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Forward Thinking 2 07 Magazine

  1. 1. global equity shifts gear how China and Germany are driving growth perfect mix the new elements fuelling the boom in financial advice » earn CPD points by reading our articles 2/2007 Macquarie Adviser Services Magazine
  2. 2. She is not the only European shining brightly in New York. The Statue of Liberty was gifted to the Americans by EII is perfectly positioned to exploit these fluctuations through the people of France in 1886. She pays homage to the deep local knowledge and the courage to act swiftly. millions of Europeans who made the US their home and Christian and his team have established an enviable track record helped it become the economic powerhouse it is today. over the years, consistently outperforming relevant indices. Christian Lange, founder of E II’s global property team, is one of them: born in Germany, he was a successful Their recipe for success is deceptively simple: don’t look at investment manager for wealthy Europeans before he benchmarks, find value where others aren’t looking and follow decided to set up in New York 20 years ago. your convictions. EII is now a highly regarded global property boutique manager Macquarie provides access to EII via the EII Global Property – some of the largest institutions in the US put their faith and Fund, which is now available to the Australian market as part money in EII. It’s easy to see why. Global property provides of the Macquarie Professional Series, an exclusive collection a low correlation with other asset classes. It’s further diversified of highly individual managed funds. If you are after long-term across different countries around the world, where property growth and greater diversification in your clients’ portfolios, market peaks and troughs come about at different times; we believe you’ll like EII as much as we do. Macquarie Professional Series Financial advisers call 1800 005 056, Institutional enquiries call 02 8232 7017 EII Global Property Fund ARSN 117 792 113 (“the Fund”) is offered by Macquarie Investment Management Limited ABN 66 002 867 003 (MIML). The Fund is managed by European Investors Inc (E II). Investments in the Fund are not deposits with or other liabilities of Macquarie Bank Limited ABN 46 008 583 542 or any Macquarie Bank Group company and are subject to investment risk, including possible delays in repayment and loss of income or principal invested. None of Macquarie Bank Limited, MIML or any other member company of the Macquarie Bank Group guarantees the performance of the Fund or the repayment of capital from the Fund or any particular rate of return. This information is for advisers only. It is general advice only and has been prepared without taking into account the objectives, financial situation or needs of any particular investor. Before making a decision to invest in the Fund, the investors should read the Fund’s Product Disclosure Statement (PDS) which is available from us, and consider, with or without their financial adviser, whether the investment fits their objectives, financial situation and needs. Applications for units in the Fund can only be made on an application form contained in the current PDS. Past performance is no indication of future performance.
  3. 3. Inside information One simple rule of investing is that starting without Elsewhere in this edition of Forward Thinking we a plan can be like driving without a map – take a closer look at the role of the emerging global a hazardous pastime, particularly for the adventurous. powerhouse economies in China and Germany; Financial planners have built a strong case for we assess the technical impact of Australia’s new professional success based on the fundamental superannuation laws and we introduce a new section premise that failing to plan is planning to fail. called ‘Investment Fundamentals’ – debunking a few myths while explaining how common investment But the questions Forward Thinking has posed in laws or language came to be. this edition go to the heart of the planning profession itself: what is the future destination for financial I trust you enjoy this edition of Forward Thinking. planning and what are the key shifts today shaping the advice industry of tomorrow? The news is good. Our report finds a unique set of forces – some say the perfect mix – that in 2007 deliver a healthy prognosis for financial advice in Neil Roderick this country. Our Cover Story is a starting point for Executive Director discussion, and we welcome your feedback as always. Head of Macquarie Adviser Services Contents Regular features Cover story 28 Smart investing 02 Perfect mix More than one engine driving Bruce Madden uncovers the seven global growth trends that are shaping the future of the financial advice industry: aging 30 Investment fundamentals population, bulging super accounts, Beyond the efficient frontier – how increasing sophistication, the regulators, the risk/return world was discovered technology, and product evolution. 33 The collection The evolution of the Macquarie Professional Series Main feature 34 Wrap up 4 Tech talk What’s administration Super becomes a dead certainty got to do with it? Transitions, transitions... TTR pensions more attractive 36 The hub in the new world? Go with the flow 38 Technical essentials 40 Concord stock story Macquarie Adviser Services Game on Magazine
  4. 4. Read this story to receive CPD points. 2 Simply log on to
  5. 5. perfect mi Financial advice is booming. New superannuation rules, an aging population and strong investment markets are fuelling high-spirited growth and unbounded optimism. Bruce Madden* uncovers a combination of elements – some say the perfect mix – that is stimulating growth and delivering a bright future to financial advice in Australia. 3
  6. 6. cover story Pundits say the financial advice industry may never have it so good. A robust economy, a tranche of new superannuation and retirement income rules to work through and a large proportion of the adult population – the so-called Boomer generation – reaching retirement age, meaning a potential endless stream of new clients. Such is the optimism for the future growth of the advice industry in Australia, the views of the naysayers have struggled to make a dent on the forward progress of an industry intent on cementing its future. Forward Thinking has taken a look at the trends, identifying seven clear shifts to shape the future of financial advice in Australia. Through conversations with industry insiders, the Forward Thinking list should provide food for thought for an industry currently too busy to think about tomorrow. Our interview with Macquarie’s technical guru David Shirlow on page 12 underpins the changing nature of superannuation and how «The opportunity is for the industry to understand these demographic shifts and work to create a new and compelling push to attract and retain fresh talent.» product manufacturers are expected to shift their focus to harness the shifting demographic and retirement income patterns. One brake on future growth may be the supply of fresh blood. Like the rest of the population, the financial advice industry is aging. Some go so far as to say the industry is stagnating, with no net new inflow of fresh talent to replace the retiring generals of yesteryear. A near term challenge confronting the industry is: where will the new planners come from? The opportunity is for the industry to understand these demographic shifts and work to create a new and compelling push to attract and retain fresh talent. If the industry can get that right, then its future – based on the sheer weight of demographic numbers – looks assured. 4
