Exposure draft released on consideration of Insurance, Separation of Assets and Valuation of Assets at Net Market Value for SMSFs

June 1, 2012 By Leave a Comment

The Super System Review submitted to Government back on 30 June 2010 made several recommendations to improve the operation and regulation of the self managed super fund sector. Many of these recommendations were accepted by Government and formed part of the Stronger Super reforms to take effect from 1 July 2012.  We have now seen the issue in of the draft regulations in respect to some of the recommendations around consideration of:

  • insurance within an SMSF investment strategy;
  • the inclusion as an operating standard the requirement to have fund assets held separately from personal or employer assets; and
  • fund assets to be valued at net market value for reporting purposes

Trustee requirement to consider insurance for SMSF members as part of their investment strategy

The proposed regulations are to insert a new paragraph into sub-regulation 4.09 (2) to ensure that trustees consider whether they should hold a contract of insurance that provides insurance cover for one or more members of the fund.  With less than 13% of SMSF’s holding insurance for members, this recommendation aims to ensure that trustees appropriately consider the holding of insurance for fund members.

There will be a requirement for trustees to consider whether to hold insurance for their members such as life insurance when they formulate, regularly review and give effect to the fund’s investment strategy. It is expected that trustees will evidence this requirement by documenting decisions in the funds investment strategy or minutes of trustee meetings that are held during an income year.

In addition to the consideration of insurance within a fund’s investment strategy, this regulation would also amend subsection 4.09 (2) to require trustees to regularly review the funds investment strategy.  This will require trustees to evidence this review by documenting decisions in the minutes of trustee meetings are held during the income year.

The separation of fund assets from personal or employer assets

These regulations would insert into sub regulation 4.09A to require that a fund trustee keep money and other assets of the fund separate from money or assets held by the trustee personally or by a standard employer sponsor.  Currently this requirement forms part of a covenant (section 52(2)(d) of SIS Act) that is deemed to be incorporated into the governing rules of the fund (i.e. trust deed).  The ATO is currently unable to enforce compliance with covenants and relies on voluntary compliance by trustees.

It is not uncommon within SMSFs that breaches occur within this existing covenant where investments are incorrectly held by the fund.  This may include the fund bank account or other investments that maybe incorrectly recorded in a member’s own name rather than in the capacity as trustee of the SMSF.  Contraventions of this existing covenant are one of the most commonly reported contraventions sent by auditors to the ATO.

With this regulation becoming a prescribed standard applicable to the operation of a SMSF, the Regulator will have powers to enforce fines of up to $11,000 for a person who intentionally or recklessly contravenes the standard.

Valuing fund assets at net market value

A SMSF is required under section 35B of the SIS Act to prepare a Statement of Financial Position and Operating Statement each income year.  From the 2012/13 financial year, all SMSF’s will be required to value an asset at its net market value when preparing accounts and statements.

Sub-regulation 8.02A(2) will define net market value as the amount that could be expected to be received from the disposal of an asset, in an orderly market, after deducting costs expected to be incurred in realising the proceeds of such a disposal.  Currently, SMSFs are generally able to choose either historical cost or market valuation methods to determine the value of fund assets when preparing financial statements.  There are however requirements for a fund in pension phase (see TD 2009/29) or for in-house asset purposes (see s.82, SIS Act) that assets should be valued at market value each year.

The lack of consistency in valuation methodology has not only lead to an impact on a member to not be able to ascertain the current value of their super benefits, but it also affects the reliability and usefulness of superannuation data to make accurate comparisons across the entire superannuation sector (where APRA regulated funds are required as reporting entities to value their assets at net market value as required by Australian Accounting Standard, AAS 25).

The requirement to value assets to their net market value will ensure that members are provided with current and accurate information about the financial position of their fund and entitlements, along with an ability to better compare and understand the financial information across all sectors of the superannuation system.  Failure to comply with this reporting requirement will carry penalties of $11,000 and is also a strict liability offence and carries a penalty of $5,500.

My views

It will be interesting to watch over the coming years as to the influence of the inclusion within the fund’s investment strategy to consider insurance.  I would argue that many SMSF trustees (not all) lack a solid written investment strategy, with a large number of funds only having something in existence to ensure compliance with the auditor’s sign off under the compliance audit.  Far too often it is not actually used as a tool to set objectives consider risk, diversification, liquidity and from 1 July, insurance.  With a large proportion SMSF members at or nearing retirement, the need for insurance traditionally diminishes over time.  I do however believe this to be a positive step with the number of younger SMSF members entering the market, in particular where individuals are now undertaking borrowing within superannuation to acquire assets.

