conflicts of interest that may inhibit advice being in the best interests of members.

2. The Review to be conducted around the concepts of the best interests of the member and the maximising of retirement incomes for Australians.

3. The Review to be conducted with reference to improving the regulation of the superannuation system, whilst also reducing business costs within the system.

4. The Review will be a systemic examination, including all superannuation fund sectors.

5. In conducting its work, and in determining its recommendations, the Review will have regard to the Communiqué of Principles (see separate attachment to this release).

6. The Review will comparatively examine international jurisdictions and will consult with experts as needed from other jurisdictions.

7. The Review is excluded from considering the issues before the Australia’s Future Tax System review concerning system inputs such as the level of superannuation contributions, taxation including taxation concessions and other incentives.

8. The Review is excluded from considering the development of a superannuation clearing house or the project addressing the consolidation of lost accounts, as these are the subject of separate and already commenced processes.

COMPOSITION AND CONSULTATION:

9. The Review to be led by an expert panel made up of a full-time Chair and five part-time members, supported by a secretariat drawing on the skills of the key policy and regulatory agencies of the Commonwealth, as well as market expertise. The Review may also draw on external expertise where necessary.

10. The Review will consult the superannuation industry, other stakeholders and the broader public.

TIMING:

11. The Review will make recommendations to the Government by 30 June 2010 on possible options for reform, including appropriate transitional arrangements. The Review may report on particular issues prior to the finalisation of the final report.

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