  7. 7. perfect mix Despite the massive pool of accumulated savings and the probable extension of working life beyond 6 for many Australians, the Intergenerational Report predicts the economy will inevitably slow over the next 40 years. The study says the average rate of growth in GDP per person will slow from 2. per cent in the last 40 years to .6 per cent in the next 40 years. As well, the country will face fiscal challenges that could threaten some of the basic assumptions Australians have about what their government should provide for them: the Age Pension, healthcare, education and other support services will increasingly come under pressure as governments inexorably head into deficit. The Intergenerational Report notes that the responsibility for retirement planning will fall more onto individuals. “As people live longer, the way they plan work and retirement, may change. Policy frameworks need to Aging population – provide opportunities for people to plan for their own shift the great demographic driver future,” the report says. But as the advisory profession is part of the same aging trend the question is will there be enough financial planners around to help the rest of the This is old news: Australia is aging. population make the right decisions? Demographers have been forecasting an increasingly The issue of an aging adviser workforce has already aged population for some time but the transition to begun to shape the thinking of large dealer groups a nation of pensioners has been barely noticeable. and small practices alike. The expression ‘succession planning’ has taken on a whole new meaning for That is about to change. financial advice businesses both large and small, with the emphasis on recruiting new talent beyond According to the second government Intergenerational the traditional sources – like life insurance sales for Report released this April, the proportion of Australians example – that have served the industry to date. aged 6 and over is expected to double in the next 40 years to nearly a quarter of the total population. At the Should we solve the ‘war for talent’ conundrum, same time the number of those aged 8 and up will tomorrow’s financial advisers will find themselves triple to .6 per cent of the total population. playing a central role in the lives of clients who are living better for longer, and will thus require smart From a taxpayer’s perspective the numbers are advice and product solutions to help overcome even more sobering: today there are five people the very real prospect that clients may one day of working age for each one aged 6 and over but outlive their retirement savings. by 2047 that proportion will have slumped to 2.4 of working age for everyone 6 and above. There are further lifestyle needs which pose significant challenges by the aging Boomers, who And if 40 years seems far enough away to be think differently about the traditional meaning of irrelevant the Intergenerational Report will cure ‘retirement’. For example, the shift towards planned anyone of that illusion. retirement communities offering five star facilities “The pace of aging of the population is projected to and on-call personal services is a sign of things to quicken after 200, as the baby boomer generation come. And the rise of the part-time employee among starts to reach the age of 6,” the Report says. older Australians is another visible trend, as people scale back or return to the workforce to remain Of course, this is exactly the demographic hole active and help fill the growing shortage gap of the designers of Australia’s retirement savings skilled labour. system hoped to fill with the establishment of the Superannuation Guarantee (SG) scheme in 992. But the SG alone won’t prevent what is likely to be a painful societal adjustment to old age.
  8. 8. cover story In a report, NATSEM researcher, Simon Kelly, found that most baby boomers hoping for a large inheritance will be disappointed as “the richest one-fifth of those aged 6 and over in 2002 owned 63 per cent of all the wealth held by this age cohort”. In other words, only those who don’t need a large inheritance (i.e. the already wealthy) are likely to get one. Kelly also listed several social trends that could limit the intergenerational wealth transfer: medical advances mean the elderly are living longer and thus consuming more of any inheritance; many parents are choosing to spend their assets rather than live frugally so their children can inherit – the so-called ‘ski’ trend (spend your kids’ inheritance); baby boomers’ parents may choose to hand whatever inheritance there is to their grand-children Bulging super accounts and rather than their own children who will themselves shift intergenerational wealth transfer be close to retirement. So if the $600 billion doesn’t end up in the Boomers’ pockets they will be rich on their super anyway, right? Well, not according to an analysis Australia is putting on weight at an alarming of super balances published by the Association of rate. But don’t worry, the trend is healthy. In fact, Superannuation Funds Australia (ASFA) this June. the weight of money flowing into the Australian ASFA found that the average super payout this superannuation system has not only built up year is likely to be around $30,000 for men and impressively in the years since compulsion came $4,000 for women. Over the next -2 years into force, but latest figures from the Australian the average super payout will only increase to an Prudential and Regulatory Authority (APRA) show average $83,000 for men and $93,000 for women, that in the year to June 30, 2006, superannuation according to ASFA. assets grew by almost 20 per cent to $92 billion. At best, ASFA says, over the next two decades This massive pool of money has swollen by an super will be a “useful but modest supplement to even greater amount this year as the twin faucets the Age Pension”. of buoyant markets and the one-off tax-free contribution window pour in their contents. It has As well ASFA also found that the latest government- been predicted that the government’s decision encouraged splurge into super will only marginally to allow individuals to contribute up to $ million increase the number of people with over $ million tax-free to their super before July this year (part of balances in superannuation funds or retirement Peter Costello’s ‘Simpler Super’ reforms) will result in income products from the current estimate of 7,000. $00 billion extra flows into superannuation funds. However the clear opportunity for financial advisers If you add the estimated $600 billion intergenerational is to harness the greater need to grow or manage wealth transfer that is expected to pass into the wealth. The demand for appropriate financial hands of baby boomers over the next 20 years it planning services will not diminish, whichever way seems as though the market for financial advice can the pie is split. only get better. But there are some very important caveats to add to these heady numbers. Firstly, recent research by the National Centre for Social and Economic Modelling (NATSEM) has cast doubt on the extent and distribution of any intergenerational wealth transfer. 6
