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Self-managed super fund (SMSF) trustees in retirement phase have very different needs to those in accumulation phase. They need their SMSF to fund an income they can live on, while those not yet retired are trying to create as big a balance as possible.
Investment strategies developed by SMSFs have always been required to explain how the investments they choose meet the individual needs of members. When there are members in both accumulation and retirement phase – the investment strategy needs to explain how the needs of both kinds of members are being met.
While the release of draft legislation by Treasury is putting a greater focus on how all superannuation trustees satisfy the income requirements of members in retirement, SMSF trustees will not be legally obliged to comply.
The retirement income covenant
After releasing a position paper mid-July, the Treasury Laws Amendment (Measure for a later sitting) Bill 2021: Retirement income covenant was released on 21 September 2021. Stakeholders were given until 15 October 2021 to provide any feedback.
The Government plans for the covenant to take effect from 1 July 2022.
The federal government first announced its intention to introduce a retirement covenant for all superannuation trustees (including SMSFs) in the 2018–19 Budget. It wanted to strengthen existing covenants in the Superannuation Industry Supervision (SIS) Act 1993, which include obligations to formulate, regularly review and give effect to investment, risk management and insurance strategies. The inclusion of a retirement income covenant would ensure that the retirement needs of members are being met.
“The draft legislation would codify the obligation for superannuation trustees to have a retirement income strategy that outlines how they plan to assist their members in retirement. The strategy must consider how the trustee will assist their members to balance maximising their retirement income, managing risks and have some flexible access to savings,” Minister for Superannuation, Financial Services and the Digital Economy, Senator Jane Hume, said when releasing the draft legislation.
But after lobbying by sections of the SMSF industry, SMSF trustees were dropped from the draft legislation (see ‘What does it mean for SMSFs?’ below).
How did the retirement income covenant come about?
The covenant stems from concerns that retirees do not draw down on the capital of their super balance, and instead attempt to live on the income from that capital balance.
“The ‘nest egg’ framing of superannuation compounds the complexities around deciding how to manage their superannuation in retirement. Partly because they have only ever been primed to save as large a lump sum as possible, retirees struggle with the concept that superannuation is to be consumed to fund their retirement,” the initial discussion paper stated.
It goes on to say that “multiple studies have shown that retirees die with around 90% of the assets they had at retirement” and that without a change in behaviour it is projected that by 2060 one in every three dollars paid out of the superannuation system will be part of a bequest.
The paper is using findings from the Retirement Income Review 2020. However, a separate study by the Association of Superannuation Funds of Australia (ASFA) – Superannuation balances of Australia just before death – has found that the majority of Australians actually exhaust their superannuation before they die.
Using Household, Income and Labour Dynamics in Australia (HILDA) survey results, ASFA found that over 90% of people aged 80 or over who died in the period 2014 to 2018 had no super in the four-year period before their death and only 5% of that group had more than $110,000 in superannuation in the period of up to four years before their death.
What does it mean for SMSFs?
Importantly, the draft legislation makes it clear that the government does not intend for it to apply to SMSFs by explicitly stating in its explanatory memorandum: “This covenant does not apply to trustees of self-managed superannuation funds”.
However, whether or not it would apply to SMSFs was not clear in the initial consultation paper and while many in the industry welcomed the above clarification, some say that it would not hurt for SMSF trustees to have a more explicit directive to consider retirement income requirements of trustees.
SMSF Association chief executive officer John Maroney, for example, welcomed the clarification of the covenant’s requirement on SMSFs and said the association threw its in principle support behind the decision. However, he also said that just because it wouldn’t become a legal requirement didn’t mean SMSFs shouldn’t consider having a retirement income strategy.
“It’s not a green light for SMSF trustees to ignore the spirit of a retirement income covenant, as we know from bitter experience that failure to properly address these issues can derail even the best laid retirement income plans,” he said.
Director, SMSF specialist adviser and financial planner at Verante Financial Planning, Liam Shorte, would prefer SMSFs to be included in the retirement income covenant. He says their exclusion may give some another opportunity to criticise SMSFs.
“My only concern is when you don’t have one rule for all it gives people the opportunity to whinge or target those who might be receiving [perceived] favourable treatment,” he says.
It also wouldn’t hurt SMSF trustees to consider their long-term retirement income needs as part of their investment strategy.
“I still believe that every SMSF trustee needs to plan for the longer term and not just the shorter term and really understand the benefits of being in pension phase,” Shorte said.
What to do?
Even if it is not a legal requirement, the retirement income covenant draft legislation is a timely reminder to SMSF trustees to carefully consider how their funds are to be invested, managed and used in retirement.
All SMSF trustees already have to complete an investment strategy, which is required to include the fund’s ability to pay benefits, along with the risks involved in making certain investments and the likely return from the fund’s investments regarding its objectives and cash flow requirements.
If all members are in retirement phase, the investment strategy would need to include how it planned to meet the income demands of members, how current investments would satisfy those demands and if assets need to be sold or reallocated to meet that demand.
SMSF trustees should use this opportunity to update their investment strategies if required and the SMSF Association’s Moroney suggested SMSF trustees could use the draft legislation as a guide.
“The exposure draft legislation, by outlining the different matters and risks that APRA-regulated fund trustees should address in relation to maximising the expected retirement income of members, can act as a useful action plan or blueprint for SMSF trustees,” he said.
“It also highlights the importance of specialist SMSF advice to assist SMSF trustees identify and mitigate these risks as well as addressing specific SMSF issues such as planning for loss of capacity, ensuring there are valid enduring powers of attorney in place, and assessing the ongoing suitability and viability of an SMSF.”
SMSF trustees could consider a specific section in their investment strategy on their retirement income approach, which might include larger drawdown rates on their allocated pensions and reallocation of investments to enable these larger drawdowns.
For instance, assets that are less risky should be used to pay pensions and expenses, which may require reallocation of some riskier assets into other investment classes such as cash and term deposits.