You can access information about these draft regulations and explanatory memorandum on the Stronger Super website.

Filed Under: Announcements, SMSF, SMSF Compliance, Trustee education Tagged With: , , , , , ,

Latest SMSF statistical report highlights growth but also the need to greater reform

April 15, 2012 By Leave a Comment

As we progress (albeit slowly) towards industry reforms with the superannuation sector, it is somewhat timely that the Australian Taxation Office has released their latest statistical overview of the SMSF industry, providing details of the 2009-10 financial year.  This statistical report now in its third year of data was first published as part of the Super System Review by Jeremy Cooper, which debunked many of the myths surrounding SMSFs and demonstrated that the industry as a whole was fairly robust and well-managed.

Download the ATO’s Self-managed superannuation funds: A statistical overview 2009-10.

Many of the statistics regarding the growth of the SMSF industry are now well-known as the sector appears to grow from strength to strength.  The more pertinent data when reading this review is the impact of Government policy, ongoing consumer confidence in financial markets (and Government), the important role of advice and specialisation within the sector.  Much of what I discuss below focus on these key themes.

The impact of Government Policy

SMSFs were arguably the biggest loser from the Labor Government’s decision to halve the concessional contribution cap in 2009-10.  Not only were contribution inflows impacted, but it most probably SMSF members who were hit the most in the significant rise of excess contributions tax assessments for the financial year as well (up 296% on the previous year).

The need for greater certainty with concessional contributions is important for the sector going forward.  With the transitional period for those 50 years of age and over ending at 30 June 2012, these individuals need clear direction from Government about planning contributions for 2012-13.

The demise of the corporate trustee

The continued growth in the use of individual trustees is a concern, with 90.13% of all new SMSFs established with individual trustees in 2009-10.  Unfortunately, this alarming trend has probably arisen from the highly competitive nature of the SMSF administration/accounting market.  With some administrators offering free SMSF establishments, this enticement to the market appears to be coming at a cost: the cost of advice!  Individuals appears to continue to setup SMSFs without knowing or understanding the differences/limitations in the different trustee structures.

It was acknowledged by the Cooper Review Panel that a corporate trustee was a far superior trustee structure, so it staggers me why individual trustees continue to grow.

Pension Phase

It is very apparent from the statistics that a growing proportion of SMSF members are moving to retirement phase.  55.7% of all SMSF members are now at an age (55 years and above) where they could draw an income stream from their SMSF, whether as an Account Based Pension (ABP) or Transition to Retirement Income Stream (TRIS).  The statistics show that 34% of SMSFs are paying a pension to at least one member; even more interesting is that this proportion of SMSFs actually represent 52% of all fund assets.  This would account for a significant amount of tax revenue (and growing) forfeited by Government due to policy in providing tax exemption within pension phase.  Add to this, tax-free pension payments from age 60, you must wonder about the longevity of the current policy with retirement incomes.

Whilst the statistics have traditionally had members being within the SMSF system for anywhere up to five years prior to drawing an income stream, this trend is shifting, with many new SMSF entrants commencing the payment of pensions in the first year of existence.

The growth in the payment of pensions is seeing the ATO take a greater interest in the area across several fronts including education and enforcement.  A new ATO publication on SMSF pensions (due out in July 2012), the finalisation of TR 2011/D3 (April 2012), and a focus on Exempt Current Pension Income (ECPI) with the 2011-12 compliance program, means we will expect more and more activity from the Regulator in this space.

Asset ranges & fees

They say that “size does matter”… although its not always the determining factor when it comes to SMSFs.  There is however a trend showing a reduction in lower account balances and growth in higher account balances.  It appears that education and the role of advice may be playing a role in people deciding to set up SMSFs.

The average expense ratio within SMSFs continues to decline, down to 0.54% in 2010 from 0.69% in 2008.  However, this is likely to be distorted by the growing number of SMSFs moving to pension phase where deductions are required to be proportionately reduced by the exempt income percentage applicable to the fund.  This issue has been recognised by the ATO, with changes expected to the SMSF Annual Return to capture both deductible and non-deductible expenses.