  9. 9. perfect mix for these generations, whether it be shopping mall kiosks or web-based services. One thing is for certain, the Xs and Ys will have lived, and retired, with the benefit of compulsory superannuation all of their working lives, which is more than you can say for the older population segment. A recent ASFA study highlighted the fact that for most Australians, at least in the medium-term, superannuation will not completely cure their long- term retirement woes. However, as super balances continue to grow, the subject of investment and finance is increasingly entering the vernacular of everyday Australians. For most of them superannuation is now their biggest asset outside the family home. Anecdotal evidence suggests that when super balances hit $0,000 many people start taking a serious interest in how their money is invested. ASFA estimates the average super balance today More sophisticated investors – for all those aged between 2 and 64 is $48,000. shift the age of financial literacy And today Australians have been handed the power to make many important decisions about their super. Almost half of all super funds offer investment choice to members, according to the June 2006 report from APRA, up from only 38 per cent the year before. In terms of sophistication, they don’t come much More tellingly only 48.8 per cent of super money now savvier than our nation’s youth. And while whole sits in default strategies compared to 60.4 per cent forests of newsprint have been sacrificed to report at June 200. the rise of generations X and Y, many in the financial advice industry have so far failed to grasp the impact Clearly, Australians are enjoying the ability to make that these two demographic groups will have. sophisticated investment decisions and with choice of super fund now a reality they have been given even Experts tell us we are broadly dealing with an more flexibility. ambitious, impatient and tech-savvy cohort more interested in immediate gratification than the long- The fact self-managed super funds have grown at term planning and prudent financial management such an extraordinary rate (almost 23 per cent in undertaken by their parents and grandparents. the year to June 2006) shows many individuals are There is also a strong do it yourself streak. Take the confident of taking responsibility for their own savings. global success of the YouTube web portal as proxy Coupled with this, super-driven individual investment for the Y generation; we can see the emergence education is an intensive effort at the macro-level of the cult of DIY instant celebrity. This can be by government and the industry to lift the financial witnessed through politicians such as John Howard knowledge of all Australians. and Kevin Rudd getting on YouTube. Last year the assistant Treasurer, Peter Dutton, We also know that shifting consumer patterns of said the government “is committed to working in younger Australians means they will demand a different partnership with industry to improve the ability of all way of conducting their personal affairs. The internet Australians, from school children to retirees, to make will figure largely in their interactions with professional better decisions in managing their money”. service firms, and their loyalty to a particular service proposition or brand will prove perhaps fickle at best. The Financial Literacy Foundation launched in 200 is the most high-profile of the government’s initiatives in As employees, these younger Australians are this area and it can already claim some success. As a expected to move around a lot, choosing to stay result of its lobbying, financial literacy will be embedded in any one job for shorter periods, but of course in the schools curriculum across Australia in 2008. demanding higher remuneration and benefits. Expect increased pressure from these generations Financial advisers are likely to find tomorrow’s clients to also ‘fast track’ their exposure to more complex a more questioning and knowledgeable bunch than work – the ambitious “I want it now” mentality means ever, and the challenge is that education standards they have precious little time to ‘do their time”. for advisers must keep pace with the sophisticated needs of the emerging savvy investor. Watch for a rise Indeed, whether or not this cohort will even want in minimum entry standards, and increased pressure advice remains to be seen. The challenge for the to promote degree level standards as the benchmark industry is to create appealing points of access price of admission to the industry’s ranks. 7
  10. 10. cover story planners saying ‘Open the books – we want to check what you’re doing.’” Choice’s latest demands for change in the advice industry include that: the price for advice be agreed before any product selection; ASIC should ban some conflicts of interest; investors who buy funds direct should not have to pay administrative expenses that include an advice component; hidden trail commissions must be disclosed separately with consumers able to turn off trails if they are not receiving ongoing advice and get rebates for trails paid when there was no advice. FSRA might have switched on a torch for consumers and government to peer into the far corners of the financial planning industry but in 2007 advisers are operating in the full floodlit glare of public scrutiny. Consumerism and shift the rise of the regulators Those lights will not be dimmed. What does this mean? With an increased compliance burden, the industry will find new and innovative ways to meet their regulatory obligations to allow time to pursue the core function of their role: delivering advice. Even as recently as five years ago the financial Just as the Statement of Advice requirements have advisory business in Australia (with the exception forced a re-think on front end software to help of a few high-profile scandals) had escaped streamline what can be a cumbersome and time much serious attention from regulators and consuming chore, future regulatory standards will see mainstream press. the evolution of new front end software solutions. The Financial Services Reform Act (FSRA) The most successful advice businesses will be those of 2002 marked the end of that era. who can multi-task most efficiently, using clever As formerly free-wheeling financial planners software and time management tools to juggle the struggled with the unaccustomed burdens of combined demands of compliance, administration disclosure and compliance the Australian Securities and client service. It would follow that consumer and Investments Commission (ASIC) moved in for confidence in the industry would rise in line with the a closer look. higher compliance standards. This is further good news for the future of advice in Australia. A few secret-shopping expeditions later and ASIC was ready to expose the conflicts of interest in an industry the consumer lobby (Choice) had notoriously labelled “structurally corrupt”. And the mainstream press happily followed the regulator’s lead – a process that was accelerated even further by the Westpoint collapse. Today the inner workings of the financial planning industry have been laid bare by a deeply suspicious media. Well-known economics journalist Alan Kohler, for example, has turned his railings against the evils of commissions and platforms into a new business (see The Eureka Report). Consumer bodies, too, have become more sophisticated in their accusations against financial advisers. Post the 2003 shadow shopper exercise an outraged Australian Consumers’ Association (now called Choice) could only ask for ASIC to show up “on the doorsteps of many more financial 8
