By Mike SeccombeApril 13, 2012
Super funds haven’t been generating an extraordinary rate of return — unless you’re a high-income earner counting the tax benefits.
The average punter might be excused for having been a little hostile, over recent years, to the very concept of compulsory superannuation.
Alex Dunnin acknowledges this. There's the government, conscripting nine per cent of their income into an investment vehicle which is doing them little or no financial good.
"At the moment super funds are sitting on a return that's barely positive," says Dunnin, who is the research director at Rainmaker, a financial services information company.
"Inflation's about two to three per cent, so they [superannuation investments] are returning effectively zero per cent. Over the past five years, they've been averaging about five per cent, only marginally above inflation.
"Most people must be scratching their heads and asking: 'Tell me why this superannuation thing's a goods idea?'"
Put it to him that a lot of people would have been better off if they'd just shoved it in the bank, where you can currently get a rather better rate of return, and he agrees wholeheartedly.
"That's why money has been pouring into the bank deposit system," he says.
"The last time I looked, at the end of December, there was $1.6 trillion in deposits in banks. That's not just retail term deposits, of course, but that's where a lot has been going."
For comparison, he offers a couple of other figures: Australia's gross domestic product (GDP) is around $1.3 trillion, and the total held in super is about the same.
"Right now," he says, "if you put your money in cash, that makes you one of Australia's premier investment managers."
Yet money continues also to pour into superannuation. About $110 billion last year alone. And here's the superficially surprising thing: less than half of that came from compulsory super. Most of it was put in voluntarily. The aforementioned average punter might well wonder why this is happening, given the rates of return he or she sees on his or her super account.
Mike Rafferty, senior research fellow at the school of business at Sydney University explains what it is they're not seeing:
"There are basically two types of superannuation in Australia. One type is driven essentially by the industrial relations system. That's the compulsory nine per cent."
That money almost all flows into retail or industry funds.
"The second type is almost entirely driven by the tax system, and almost all of those funds go into self-managed super funds [SMSFs, referred to in the industry as Smurfs], which are, you might say, the superannuation version of family trusts. They typically have only one or two people in them, a husband and wife, they are currently one of the most tax-concessional types of saving for high-income, high-net-worth individuals and families."
For people on high marginal tax rates, super contributions present a great opportunity. The tax rate on contributions is just 15 per cent, up to a cap of $25,000 per year for those under age 50, or $50,000 for anyone over 50, or whose account balance is less than $500,000.
Clearly, if you are looking at a top marginal rate of 45 per cent tax, the prospect of reducing that by two-thirds through channeling money into super is very attractive. Unsurprisingly, a lot of people are doing it.
Quite a lot of people, actually, as Dunnin showed in a research paper done late last year for Rainmaker. At the end of last year there were 462,000 self-managed funds, holding some $400 billion. The average size of a SMSF was $921,000, or $442,000 per member.
The average SMSF member was kicking in $50,000 annually, he calculated, "which coincidentally matches the much-criticised contribution cap."
That average $50,000 self-managed super contribution also amounted to more than most people take home in pay.
Not only were 30,000 new funds created in 2011, existing funds were getting fatter.
"In six years the proportion with over $1m FUM [funds under management] has more than doubled from 12 per cent to 27 per cent as the proportion with less than $100,000 has halved from 26 per cent to 13 per cent," his research paper said.
"Reinforcing this tilting to the top-end, the proportion between $500,000 and $1m has gone from 18 per cent to 23 per cent and the proportion with $1-5m has more than doubled from 11 per cent to 25 per cent. The wealth being stored in SMSFs is consequently becoming extraordinary, accumulating ironically behind the walls of tax concessions designed for lower and average income earners, shattering the illusion that SMSFs are being used by low balance fund members previously inclined to use traditional prudentially regulated funds."
Says Dunnin: 'The government estimates those tax breaks are costing the country each year about $30 billion. We estimate at least a third of the tax breaks go to people in self-managed super funds. We think the people getting the greatest benefits are very high income earners."
Others who have studied the situation concur. As I noted in last week's story on superannuation, the Treasury itself estimated that 5 per cent of individuals accounted for over 37 per cent of concessional superannuation contributions. In its February 2012 paper advocating superannuation reform, the Australian Council of Social Service estimated 47 per cent of the tax breaks accrued to the top 12 per cent of taxpayers.
These tax breaks do not relate just to contributions. Once the money is in the fund, it also is taxed concessionally at a maximum of 15 per cent, although, says Dunnin, most smurfs pay only around six per cent.
Once you have your self-managed fund, you can load all sorts of assets into it — not the family home, but other real estate, shares, cash, even (a tiny proportion of the total) collectibles.
"The self-managed system is entirely a creature of the tax system," says Rafferty. "It exists to allow high income earners to package up all their other savings … and receive favourable tax treatment on them."
Dunnin expands on this. "If you've got a self-managed fund, you are not just a member, you are a trustee. And self-managed funds have easier rules than other [super] funds. For example, you can borrow against the assets of the fund."
He cites an example of the lurks available:
"Say you have a small business. You set up a property trust, through your superfund, which buys the building where your business is. You then pay rent to that property trust. So you are paying rent to yourself. You're recycling your money."
And getting a tax break. Then, when you retire, the trust sells the building. Because withdrawals from super are tax free, you avoid paying tax on the capital gains accrued over the years.
All in all, it's a pretty sweet deal for those in a position to set up their own fund.
But how did it come to this?
