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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.
But the release of a new position paper by Treasury is putting a greater focus on how SMSFs satisfy the income requirements of members in retirement.
The Retirement Income Covenant
The so-called Retirement Income Covenant position paper was released mid July with submissions closing 6 August.
SuperConcepts executive manager, SMSF technical and private wealth, Graeme Colley, says the covenant has been in the wind for some time and will probably take some time to become legislation, even though the Government intends for it to take effect from 1 July 2022.
Indeed, the federal government announced in the 2018–19 Budget its intentions to introduce a retirement covenant for superannuation trustees (of all funds, including SMSFs).
It wants to add to 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 – to ensure that the retirement needs of members are being met.
“The government intends to introduce a retirement income covenant in the Superannuation Industry (Supervision) Act 1993 outlining a fundamental obligation of trustees to formulate, regularly review and give effect to a retirement income strategy,” the position paper states.
Where did it come from?
The position paper, and the intent of the covenant, covers all kinds of superannuation funds; not just SMSFs.
It 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 paper states.
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?
Although the paper mentions member cohorts for larger super funds, SMSFs should not assume they will not be included in the requirements if they are introduced.
The position paper states:
Trustees are required to formulate, regularly review and give effect to a retirement income strategy for the retired members of their fund, and the members of their fund approaching retirement.
The retirement income strategy requirement will apply for all trustees, including trustees of self-managed superannuation funds (SMSFs) and small APRA funds (SAFs).
The paper also says that it is up to the trustee as to whether they have a retirement income strategy if all members of an SMSF or SAF are in the accumulation phase.
In most instances trustees of SMSFs and SAFS are not expected to develop strategies for different members cohorts, like larger superannuation funds may be required to do.
However, if trustees of SMSFs and SAFs identify that their members need markedly different approaches to balance the objectives under the strategy, they are not precluded from developing their strategy for cohorts of their members.
What to do?
The position paper states that: “How retirees draw down on their superannuation can be more important than whether they make additional contributions to superannuation in working life. People could have a higher standard of living in retirement if they had greater confidence to spend their superannuation.”
Even if it is sometime before it is implemented, it 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.
The position paper says that a retirement income strategy is to be a “strategic document developed by the trustee that identifies and recognises the retirement income needs of the members of the fund and presents a plan to build the fund’s capacity and capability to service those needs.”
The SMSF Association has said that for SMSF trustees they believe there is an element of overlap between the proposed retirement income covenant and the investment strategy covenant.
“We appreciate the policy intent, but are of the view that including, for example, the longevity and risk consideration alongside a robust investment strategy, could accomplish this objective,” SMSF Association chief executive officer, John Maroney, said.
In light of this, SMSF trustees could consider a specific section in their investment strategy on their retirement income strategy, which might include larger drawdown rates on their allocated pensions and reallocation of investments to enable these larger drawdowns.
“Those assets that are less risky should be used to pay pensions and expenses, which may require allocation of some riskier assets into other investment classes such as cash and term deposits,” Colley adds.
Such a section could then be further built out into a “strategic document” if and when the time comes.