  11. 11. perfect mix In ‘The next generation of Australian wraps’, Forrester says: “The next few years will be marked by consolidation and platform development. The bank-owned platforms are already building the next-generation platforms, which will secure their domination over the next five years and have far-reaching effects. “Development will focus on opportunities arising from industry inefficiencies. As a result, insurers, financial planning software vendors, practice management consultants, and non-bank platform providers will all be forced to change their business models.” In the past, technology providers might have over- promised and under-delivered (or not delivered at all) to advisers but this time the revolution could go further than many might like. The opportunity is to create even greater efficiency in the way advice is done. As firms become ever technology augmenting more streamlined, the business of delivering financial shift many adviser functions advice will surely benefit. It is difficult to contemplate how any business today could function without computer technology but it is impossible to imagine an IT-less financial planning industry. The growth of the investment platform and advisory software systems in Australia over the last decade is testament to the seemingly endless appetite of advisers for ‘IT solutions’. From simple fund reporting tools a decade ago, platforms have evolved into complex beasts capable of multi-tasking at the push of a button. Front-end software, meanwhile, has extended its ambit beyond basic portfolio modelling into CRM and is now pushing ever deeper into adviser back-office processes. After a relatively slow start financial planners are now realising the benefits of an online world, according to a 2006 report from researcher Investment Trends. “As an industry, planners now estimate conducting 34 per cent of their activities via the internet, up from 30 per cent in 200 and they are on track to reach 42 per cent within three years,” the Investment Trends report says. “There was a 0 per cent shift in most activities over the last year...” However, despite all the great leaps forward, financial advisers, when surveyed, have always wanted more from their technology providers. Last December, Forrester Research published a report that suggested advisers will soon get just what they have wanted. 9
  12. 12. cover story Even if you remain skeptical about the claims of peak-oil research and global warming believers their impact on the political, and therefore investment, agenda is undeniable. An article published this February in USA Today quoted Citigroup strategist, Edward Kerschner, as saying from an investor’s point of view it doesn’t matter if greenhouse gases are causing global warming or not. “What does matter is if consumers, regulators, governments and corporations react to the perceived threat,” Kerschner said in the article. Analysts are already trying to pick the winners and losers from the global warming trend and have earmarked companies to look out for in industries such as agriculture, alternative energy, financial services, automotive and technology. As long as capitalism greets each challenge as if it is an opportunity the range of ‘alternative’ investment products will be inexhaustible. product/market evolution shift Anybody up for a North Korea fund? In 2004, the BBC found one English ‘entrepreneur’ ready to talk up the investment benefits of the Stalinist throwback state. Hedge funds; contracts for difference; private equity; “It’s like China in the eighties... The market reforms infrastructure; commodity derivatives; China funds; are very evident,” Barrett said. reverse mortgages... “It’s an exciting time to join the market.” It always is. Five years ago any of the above products would have been treated with bewilderment or downright In an increasingly complex investment environment, hostility by most investors and advisers; now they the need for clear and dispassionate counsel will are almost commonplace. remain a constant. It is a long time since a diversified portfolio consisted of /3 cash, /3 bonds, /3 equities and financial engineers have responded to the desire for new product with ingenuity. While the trend is global, from an Australian point of view the push into ‘alternative’ products has also taken on an international edge as our superannuation assets outgrow local markets. Will we, like the good people of Holland, become net exporters of capital? That trend is already emerging as the weight of domestic capital requires new markets and new market sub-sets to, in effect, absorb the excess flood of money. This has already seen the rise of new and interesting product lines like capital protected structured investments; hybrids; new investments based on renewable energy, environmental concerns and clean energy technology. Structurally, the new product sets also feature innovations like performance-based fees. But as investment markets hit such creative highs the world around them often seems close to a nervous breakdown. War and catastrophe, as always, hog the evening news but the ogre of climate change is giving them a run for their money. 0
  13. 13. perfect mix the new advice paradigm shift As Australians get richer and older (and perhaps wiser) the demand for financial advice is reaching a new peak. In the long term, increased financial literacy and technological advances could reduce the need for advice but not in time for the current generations. In the meantime the supply of advisers is not rising in step with demand. Using the membership figures of the Financial Planning Association (FPA) as a proxy for the industry it is clear adviser numbers are static. According to the 2006 FPA annual report, “the number of practitioner members of the FPA remained almost unchanged at 7,320 on 30 June 2006, compared with 7,289 a year earlier”. So who’s going to provide the advice? One obvious answer is the industry funds that are rapidly developing advice models. REST, for example, has recently instigated a telephone advice system for its members and other funds have adopted similar strategies. As industry funds and other technology-based providers step in to the breach for ‘lower value’ clients, traditional financial planning businesses are staking out their claims in the mass-affluent and high net worth markets. Financial planning is becoming an increasingly stratified business, evolving rapidly along the strong currents of mandated growth and the emerging wealth accumulators in the pre-retiree market. The current political debate about whether to separate out advice from ‘sales recommendations’ is just another reminder that the days of an undifferentiated financial planning industry are numbered.
  14. 14. cover story feedback. What do you think? These are just some of the big picture trends to shape the future face of financial advice. Share your views with other Forward Thinking readers by emailing us at Macquarie technical guru David Shirlow explains why superannuation – no matter how simple – will always attract new debate and require further B ruceMaddenhascommentedonandadvisedthefinancialadviceindustryforover15years. HeistheformereditorofMoneyManagementandlauncheditorofAssetmagazine.Today tinkering at the margins. hisspecialistconsultingfirmBlueChipCommunicationprovidesmediaandPRservices tothefinancialservicesindustryandgovernment,includingthefederalTreasury’sFinancial Federal treasurer Peter Costello might have pitched LiteracyFoundation. his ‘Simpler Super’ regime as the last word on Appendix 1Source:APRAAnnualSuperannuationBulletin2005 superannuation, but for the investment and financial Investmentchoiceandassetallocationofentitieswithmorethanfourmembers,38.2per advice sector the conversations continue unabated. centofferedinvestmentchoicetotheirmembers.Retailfundsofferedthegreatestnumberof investmentchoicestomembers,withanaverageof71optionsperentity.Industryfundshad According to Macquarie Adviser Services’ technical anaverageofnineinvestmentoptionsperfund,publicsectorfundshadanaverageofseven chief, David Shirlow, there is a sense of inevitability investmentchoicesandcorporatefundshadanaverageoffivechoicesperfund.Ofthetotal that Australia’s superannuation rules will require assetsheldbytheentitieswithmorethanfourmembers,60.4percentofassets($329.5billion) further ‘tinkering’ along the way. wereheldinthedefaultinvestmentstrategy.At30June2005,themajorityofdefaultstrategy assetswereheldinequities:32.0percentinAustraliansharesand22.9percentininternational “For example, the super guarantee system is still shares.Afurther14.1percentwereheldinAustralianfixedinterest,10.3percentinotherassets, maturing. The way that dovetails into the aged 7.7percentinproperty,7.2percentincashand5.7percentininternationalfixedinterest. pension will require some ongoing maintenance. 