As the industry grows however and technology plays a greater role, we will continue to see the operating costs of SMSFs go down.  Due to the typically lower volumes of SMSFs per tax agent, the industry does appear to have a very slow uptake in technology advancements to become more efficient.  The statistics also show progressive decreases in SMSF auditor fees, a reflection of a growing number of specialist auditors starting to build streamlined and efficient businesses to handle high volumes of audits each year.

SMSF Assets

Interesting to note that the number of SMSFs with more than $1 million of assets has grown from 19% in 2006 to 26.7% in 2010.  The industry continues to see many new SMSF entrants coming from industry and retails funds with sizeable balances.  Even with volatile global financial markets during this time, SMSFs have continued to build their average and median total assets.

Investment Performance

The traditionally high proportion of cash and deposits held by SMSFs augured well during the GFC, however in a year where markets bounced back positively, the SMSF industry was generally outperformed by APRA regulated funds.  See comparison table below for 2008, 2009 and 2010 financial years between SMSFs & APRA regulated funds:

When looking at the Return on Assets (“ROA”) for the 2010 financial year where markets rebounded, the rate of return achieved on average per SMSF increased progressively across the asset-range bands, with 8.90% achieved on average for funds with greater than $2 million.  This compared with a -8.64% average ROA for balances under $50k.  This can be seen in the chart below:

In my view, the statistics reflect an an emerging industry, with some areas of compliance still a concern as with a greater need for competency across professional services including financial advice, accounting and the approved auditor functions.  With both the Future of Financial Advice (“FOFA”) and Stronger reforms intending to impact the quality of advice and competency requirements for these industries, I think it will be fair to say the landscape will look significantly different when reviewing the statistical summary in 5 and 10 year’s time.

For SMSF trustees, these statistics and the recent SPAA/Russell SMSF survey highlight a lack of confidence in current market conditions and also in the ever-changing nature of Government policy with superannuation.  In addition, a focus on mainstream media for advice (52% of respondents in SPAA/Russell survey), means many people may end up like a “deer in headlights” if issues arise through the lack of advice.

However, I do think it is an exciting time for the SMSF industry, and these statistics continue to prove it…

Filed Under: SMSF Tagged With: , , , , , , , , , , , , ,

Greater enforcement to rectify contraventions a key part of the new SMSF landscape

April 10, 2012 By Leave a Comment

The powers provided to the Australian Taxation Office (ATO) to deal with issues of non-compliance by SMSF trustees has been reasonably inadequate, something that was acknowledged by the Cooper Review Panel as part of the Super System Review.  The ATO in many respects had been known to have two options in dealing with trustee contraventions:

  • the “feather duster”approach – where limited penalties or undertakings could be applied against SMSF trustees ;or
  • the “nuclear”option – where fund’s were made non-complying for more serious breaches

A key outcome from the Stronger Super reforms to take effect from 1 July 2012 is the greater powers to be provided to the Regulator when dealing with contraventions by SMSF trustees.  Currently, where the fund trustees have contravened part of superannuation law, it is the trustee that may enter into an Enforceable Undertaking (EU) with the ATO to remedy the breach.  The Regulator may then accept or reject the enforceable undertaking from the trustee.

This however changes from next financial year, where new powers will allow the ATO to direct a SMSF trustee to rectify a contravention where it remains unrectified.  These powers will provide the ATO with greater capabilities to improve the timeliness and efficiency of remedying these issues.

These powers will range from providing penalties and sanctions on fund trustees, where SMSF Annual Returns may be outstanding or more serious breaches including loans to members, in-house asset issues or breaches of financial assistance.  Part of this rectification process may also require SMSF trustees to undertake mandatory education to continue to carry on their role as a trustee.

Since taking over as Regulator of SMSFs in 2000, the ATO has taken an educative approach to ensure trustees understand and comply with superannuation law and their ongoing statutory requirements.  Whilst the education process plays an important part in the overall ATO compliance program, we will expect to see a greater role in enforcement to protect the integrity of this burgeoning superannuation industry.

Filed Under: Audit, Professionals, SMSF, SMSF Compliance, Trustee education Tagged With: , , , , , , , , ,

Are we making a mountain out of a SMSF collectables mole hill?

