Superannuation

Which financial service product is most widely held by Australian adults? It’s superannuation. 14.8 million Australians have a super account, and 40% have more than one. There is $2.5 trilllion in super, that’s $2,530 billion or 253 followed by 10 zeros. There are 500 superannuation funds, 362 with assets over $50 million, regulated by APRA (so not counting self managed superannuation). It’s where we hold most of our savings.

If that’s not enough, Deloittes estimates that super will have $9.5 trillion in assets by 2035. That quadrupling makes it the biggest game in town. Critical to the wellbeing of Australians and a massive business opportunity.

A history lesson.

Superannuation has been around for a long time. But it was only there for a select few, usually people employed by government and large companies which either managed their own super or had AMP or MLC manage a superannuation policy for them. Some of these corporate super schemes still exist.

In 1992 the Keating government introduced compulsory superannuation for all workers. It was a high inflation period and the country was faced with rampant wages growth. With an aging population, the anticipation was that Australian taxpayers would not be able to afford future retirement pensions. So in a “one in every decade or two” forward thinking move, superannuation was introduced to lift the self-sufficiency of retirees. In an accord with workers, wage rises were foregone to quickly lift the contribution rate to a viable level.

What differentiates the system today from the old corporate funds is that it is compulsory and it comes with tax concessions.

Superannuation is saving for the future. Compulsory contributions, the superannuation guarantee levy, are made from your salary at a rate of 9.5%, rising to 12% by 2026 under the current timetable. The contribution and forward earnings are taxed at 15%, a concession on the average marginal tax rate. In return, you can’t access your super until 60 if you retire or 65 whether or not you retire.  It means that you are receiving tax benefits today, but a 20 year old won’t see her money for 45 years (maybe longer by then).

As the system has evolved there are all sorts of exceptions to most of the rules, earlier access for older workers, opportunities to make extra contributions with differing tax treatments, transition to retirement provisions, etc., etc. These are way too complex for this module.

The growth being projected for superannuation savings looks crazy high.

It looks like this for three reasons:

• The population and workforce are growing, which means contributions on behalf of more workers.
• There is a linear growth in super balances provided by the 9.5% and growing compulsory contribution.
• Investment earnings on balances compound over the work life and into retirement. Being taxed concessionally at 15%, there is only a small leakage from the compounding.

The magic of super is the magic of compounding. This is what accounts for the exponential growth rate.

For individuals it is the same story. Contribute for 40 years, leave the savings untouched (as they must), and compounding returns on appreciating assets for 40 years means a nest egg on retirement.

Account based pensions or self managed super

• Account based pensions (supervised by APRA) allow you to pay your contributions into a super fund and allow the fund to manage your investments and administration of your super. Funds like Sunsuper and Australian Super.
• With self managed super funds (also technically account based but supervised by the Australian Taxation Office), you manage your own investments and administration. The administration is subject to a whole body of regulation and most individuals put this in the hands of their accountant. With higher fixed costs of administration but lower percentage based fees, they are most viable for balances below $250,000 to $300,000.

SMSF’s are the fastest growing part of the industry, but in terms of member numbers the account based pensions swamp them. My comments relate to account based super.

Accumulation fund or defined benefits fund – what benefits are paid

• The accumulation fund retirement benefit depends on the money put in by you and your employers and the investment return generated by the fund.
• With a defined benefits fund the benefit you receive is defined – for example you receive a pension for life equal to 75% of your average salary for the final 3 years in employment, sometimes indexed for inflation. Most of the original corporate and public service funds started this way. A tiny proportion of the workforce still has one of these, but the only way I know of joining such a fund today is to be elected to parliament.
• Annuities are an investment option that allows you on retirement to replicate a defined benefits style of benefit.

My comments here relate to the common form, the accumulation fund.

Accumulation phase or pension phase

• Accumulation phase continues while you are in the workforce and are making contributions.
• Pension phase is when you have retired and are drawing on you super, not continuing to contribute.

I am dealing here with the accumulation phase.

Industry funds or retail funds

• Industry funds did not exist prior to the 1992 reforms. The unions were quick to seize the opportunity and set up aligned super funds. They are largely not-for-profit, though some make contributions to unions, with fees charged to cover the cost of the service. The fund is managed to optimise outcomes for the members.

Members’ return = investment returns – expenses

• Retail funds are for profit organisation, like banks, who charge fees to cover the cost of the service and to generate a return on shareholders’ funds. Controversially, the fund is managed to meet member expectations and to optimise returns to the business.

Members’ return = investment returns – expenses – manager’s return.

The two are direct substitutes and my comments relate equally to both.

Most Australians are in super because they have to be. Some even believe super is a tax.

Superannuation is enforced savings for your retirement, to provide a higher standard of living than the age pension. With the age for pension moving to 67, super also cuts in earlier, allowing an earlier retirement. But that could change, as many things about super do.

The 15% tax concession, applying to the investment earnings of the fund and to your contributions, is there to accelerate the savings accumulation. Not because successive Treasurers are generous, but to get people off the dependency on government for retirement living. (In fact at the start of compulsory super, it was altogether tax free.)