2006investmentchoiceandassetallocationofentitieswithmorethanfourmembers,49.1per We’re getting an increasing portion of people who centofferedinvestmentchoicetotheirmembers.Retailfundsofferedthegreatestnumberof are up for aged care and how that sits in relation to investmentchoicestomembers,withanaverageof88optionsperentity.Industryfundshadan retirement incomes policy will require some thought,” averageof10investmentoptionsperfundandpublicsectorfundsandcorporatefundshadan averageofsevenandsixinvestmentchoicesperfundrespectively.Ofthetotalassetsheldbythe Shirlow says. entitieswithmorethanfourmembers,48.8percentofassets($318.7billion)wereheldinthe But while those are medium to long-term issues he defaultinvestmentstrategy.At30June2006,themajorityofdefaultstrategyassetswereheld inequities:31.7percentinAustraliansharesand24.2percentininternationalshares.Afurther says even Costello’s recent ‘simplification’ will require 11.3percentwereheldinAustralianfixedinterest,11.0percentinotherassets,8.7percentin some more immediate adjustments, particularly property,7.9percentincashand5.3percentininternationalfixedinterest. around death and disability pensions. 2
  15. 15. perfect mix super: a never-ending story “Just to take one example, the idea that if you die “Now that could be because their portfolio is insured and your benefit goes to your adult kids, you’ll pay in some way, or protected from an investment risk. tax. But if you manage to pay it out of the fund Or it could be some kind of mortality risk,” he says. (and you’re already 60) to those kids, the day before “That’s not an ‘across the industry’ thing, that’s more you die, you’re okay,” Shirlow says. each competitor coming up with its own kind of product features to address the specific issue.” “In other words slow death versus fast death produces a different result! We’ll get plenty of But while the focus of the latest super shake-up has tinkering just because we’ve had such a big change, quite naturally been on how it affects current and and things like that will need to be worked through.” imminent retirees, Shirlow says younger savers were also handed incentives in Costello’s package. For product providers too, ‘Simpler Super’ throws up a few conundrums. But were those incentives enough to encourage younger workers to stash more away in super? Shirlow says as a result of the latest changes it is likely people will have more money in super for “Arguably not,” Shirlow says. “We might see more a longer period, including during the retirement incentives in that area in terms of co-contribution income phase. incentives or something along those lines. We might see more compulsion ultimately... depending on “It becomes more important that retirees invest which government we have in future years.” for the long-term which means that typically they’ll be better placed in long-term assets and “In fact there have been ideas like a voluntary opt-out not just wanting to limit themselves to fixed-return type system where employers will also contribute an arrangements,” he says. extra 3 per cent of your salary unless you choose not to have that included. So the default is your own “Having said that, over time I’m sure we’ll see a money goes in.” return to higher interest rates. So there will be an appetite no doubt for various ways of guaranteeing Whatever happens, one of the few future guarantees a certain level of income. I think we’ll see some Australians have about their superannuation creativity around providing a floor, if you like, system is that it will be talked about, if not tinkered for people limiting the downside on peoples’ with, forever. pension accounts.” Capital protection expected According to Shirlow, many product providers are already grappling with how to provide retirees with some form of income or capital protection. 3
  16. 16. MAstech estate planning: super becomes a dead certainty 4
  17. 17. David Shirlow Head of MAstech tech talk The time has come to revisit insurance and estate planning in relation to superannuation. David Shirlow explores features of the new super regime which give it certain estate planning appeal as well as identifying a number of key tax aspects which remain uncertain. Read this story to receive CPD points. Simply log on to Recent developments have made the case for standard death insurance and disability cover via superannuation compelling from a tax perspective in most typical cases. For wealthier clients, or those requiring high levels of insurance, the removal of reasonable benefit limits will have an obvious impact in this regard. Quite aside from insurance, many clients have been re-weighting their wealth from non-superannuation entities to superannuation – for this reason alone it will generally be necessary to review the manner in which their wealth is dealt with on death or disability. And there are numerous recent rule changes which can have a direct influence on the treatment of a client’s death or disability benefits.
  18. 18. MAstech RIP RBLs: insurance via super generally As a general proposition, the appeal of insuring via In this article we will examine each of the changes superannuation for various types of cover has been identified for life cover but not the incapacity reinforced in a number of respects. The table below changes. The key point to note is that the combined outlines some key changes, most of which are effect of all these changes is likely to be significant positive for superannuation. enough for many clients who currently hold these insurances outside of superannuation to rethink these arrangements. Cover type Change Life removal of RBLs benefits tax reduction, especially from age 60 restrictions on to whom (and for how long) pensions may be paid permanent incapacity removal of RBLs benefits tax reduction, especially for non- employed clients and from age 60 broader definition of permanent incapacity, to cater for non-employees temporary incapacity – full deductibility of premiums, including cover income protection beyond first two years Death benefits: how they’re taxed now Lump sum benefits The tax treatment of lump sum death benefits paid from taxed superannuation funds is as follows: Recipient’s status (under tax law) Tax component Rate of tax (plus Medicare) Dependant tax free and 0% taxable component Non-dependant tax free component taxable component – element taxed 16.5% – element untaxed 31.5% There are no limits to this concessional treatment: arrangements funded by tax deductible if, for example, a lump sum death benefit is paid superannuation contributions will typically to a dependant for tax purposes then it will be tax be significantly more tax efficient than non- free regardless of its size. And, as we will show, superannuation arrangements, whether they so far as insured benefits are concerned, are payable to dependants or non-dependants. 6