In his October 2010 paper, Superannuation: Our Magic Pudding, Ian McAuley, from the Centre for Policy Development and the University of Canberra, notes that when the Hawke Government first introduced compulsory super, at a three per cent contribution rate, it did so largely to address an immediate economic problem, rather than to help workers provide for their long-term financial futures.
"By 1986," he wrote, "the economy was in a positive feedback loop, with high inflation feeding into high wages as built into the Hawke Government's Accord which indexed wages to the CPI, which in turn fed into demand and high inflation. The pragmatic response, negotiated through the Conciliation and Arbitration Commission, was to award a six percent pay rise split between a three percent wage rise and three percent award-based superannuation. (Such a low level of contribution could never provide a useful retirement income; its purpose was to break inflation.)"
Over the years, superannuation has served many policy ends, he says, from breaking inflation to "boosting saving and investment, supporting the financial sector, reducing long-term fiscal pressure, protecting our current account." Oh, and, almost incidentally, providing retirement incomes.
Mike Rafferty also points to the way that superannuation has been re-purposed over the past couple of decades. It was 1992, when Paul Keating was Prime Minister, that the government committed itself to raising the rate to nine per cent by 2003, where it remained until the recent decision to take it to 12 by 2020.
"When it was originally sold, it was to top up the age pension. They said, 'We're not going to increase the pension, because you've got this to top it up.'
"Now increasingly it's to replace the pension. The goal is to make superannuation the primary retirement savings vehicle, with the age pension a poverty safety net. That's a very, very big change from the original idea."
But few people now deny the demographic pressures forcing retirement incomes policy away from pensions and towards self-provision through super. In just the past 20 years, average lifespans have increased three years; they are expected to keep on extending, threatening to overwhelm pension schemes.
The conservative parties were slow to warm to the idea of compulsory super, and even now are uneasy about the power of unions in managing it. While Labor drove compulsory super for workers, the massive increase in self-funded super was mostly down to the Howard/Costello Government.
"The rorts were really brought in by Costello when he was Treasurer," says Rafferty.
Dunnin takes up the story.
"It really exploded when Howard and Costello in 2007 … made superannuation effectively tax-free for retirees, and for a short time you could put up to a million dollars into your super and still get all the concessional benefits.
"Well, what are you going to do if you've got the money? Pour it into super. And people were pouring so much in that contributions doubled in that year, to $170 billion.
"And more than two-thirds of that surge went into self-managed super … from people who had lots of money already, and wanted to get the tax break on it," he says.
And the super industry, or at least that part of it, no longer had anything to do with helping people provide for their retirement, or taking pressure off the pension system, for these people would already have had secure retirements. It was all about "tax arbitrage", he says.
Dunnin thinks the increase from nine to twelve per cent compulsory super for most workers is "terrific".
"But from a national savings perspective it's going to have no impact whatsoever, because currently the equivalent of 18 to 20 per cent of wages goes into superannuation.
"Not everyone is putting it in in equal measure, and not everyone is getting equal benefit because of all the distortions. It comes back to equity," he says.
Indeed. As noted in our previous story of super, the most recent official statistics show the average male retiree got a payout of $198,000 and the average female $112,600. But Dunnin points to more than 100,000 self-managed super accounts holding between one and five million dollars, and thousands more holding between five and ten million. Some people with knowledge of the industry claim a handful of super accounts hold close to a hundred million.
All taxpayer subsidized.
The inequity of the system was highlighted by Richard Denniss and David Baker in their 2011 paper What Price Dignity? which noted that people with millions in super, living on large, tax-free retirement incomes, also received health concessions and money towards their utility bills:
"This particularly inequitable arrangement arose as a result of the Howard Government decision to provide, tax free, a payment of $800 per year to help pensioners with the cost of water and electricity. This $800 payment is being made available only to those with an adjusted taxable income of $50,000, or $80,000 for couples. But since pensions drawn from a superannuation fund are no longer considered to be taxable income there is nothing to prevent people with millions of dollars invested in super, who draw incomes of hundreds of thousands of dollars per year, from successfully applying for the Commonwealth Seniors Health Card. In turn, all recipients of the CSHC receive the tax free Seniors Supplement of around $200 per quarter which replaced the Seniors Concession Allowance and Telephone Allowance."
This is not big money in the scheme of things, but it does serve to indicate how readily the system can be exploited.
Now, Alex Dunnin is not saying the whole self-managed super industry is a scam "because it's not."
Most of it is entirely legitimate, if highly tax-effective.
"But there are 460,000 of these funds. Let's say just one per cent are manipulating the system. That's 4,600 funds doing it. Now, the average SMSF has nearly $1 million in it. So even if only a tiny proportion are doing it, you've got a lot of money there. There is a lot of flexibility to push the edge."
Like most people who have looked closely at the system — from the Henry tax review to the Australian Council of Social Service, to various experts quoted here — he believes big reform is needed to stop people piling up big sums in super, way beyond what they need to secure their retirement.
The tax breaks, he says, are far too generous.
"One of the legacies of the Howard Government … was that middle-class welfare was turned into an art form, and if you try to peel that back, as we are seeing now in the public debate, it's really hard.
"There is this view around the superannuation sector that we've got this human right to more and more tax breaks, because that's how we've been trained now," Dunnin says.
It's a pity, because Australia has got half a great system, one which could provide not just secure retirement, but investment for a better country.
"It comes back to deciding how we want to spend our money. Do we want to build airports and fast trains and schools and hospitals?" he asks.
Or do we want to spend it "on middle-class tax breaks and welfare?"
Time, he suggests, for a big re-think.