At 60 and retirement or at age 65, the funds become available for withdrawal either progressively or as a lump sum. The withdrawals are tax free. Again designed to stretch peoples’ retirement savings to the max, to keep them off the pension. Your super is put into pension mode and investment earnings also become tax free. Contributions cease on retirement.

If you are still working and over 65 (work test is a minimum 40 hours in a successive 30days), you may continue to make contributions up to $25,000 pa.  Your employer is still required to deduct the levy from your pay. It has to go into a separate accumulation account. Contributions cease at age 75 (except for the SGC). There is a $1.6m cap on the tax free balance in a pension fund.

Typically someone retiring today has had superannuation savings accumulating for two-thirds of their work life. For a worker on average income, this is not enough to support them through retirement and typically there would still be reliance on a part pension, and eventually as retirement savings dwindle, a full pension. At the bottom end of the scale, super is adequate only to knock off a mortgage or purchase the caravan.

So the reforms brought in by the Keating government are yet to fully yield the benefit hoped for, but with compounding of investment returns and contributions made over the full work life, that might still happen in the future.

The other thing that super provides is life insurance. Insurance fits a little uncomfortably in superannuation as it doesn’t contribute to the accumulation of retirement savings. To the contrary, every dollar put into a life insurance premium is a dollar less contributing to your retirement.

It is inside super for a few reasons:

• Default cover through industry funds comes automatically without underwriting and health checks
• That is where people can afford to pay premiums from. People don’t see their premiums as a drain on the household if it comes out of super contributions they never had.
• Being paid from contributions taxed at 15% rather than a 30% marginal tax rate makes the premiums cheaper.
• Super funds are able to negotiate a cheaper “wholesale” price for group insurance.

But that doesn’t change the fact that insurance diminishes the core purpose of super, retirement savings.

Industry funds provide default insurance to all members. Retail funds don’t have default cover but provide access to their range of insurances through an adviser. Their policies are generally more comprehensive and the mix is tailored to you, but they are subject to underwriting and you might not qualify.

Industry funds provide standardised policies for life insurance (death), total and permanent disability (TPD), and some provide Income Protection (IP). The policy definitions for TPD and IP tend to make it tougher to claim and the coverage is not as comprehensive as the retail cover. An example is that your IP usually cuts out after 2 years, compared to retail offerings that can go through to age 75.

Underinsurance is rife in Australia, and default insurance at least in part addresses this. However the level of default cover with some super funds is way too low (and reduces further with age) to properly provide for needs of the family or individual. It can actually lead to complacency that people are covered, when in fact their cover is wholly inadequate. There is sometimes the option to top up cover, or for that matter to go the other way and opt out.

There is controversy around insurance in super in relation to the quality of cover, the advice or lack of advice when a fee is charged (retail funds), and whether it should be default for younger members.

The last is interesting.  You need life cover when you have financial dependants. If you don’t have dependants, maybe you shouldn’t be paying premiums. (A mortgage will be paid out from sale of the house, so if you don’t have dependants, does it matter if there is a modest shortfall?) Claims are low for young people, meaning that they are subsidising older claimants. This is so of course for most insurances, but the difference here is that the young people are defaulted into insurance without exercising a conscious choice. The government has legislated to make insurance opt in for people under 25, rather than the current opt out.

Default insurance has some benefits, but the scenario above is just one symptom of why auto solutions might not suit individuals when it comes to insurance.

The primary goal to maximise my retirement savings. Most people will go through their work life making the minimum contributions and then retire. Some will make additional contributions and pursue investment or strategies like transition to retirement in the later stages of their career.

The things to look for to meet the retirement savings goal

High investment returns

You are placing your savings with a super fund for the long term and want them to manage your share of the investments to return you strong growth.

Outperforming the market is challenging and the body of evidence is that maintaining top quartile returns is not attainable. However top quartile investment returns are not required to produce a superior outcome retirement savings. Outperforming the market by 1% over the long term is enough to provide a massive boost to your nest egg. Comparison of returns suggests that some industry funds have been able to do this in the long term by including a high proportion of direct investments in infrastructure and property, effectively cutting out the middle man who is also after a clip of the ticket.

Risk of course matters and you don’t want to lose your retirement savings. This is why APRA requires diversification of investments. More on this in the Investment section that follows.

Low fees

If you are paying high fees, stop. There is no benefit in finding an extra 1% in performance if you give it away to the super fund manager by way of higher fees. Death, taxes and fees are certain, whereas investment returns are a world of uncertainty. High fees reduce the net return and are one of the biggest predictors of over or under performance.

If you’re paying over 1% all up for a balanced investment option, you are paying too much (and you can do a lot better than 1%). Time to switch providers.

Reasonably priced insurance premiums come into this also.

Tools, advice, choice of investment

The right tools can equip you to make better decisions. These can be access to advice on investment or transition to retirement strategies, general education to help you understand your choices, tools and calculators to help you plan, quality reporting to help you track progress.