  19. 19. tech talk To illustrate, Frank is age 4 and on the top marginal and the net insurance required is only $.m. In this tax rate. He has an accumulated superannuation case the pre-tax cost is 87% better than insuring benefit of $00k in Fund A. It has been funded outside of superannuation. entirely from salary sacrifice contributions and the Column C shows that if the death benefit is service period is 20 years. He has a normal retirement to be paid to a tax non-dependant then, if the age of 6. The table below compares insuring for superannuation option is chosen, the amount of a net $.m via salary sacrifice contributions to his insurance will need to be grossed up to cover existing Fund A with insuring for that amount outside the tax payable on the insured amount and the of superannuation (based on Macquarie Futurewise additional tax payable on the accumulation amount. premium rates for a male non-smoking professional). (The latter arises because we are introducing some Column A shows that if the death benefit is to be ‘element untaxed’ into the tax benefit calculations paid to a tax dependant then there will be no tax – see breakout box on following page). A. super B. Non-super C. super to to dependant insurance non-dependant Accumulated super $00k $00k $00k Life insurance $.m $.m $2.023m Effective tax on Nil Nil $23k insurance proceeds Net insurance benefit $.m $.m $.m premium rate per $1k $.3 $.3 $.3 pre-tax cost $689.60 $38.3 $2278.72 (46.5% MtR) Clients with non-dependent and dependent beneficiaries The fund arrangement issues, discussed on the splits between the sub-components of the taxable following page, are worth contemplating in the component (i.e. ‘elements taxed’ and ‘untaxed’). context of nominating which beneficiaries are to receive particular benefits. Unlike non-dependants, Revisiting Frank’s case, if a tax non-dependant is to dependent beneficiaries are unaffected by the ratio of be paid a benefit of a particular amount, it may make ‘element taxed’ to ‘element untaxed’, since they won’t sense for Frank to nominate a benefit which does pay tax on any of the taxable component of a lump not attract any ‘element untaxed’ (i.e. a non-insured sum benefit. So, if different benefits have different benefit) to be paid to the non-dependant if possible. levels of ‘elements taxed’ and ‘elements untaxed’, And if Frank had built up his accumulated benefit different results can arise via different nominations. with some non-concessional contributions the location of the resulting tax-free component would Further, since dependent beneficiaries don’t pay tax ideally be such that it could be directed first and on any of a lump sum benefit, they are also unaffected foremost to the tax non-dependant. by the level of tax-free component they receive. Non- dependants are generally in a very different position. So, if significant benefits are to be paid to non- dependants on death, then it is worth examining Benefits paid on the death of an accumulation- a client’s fund and insurance arrangements. phase member to different beneficiaries from the one fund will typically all carry the same percentage Thought also needs to be given to the after-tax value break-up as between the overall taxable and tax-free of superannuation benefits to be allocated to various component where death occurs in the accumulation dependants and non-dependants, and (as discussed phase. However, such benefits paid from different later) how that sits alongside the allocation of non- funds (and, in some cases, from different accounts superannuation assets amongst these beneficiaries. within a large fund) may each have different tax Naturally, the client needs to be comfortable that the component percentage break-ups as well as different allocations are appropriate overall. 7
  20. 20. MAstech Non-dependent beneficiaries – impact of deceased’s service period For non-dependent recipients of lump sum death actual fund service period). Clearly the client’s age benefits, the ‘element untaxed’ is more highly taxed also affects this equation. on the basis that it represents the insured part of the benefit. That is, it represents that part of the benefit Let’s return to Frank’s case to explore the way his upon which no contributions tax was paid in effect, superannuation arrangements can have an effect because a deduction has been claimed in relation to on the amount of tax paid by non-dependent the insured benefit. beneficiaries in the event of his death. We will now assume that the benefits are definitely going to be As with pre-reform law, current law continues to paid to a non-dependant and that Frank has decided identify the ‘element untaxed’ by working out the to have exactly $2m of cover inside superannuation. ‘future service’ component of the benefit in the manner outlined below, rather than simply identifying Frank’s actual service period for his existing the insurance proceeds. ‘Future service’ is generally superannuation in Fund A is 20 years. This is the the period from death through until the time the client same as his future service period, so if he insures via would have turned 6. Fund A then the taxable component of a death benefit paid from that fund currently would be split 0:0 This means there is often a mismatch between the between ‘element taxed’ and ‘element untaxed’. amount taxed at a higher rate and the amount of The first row in the table below summarises the tax insurance proceeds. This can work for or against a position if he takes this approach. client’s beneficiaries in the event of death, depending on the amount of insurance, accumulated benefits, If instead Frank was to arrange for the $2m cover to age and fund service period. be effected via a second fund (Fund B), in which he had no accumulated benefit and no service period Typically, the greater the actual service period then to speak of, then the tax result on death would be (assuming other factors are constant) the greater the $72.k. The reason for the deterioration in the result is ‘element taxed’ portion of the taxable component, so that the insured benefit is bigger than the accumulated that less tax is payable. This is because the taxable benefit, and the insured benefit is virtually all taxed component is split into elements taxed and untaxed in at 3.% due to the lack of past service. (If, on the proportion to the client’s actual and future service. other hand, the accumulated benefit had been bigger, The ‘element taxed’ is in effect the part of the this fund arrangement would have produced a better taxable component on which contributions tax is result. This is because no ‘element untaxed’ exists for deemed to have been paid (i.e. the part of the benefit the benefit accumulated in Fund A since none of it is accumulated from taxable contributions during the funded from deductible insurance.) Accumulated insured Actual tax payable benefit benefit service period (rounded: nearest $100) scenario 1 $00k $2m 20 years $600k Fund A: insurance and accumulation scenario 2 Fund A: accumulation only $00k $nil 20 years $82.k Fund B: insurance only $nil $2m Virtually nil $630k $72.k Total Now let’s assume that, due to a change of his insurance arrangements in Fund A intact. employment, Frank had insured in Fund A This scenario produces the best result for his (as per scenario ) but just prior to death had non-dependent beneficiaries, as follows: rolled his accumulated benefit to Fund B but left Accumulated insured Actual tax payable benefit benefit service period (rounded: nearest $100) scenario 3 $480k Fund A: insurance only $nil $2m 20 years $82.k Fund B: accumulation only $00k $nil 20 years $62.k Total 8
