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As professionals in the wealth management industry, we occasionally encounter statements made about superannuation, which are at best over-simplified generalisations and at worst egregious misconceptions. In this article we will explore some of these misconceptions and key failings (or limitations if we are being polite) of superannuation that we think everyone should be aware of.
Whilst we maintain a positive view of superannuation on the whole it’s important to understand its limitations and failings, and to take these into consideration in your holistic approach to the creation, consumption and eventual transfer of wealth.
Misconceptions
Misconception #1: Superannuation is an investment
While superannuation is legally considered a financial product, it is not of itself an investment. Rather it is a tax structure with some generous concessions, through which underlying investments are held.
Like any financial product or tax structure it has pros and cons, which means that there is a way in which to utilise it, as well as situations in which alternative structures might be more advisable.
Misconception #2: Superannuation is always the optimal or most tax-effective savings vehicle for retirement
Superannuation is generally very tax effective for saving for retirement but this can depend on the individual’s circumstances. There are situations in which it can cease to be the optimal tax structure or savings vehicle.
Due to the changes in legislation (and amplified by the recent Federal Government proposal to reduce tax concessions on member balances above $3 million) we are encountering an increasing number of situations where structures other than superannuation present a more tax-effective option for wealth creation, transfer and distribution.
Misconception #3: There are no death or inheritance taxes or duties in Australia
Although Australia does not have an inheritance tax, there are tax obligations that can arise on death. The extent to which a death benefit lump sum is comprised of a taxable component, will be taxed at 15% plus Medicare levy when paid to a beneficiary who is not a dependent under the tax laws.
Unless the amount is paid to:
- a spouse (including a former spouse),
- a child under the age of 18 who is financially dependent on the deceased or
- someone with whom the individual had an interdependency relationship,
the payment will attract the afore mentioned tax which, in our experience, is often quite a sizable amount.
Misconception #4: Superannuation is great for distributing my wealth
There are several limitations that you need to be aware of when relying on superannuation as a tool for distributing wealth. Firstly, unless specifically paid to the estate, superannuation is not governed by a deceased’s Will.
The member may make a nomination to the Trustee about whom they want the residual member balance to be paid to, but unless that nomination is specifically permitted by superannuation laws and remains a valid selection at the date of the members passing, it may not be paid as intended.
Additionally, unless the nomination was binding upon a trustee there are situations where the trustee may decide to adopt an alternative course of action, without due consideration to the tax implications.
Failings
Failing #1: Complexity
The initial concept of superannuation was very simple – ‘a pool of private savings from which to fund one’s retirement’. However, since the introduction of mandatory savings via the Superannuation Guarantee in 1993, there has been an almost continual tweaking of rules.
In the last 15 years alone we have seen:
- Limits on different contribution types (and the frequent changes to the amounts) – some indexed while others are not
- A surcharge for certain contribution types for persons with high levels of taxable income in a given year
- A threshold placed on a member’s total superannuation balance which when exceeded after tax contributions are no longer permitted to be made.
- Individual Lifetime caps placed on the amount of benefits in superannuation that can be moved into the retirement income phase to provide a member with annual income.
Complexity is not the sole domain of the superannuation legislation; the Australian Tax Office is contributing through revising its views around its expectations, tolerance or timing of certain actions which alter the landscape of what is considered acceptable administrative practise in a variety of areas.
All these changes make for increased chance of inadvertent errors and potentially missed opportunities. More so they necessitate increased reliance upon proactive professional advice providers.
Failing #2: Politicisation
Superannuation promises have become key policies of political party election campaigns. To nobody’s surprise, such policy differences primarily centre around taxation outcomes as opposed to substantive superannuation reforms.
When compulsory superannuation guarantee contributions (SGC) were originally introduced, the government of the day was concerned about the future quantum of the Age Pension it would one day have to support. More recently, contemporary governments have viewed this from the alternate perspective of considering the amount of tax that is forgone.
Increasing politicisation leads to increased risk that superannuation rules will be changed to suit political ambitions, as well as the risk of it being seen as a potential source of revenue available to fund deficits or further desired projects.
Failing #3: Taxation inefficiency
Whilst superannuation is itself a concessionally taxed environment, the investments that a member may make with their superannuation money can have their own taxation issues to contend with.
When the superannuation benefits are invested in assets housed within trust structures such as managed funds, exchange traded funds, listed investment companies, and insurance bonds, the earnings or undistributed profits can be taxed in the structure at a rate greater than the superannuation rate had it been distributed.
Issues can also arise in cases where net capital losses are incurred within the respective structure for the relevant financial year and consequently unable to be distributed to be applied against capital gains realised by the superannuation fund itself.
Failing #4: Prescribed Purpose
As per the Sole Purpose test, which is outlined in section 62 of the Superannuation Industry Supervision Act (the Act) a superannuation fund is maintained only for the purpose of providing benefits to its members upon their retirement, or for beneficiaries if a member dies and specified ancillary purposes which are aligned to the various conditions of release allowed for under the Act.
However, life presents us with moments where we need to access our savings but are not able to do so through superannuation.
For example, when a person wishes to retire earlier than the stated preservation age within the Act, or experiences significant ill health which does not meet with the technical definitions in the Act of permanent incapacity or compassionate grounds.
In such cases having all of one’s capital in superannuation is typically not able to deliver a desired outcome.
Takeaway
We are firm believers that Superannuation is only one part of a successful and robust financial plan which should include the accumulation of wealth in an efficient and flexible manner outside of this structure.
Similarly, there may also come a time where Superannuation becomes sub-optimal and better outcomes are achieved through alternative structures, particularly with respect to the eventual transference of accrued wealth to intended beneficiaries.
Next Steps
The first step in the path to greater certainty comes with improving your awareness of the investment structures that can best serve your goals.
Thereafter we suggest making the time to speak with one of our Private Client Advisers who can assist you to navigate through the complexities of better securing yours and your loved one’s futures – financially and otherwise.
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.