June 20, 2011 By Leave a Comment

There has been a significant amount of discussion and debate in recent times about the draft regulations introduced for collectable investments within SMSFs to take effect from 1 July 2011.

In more recent times, I have been reading about the concerns of increased costs as a result of changes to collectables being held within SMSFs.  How quickly these people forget that the Cooper Panel recommendation was to prohibit the acquisition of collectables and personal use assets.

As part of building “integrity” into the self-managed super fund sector and breaking the shackles of past stigmas, changes to the ability to hold collectibles represents a positive step forward for the industry.  Where collectables and personal use assets represent 0.1% of a $430 billion industry, you would think the level of press on these matters meant more than a quarter of all SMSFs were invested in collectables!!!

Whilst concerns of additional compliance costs are valid, they are the reality of the future of SMSFs when it comes to improving the system’s integrity.  This is not an area being singled out by the Stronger Super reforms; take for the example the proposed future prohibition of acquiring shares from related parties.  The inability to transfer shares in-specie to a SMSF will become a more costly exercise as well.  This area is far more prevalent than collectables, yet little has been raised around these proposed changes?

So why are we where we are on this issue of collectables? I refer you back to the “Ten Guiding Principles for SMSFs” developed by the Cooper Review Panel, designed to underpin the regulation of SMSF specifically and more broadly for future policy-making in the SMSF sector.

The recognition of special risks in a SMSF environment (principle 7) and requiring some levels of intervention means that trustees (and their advisers) will need to change how they operate in a new SMSF landscape.  These changes are there to uphold strength in retirement policy but where it provides freedom of choice and greater control in making decisions over someone’s own retirement.

The industry has a right to have input in the future direction of superannuation policy within Australia, but I think arguing the toss on collectables is really making a mountain out of a mole hill… be happy that they are here to stay (just with tighter regulation)!!

Filed Under: Investments, SMSF, SMSF Compliance, Trustee education Tagged With: , , , , , , , , , ,

Are we under-utilising technology within the SMSF industry?

February 10, 2011 By 11 Comments

The 2011 financial year is already becoming one of the most important year’s to shape the future of the superannuation and financial services industries.  SMSFs are a big part of this transformation, even though it was stated by the chair of the Super System Panel, Mr. Jeremy Cooper that the SMSF industry is in “pretty good shape”.

My observations within the industry over the past 14+ years has seen significant improvements to automation in data to produce both statutory and investment information for trustees.  I remember the “shoe box” days, which not only did we have to trawl through paperwork, but did manual revaluations of shares  by way of journal entries… how times have changed!!

However, whilst software providers strive for greater automation in our work functions, the question must be asked… Are we seeing industry-wide adoption of this technology and more importantly, how are we integrating services to improve efficiency and the client experience.

I have seen the SMSF industry evolve through a process of:

 

Innovation with web-based activities, automation through delivery of transactions, integration with banks, brokers and platforms, and adoption coming through specialist SMSF administrators (and some accounting businesses) offering scalable solutions to trustees.

The diagram at the top of the page I believe covers many of the segments that technology impacts with SMSFs.  I have outlined how I see these service segments currently operate and provide my views on the automation process, and the need for further integration by adopting technology even more than we are today.

Compliance Software - the domain of the accounting profession (and fund administrators), this provides to trustees not only statutory reporting (e.g. SMSF annual return and financials), service providers are also using investment reporting within the software as part of their client offering to trustees and their advisers.  For some service providers, multi-fund processing and data automation are combining to provide significant advancements in how efficiently work can be done.  Web-based activity is also on the rise with software providers launching products such as BGL Portal, SuperMate and Class Super.

Data Automation / Portfolio Reporting – the use of portfolio reporting directly (not using a Wrap platform) for clients through financial planning systems such as xplan is also on the rise as some planners look more to direct investment portfolio for their clients.  This along with other portfolio reporting systems such as Praemium and OneVue have been the market leaders in developing higher levels of automation for portfolio reporting and integration into compliance systems such as BGL.

Wrap / Investment Platforms – platforms have been a key part of many financial advisory firms for many years.  The SMSF industry is starting to see a better automated flow of information to not only suit the financial adviser, but also the fund administrator.  The challenge for the accounting industry is to stop using the “lazy” option for reporting wrap platform investments (as a single unit) and start to embrace technology to deliver appropriate client reporting. Technology should allow for automation of all Wrap data to be imported into an SMSF software package as quickly as it takes to do journal entries to show the income and expenses of the Wrap Investment as a single unit investment.