  21. 21. tech talk Older clients – non-dependent or dependent beneficiaries? As with scenario 2, this provides the advantage For clients aged or more with adult children, that the accumulated benefit contains no one topical issue is the extent to which their ‘element untaxed’ since none of it is funded superannuation may be passed to their children from deductible insurance. However, there is a on a tax-efficient basis. dramatic improvement in the result over scenario There are a number of ways in which an adult child 2 because the ‘element untaxed’ of the insured may receive a lump sum benefit without tax being benefit is reduced as there is a significant actual payable, including where: service period. the child receives a death benefit and is a tax Two principles emerge from this in relation to life dependant; cover effected via superannuation. Essentially, there may be an advantage in: before death a client aged 60 or more withdraws a benefit and then gives (or bequeaths) the providing the accumulated benefit and the amount to the child; or insured benefit from different funds; but the child receives a death benefit entirely having as long a service period as possible comprised of tax-free component. applying to the fund which provides the insured benefit. So far as the first point is concerned, there are various inter-generational trends emerging, such as children (Parallel principles do not appear to apply where living at home for longer, or baby boomer retirees the accumulated and insured benefits come from being more financially equipped than the following different accounts or interests within the same generations, which may lead to an increased advisory fund, because the concept of ‘service period’ focus on whether a client’s adult children qualify as applies to the whole fund.) tax dependants on the basis of the ordinary meaning While these principles are worth being aware of dependency or of inter-dependency. of, their strategic value may be limited from a As for clients withdrawing benefits before death and practical perspective. It may also be limited by giving them to their adult children, this may also be the fact that, in the case of clients insuring for increasingly typical amongst wealthier families. permanent incapacity as well as death, the best fund arrangement for each type of benefit can The gift may even be used as a superannuation often be different. contribution by the children. This might have particular appeal if the gifting occurs when your A key principle for permanent incapacity cover is clients are at a senior age, as their children may well to have as little actual service period applying to have attained their preservation age or be close to it, a benefit, because that will typically optimise the in which case access to superannuation may not be tax-free component. For example, if Frank were such an issue for them. also to have $2m permanent incapacity cover under the same arrangement as his death cover Finally, the impact of recontributions on the ultimate then if, instead of dying, he became permanently level of a client’s tax-free component warrants incapacitated, scenario 2 would produce the best consideration. This is particularly the case given the result of the three scenarios put forward. prospect of clients being able to contribute at the same time as they receive a pension in the years The tax paid on the permanent incapacity benefit from age until 6 (or, if they continue to meet the would be $268.8k, $3.8k, $268.8k under work test, until 7). In this regard it is worth noting scenarios , 2 and 3 respectively. So it can be that there has been no formal change to the ATO’s as well to be aware of the outcomes in the event position with regard to re-contribution strategies of permanent incapacity. We will explore permanent and the non-application of Part IVA ITAA36 in incapacity benefits via superannuation in a typical circumstances. future article. However, where clients do engage in recontribution, it is worth bearing in mind the discussion below about the counter-balancing impact this can have on the extent to which ‘anti-detriment’ benefits can be paid in addition to standard lump sum tax benefits. 9
  22. 22. MAstech Pension benefits The tax treatment of death benefit income streams account will not be taxed, in many cases it will continue paid from taxed superannuation funds is as below. to be tax efficient to arrange for a death benefit to be Given that the fund earnings on the relevant pension paid (at least to some extent) as a pension. Age at client’s death Tax component Rate of tax Either deceased or the tax free and taxable 0% recipient age 60 or older component Both deceased and tax free component tax free the recipient below age 60 taxable component element taxed Marginal tax rate less 15% tax offset element untaxed Marginal tax rate Death benefits: how they will be paid now A key development with regard to pension death Children who do qualify to receive a pension benefits is the constraint imposed from July 2007 The appeal of child account-based pensions (ABPs) on to whom they can be paid. as part of an estate plan will be as strong, and Essentially, pension benefits will only be able probably stronger, than it has been in the past. to be paid to: Generally, the taxable component of child pension a dependant who is not a child of the deceased payments will be assessable at adult marginal tax (i.e. a spouse, an ‘ordinary meaning’ dependant rates less a % rebate (although if the deceased or inter-dependant who is not a child of the parent was age 60 or more the payments will be tax deceased); or free). This means that in 2007/8 even a child pension comprising 00% taxable component will not a child who is: attract any tax unless pension payments exceeded – less than age 8; or $38,684, assuming the pension is the sole source of – aged 8 to 24 inclusive and is financially the child’s income. dependent on the deceased; or And while the pension will need to be discontinued by – aged 8 or more and has a qualifying disability age 2 (unless the child is disabled as defined), the (broadly, this is a disability that is permanent or commuted lump sum will be entirely tax free. likely to be permanent and results in the need So, unlike pre-reform law, there is no obvious for ongoing support and a substantially reduced downside to choosing a pension over a lump sum capacity for communication, learning or mobility). death benefit if after a year or so the beneficiary or their guardian subsequently thinks better of it and Children who don’t qualify to receive a pension decides to commute. While more adult children may qualify as tax Under the minimum (and no maximum) payment dependants as a result of various inter-generational rules for ABPs, the draw-downs can vary to suit trends, adult children over age 2 will generally be needs, including at a level which exhausts the capital prevented from receiving death benefits as pensions by a certain age at a consistent rate. whether or not they are tax dependants. So estate plans which have involved payments of pensions to And if the fund rules enable restrictions to be placed adult non-dependent children need to be reviewed on capital withdrawals and income levels (as is the bearing in mind the issues discussed earlier in case with Macquarie Super Pension Manager and relation to lump sums. SMSFs with suitably drafted deeds), the estate plan can include appropriate protections and controls for child pension beneficiaries. 20