If the tools are good you can go it alone most of the way but at some customers point you should be seeing an expert.

These services help you make the right choices about your super.

Just how does the superannuation fund invest my retirement savings? Given that you are contributing 9.5% of your pay to super, you want to make sure that the investment management is producing the right outcome of strongly compounding growth.

The super fund pools your money and invests it using their own investment managers or outsourcing to a number of investment managers or a hybrid of the two. Typical investments are in Australian listed shares (index following or actively managed), international listed shares, infrastructure projects, high rise and retail property investments, cash, government and corporate bonds. Various mixes of these investments go into the investment options presented to members.

The typical investment options – cash, conservative, balanced, growth, aggressive – are designed for different growth expectations, different risk appetite and different age groups. This is enough for most people and is consistent with the MySuper legislation, introduced to keep the offer simple and understandable, and the costs under control.

The industry funds and some of the retail funds offer these simplified schemes. Some manage the investment mix through a life stage transition product.

Some of the retail funds provide hundreds of investment choices. This may be sought by some members looking for specialist investments – eg. FAANGS or developing economies. However they come at a high cost and most people glaze over, preferring to allow the specialist funds manager to put together the right mix of investments.

The important question for the consumer is which of the options on offer to choose.

Cash is unlikely to be the right choice for a person with 40 years before they can access their money. It is low risk but historically underperforms in the long term. Growth might be the better call as even though there will be losses at times in the cycle, the 20 year old has plenty of up cycles ahead to recover those losses.

On the other hand someone approaching retirement and planning to start drawing down on their super might be shy of the growth option. If there is a market correction they might be out of time to recover financially before their savings are depleted.

Clearly risk does matter, but extreme risk aversion can damage long term savings. Risk is usually measured by the variation in returns, but when you have a 40 year time frame in the workforce and then retired life on top, you can tolerate some volatility on the way.

There are commonly three types offers:

• Membership or administrative fee – can be a flat fee or percentage of balance
• Investment fee – usually a percentage of balance, and should be low for cash and index funds, higher for international portfolios and actively managed
• Insurance premium- not strictly a fee, but has a like impact
• Advice fee – should only be charged as a flat fee when advice is given
• Transaction fees – like switching of investment option, closing account

Individually they range from trivial to a lot, but they all add up. Canstar’s 2017 star ratings estimates the total cost (excluding insurance) for an $80,000 balance. It ranges from $466 to $2,038. At the high end that amounts to one third of the annual contribution from a $60,000 wage earner and would wipe out most of the average investment earnings. Very damaging to your retirement savings.

First up choice of fund is entrenched in the legislation. Unfortunately too few people exercise this right.

Employer’s default fund

The bulk of new superannuation is opened with the employer’s default fund. A person starts a new job and is asked about super, and told of the employer’s default fund. Unfortunately the employer isn’t obliged to find a fund that is in the best interest of employees. It could just be that the entrenched fund’s systems integrate well with the employer’s payroll system.

The outcome is often  a bad match and it leads to duplicated accounts.

Online with the fund

It’s so easy to go on line to open a super account. The fund is also able to consolidate you old funds to avoid duplicated fees and insurance. Yet there are millions of duplicated accounts.

Your bank

All of the bigger banks have superannuation businesses, selling their own brand, though these businesses are on the sales block.

Adviser

Retail funds still have armies of investment advisers selling super.

Comparison sites

When you can compare the 70 biggest superannuation funds in one place, compare investment returns and costs in one table, there is no reason for consumers to not exercise choice of fund.

• Of course paying too much. Don’t listen to the rhetoric. Compare net performance over 5 years.
• Getting into the wrong investment option, which compounds to a serious shortfall in retirement savings
• Holding duplicate accounts that are usually small, which means that you double up on fees and insurance premiums.
• Paying for insurances that you can’t, or are highly unlikely, to claim on.
• Not comparing your fund with others. Many of the shocking instances exposed during the Royal Commission would have been exposed sooner if people had compared.

• Retail funds – banks, fund managers, life insurers
• Industry funds – some closely aligned to an industry / union
• New age providers (like Spaceship) – struggling for scale

• Trustee who represents the members’ interests. A particularly key role in the for-profit funds as there will frequently be a grey area where the interests of the manager conflict with the interests of members. Unfortunately the Royal Commission exposed clear instances where the trustee appeared to be unclear about the role..
• There are three regulators – APRA for system stability, ASIC for disclosure and conduct, ATO for SMSF. Again the Royal Commission exposed instances where the regulators were left looking at each other as the ball flew through slips.

• Duplication of policies
• Advice that is poor, conflicted, charged and not given
• Superannuation funds that are sub-scale and underperform
• High charging funds
• Under-performing funds
• Life insurance policies with tough definitions
• Life insurance sold to you people who are unlikely to claim
• Performance reporting that is opaque and makes comparison difficult
• Independence of directors in industry funds
• Failure of industry fund mergers
• Superannuation rules that change every two years adding to the complexity and a plethora of grandfathered rules
• Regulators who have missed poor industry practice