Bank-data automation – obtaining bank data has always been the key to service providers from both an investment and compliance perspective as it is the “cash-hub” of the SMSF.  Web-services feeds of bank data are become common practice with banks such as Macquarie, Westpac/St George and BWA to name a few…  The accounting profession have long used intermediaries such as Banklink to aggregate bank data from a variety of sources; the ability to map and memorise transactions has been a powerful tool for improving efficiency.  It will be interesting to watch the continuing evolution of bank data integration, as we are today (as a community) already big users of online banking and the technology that it brings.

Shares/Equities - A large part of the SMSF market, we have seen the CHESS Sponsor system revolutionise how we deal with stock market transactions.  The SMSF industry has been a benefactor of this, with levels of automation around executions for buys & sells coming into portfolio systems such as Praemium & Iress.

Investment Software /Financial Data – We already see high levels of use within both the accounting and financial planning industry for financial data including share prices and asset allocation information.  We haven’t seen significant integration into investment software however to be able to manage portfolios and more importantly analyse fund performance against the key objectives of the fund’s investment strategy.

Other Service Providers & Suppliers – Online trust deed providers appear to have taken the lead with integration to the compliance software providers. Some deed providers are now integrating their SMSF trust deeds into web-access areas such as BGL Portal and Class Super.  Further advancements appear to be in the pipeline with actuarial integration with some software providers, along with far more automated processes to prepare and review information required to conduct the annual independent audit.

The Cooper Review in the Phase Three Issues Paper challenged the SMSF industry to consider technology to further drive down costs, improve efficiency in administration and improve regulation  (Section 18.2).  The Panel’s view in the Phase Three Preliminary Report was that the industry required “fewer moving parts and greater automation”.  The need for greater use of technology formed part of Principle 10, in their Ten guiding principles for SMSFs.

It  appears commonly accepted that there is a need for greater automation and use of technology within SMSFs.  However, with the accounting industry being “slow adopters” of technology, how long will it be until we see these changes and advancements of technology within the SMSF industry?  Does it need a generation change of the profession?

To put this in some context, let’s look at the table below showing number of SMSFs per tax agent:

This table is an extract from the Statistical Report into SMSFs prepared for Phase Three of the Super System Review.  The statistics clearly show a “cottage industry” in terms of preparation of work for SMSF trustees by tax agents. With 47% (yes, nearly half of all SMSFs!!) of tax agents dealing with less than 5 funds (on their lodgement program), there is little scope for any adoption of automation or integration whilst the industry remains so fragmented.

When I met with Jeremy Cooper this time last year, we discussed the topic of scale and wondered what a super fund business would look like that administered 50,000 SMSFs?  With the largest administrator in the country at around 6,000 SMSFs, it would require significant change (and innovation) within the industry to take us to delivering these type of numbers by a service provider.  The reality is that such a large-scale service provider will exist into the future where the number of SMSFs continue to grow.

The question from the above table, is at what number of SMSFs does automation and industry integration provide a tangible business benefit to change?  The topic of outsourcing has been around for many years now, but obviously the take up in this area is still very low as well…

Push & Pull?

The focus to date has very much been how you can “pull” data into compliance and portfolio systems.  With an aging population, we know that retirement modelling and longevity risk is becoming a key focus.  From a technology point of view, this is going to require administration service providers to be able to “push” automated data back to financial advisers to work with clients on these issues.  At this stage, I know of very few providers offering a push/pull solution with data to integrate between the accounting and financial planning professions.

It is hard to fathom that there are now more than 500,000,000 active users of Facebook around the world.  Social media has changed how we use the internet, including how integration can work with your Twitter account linking to your Facebook page, to your LinkedIn page, and embedding videos on YouTube or images from Flickr.  It will be interesting to see how far away the financial services & accounting professions are away from significant innovation in how we as service providers prepare our work and share information with clients.

I’d be interested to hear the thoughts of people out there as to what technology they are using to operate SMSFs (both accounting and financial services) and discuss some of the benefits and limitations that they see in offering clients a fully integrated solution.

Filed Under: Opinion, Professionals, SMSF, Technology Tagged With: , , , , , , , , , , , , , , , , , , , , , ,
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