  23. 23. tech talk A common alternative way of providing protections more children of the deceased. In these cases the and controls would be to pay a lump sum to the appeal of having the particular desired trust rules estate, and arrange for a testamentary trust to be may be offset to some degree by the appealing established pursuant to the terms of the client’s tax outcome typically produced if each child has will. This may be useful in circumstances where the a separate superannuation pension. Assessable client wants trust rules which don’t sit comfortably income paid to a minor child from a testamentary within superannuation. trust (or, for that matter, derived from any investment of property paid to a minor child out of a deceased For example, perhaps your client would like the estate) will attract adult marginal tax rates but (unlike trustee to have discretion as to the way in which the typical child pension) will not attract the % income and capital can be shared between two or rebate. So there may be a trade-off. Pension death benefits – the final analysis Super reform will clearly have different appeals for children, the primary focus will be on transferring families at different stages. For clients with younger superannuation benefits in lump sum form in a tax children the new rules on child pensions should efficient manner, perhaps prior to death. generate particular interest. For clients with older Integrating super and non-super wealth on death The abolition of RBLs not only removes the constraints On the other hand, in many cases the abolition of on the amount of tax-efficient insurance which can be RBLs means that existing will provisions (particularly effected via superannuation, it also potentially means those which refer expressly to RBLs) may need to be that a greater portion of wealth will come from super revisited to produce an effective outcome. rather than non-super sources on death. The terms of the will become especially important The importance of integrating the terms of the will with not only in how they allocate superannuation benefits death benefit nominations for benefits in all types of which fall into the estate, if any, but also in how they funds will not diminish. Amongst clients with SMSFs, ensure that, overall, the after tax allocation of the there will be an increasing demand to co-ordinate deceased’s wealth is allocated in the proportions the drafting of the death benefit provisions of the intended. (Equalisation or adjustment clauses in wills SMSF deed with the drafting of the will. The demand can have a valuable role to play in evening up the for sophisticated death benefit nominations is likely amounts paid to different beneficiaries in some cases). to escalate (for example, dealing with allocation of Finally, the art of co-ordinating the superannuation specific assets or providing contingency plans if certain position with the will may involve taking account of beneficiaries don’t survive, etc). the possibility that in some cases (particularly later in Naturally enough, the appeal in directing life, and in circumstances of ill-health) superannuation superannuation benefits first and foremost towards benefits may be withdrawn prior to death and will dependants for tax purposes (and to counter-balance potentially fall directly into a client’s estate upon death. this by directing non-superannuation assets to As a related matter, putting in place an enduring non-dependants) may still be a key component of power of attorney for appropriate family members may integrating the allocation of superannuation death be particularly important to facilitate late withdrawals benefits with the operation of the will. On the one hand, prior to death, to cover the situation where the client integration has in some respects been simplified since loses legal capacity. less attention needs to be given to particular amounts and forms of benefit payable to particular beneficiaries in line with RBL thresholds changes from year to year. 2
  24. 24. MAstech Certain death benefit uncertainties live on Anti-detriment benefits and recontributions age 62 and in good health, and they have two adult children who are in their 30s and wholly financially The basic concept of additional, ‘anti-detriment’ self-supporting. benefits to compensate for the effect of contributions tax on lump sum benefits paid to a deceased’s Jack has $400,000 in super which is presently all spouse or child (whether the child is dependent for tax taxable component, with an eligible service date of purposes or not) has survived superannuation reform. January 989. He intends to commence an ABP (These benefits were formerly provided under section with these funds upon retirement. 279D ITAA36 and are now provided under new section Let’s compare the outcome if, as soon as he retires, 29-48 ITAA97.) We await ATO guidance as to how Jack simply commences an ABP with 00% taxable to calculate the size of these benefits, given that the component with what happens if he cashes the formulae previously used have become redundant due $400k as a lump sum, immediately recontributes that to the introduction of new tax components. and then commences an ABP with 00% tax free It is worth noting that, since recontribution strategies component. The following table provides the results if generally increase the amount of tax-free component Jack were to die soon after the ABP commences and of a death benefit, they also generally decrease the a $400k benefit were to be paid in three typical ways. amount of additional anti-detriment benefit that a An important assumption in this analysis is that Jack’s beneficiary might otherwise qualify for. This needs to fund will be able to pay an anti-detriment benefit, be weighed up where recontribution is pursued with so bear in mind that it may not be relevant to some estate planning in mind. clients’ superannuation arrangements. The anti- To illustrate, take the case of Jack, who will retire from detriment benefit numbers have been estimated using full time employment just prior to his 6th birthday an adaption of a formula the ATO previously accepted in mid August 2007. He is married to Jane who is for calculating these. A. Jane takes B. Jane takes benefit C. Children take benefit benefit as ABp as lump sum as lump sum scenario 1: ABp Anti-detriment benefit? Nil $70,88 $70,88 with 100% taxable component Tax and Medicare Nil Nil $77,647 @ 6.% if applicable Total value of benefit after tax $400,000 $470,88 $392,94 scenario 2: Anti-detriment benefit? Nil Nil Nil Recontribution then ABp with 100% tax free Tax and Medicare Nil Nil Nil component @ 6.% if applicable Total value of benefit after tax $400,000 $400,000 $400,000 You can see that if the death benefit is paid to if the spouse receives it as a pension, who is likely the adult children as a lump sum then scenario 2 to receive the benefit in the event of the spouse’s produces a $7,09 better outcome because, while death? If so, the column C outcomes may be more an anti-detriment benefit is only available under relevant to the analysis than column A. scenario , it does not completely offset the tax payable. However, the net advantage of recontribution In some cases the prospect of withdrawing the benefit may be significantly less than first imagined. just prior to death and gifting the proceeds may also be worthy of consideration. You will also notice that, by contrast, if the death benefit is paid to Jane as a lump sum then scenario CGt liability of fund disposing of assets after produces a $70,88 better outcome. death and other issues So there are a range of factors to consider in assessing Under pre-reform law it was not clear in what different options for clients’ estate plans, including: circumstances, if any, a fund trustee would become liable to pay CGT on disposal, after the death of who is likely to receive the benefit (having regard to a pensioner, of assets which were backing the life expectancies, whether your client has the power pension. The position under reform law is also to decide who will receive the benefit, etc); unclear. This and a range of other interpretational and practical issues relating to death benefits will if the benefit is likely to be paid to the spouse, need to be resolved during the coming months or, whether it is likely to be received as a lump sum maybe, years. then re-contributed (having regard to the spouse’s age, work status, contribution limits, etc); 22
  25. 25. David Barrett Division Director, MAstech tech talk transitions, transitions... TTR pensions more attractive in the new world? As advisers working in the superannuation field, we’ve all just been through the biggest transition since the Superannuation Industry (Supervision) Act 993 and Superannuation Industry (Supervision) Regulations 994 (collectively referred to here as ‘SIS’) were introduced back in 994. This transition has many implications for Transition To Retirement (TTR) pensions. Read this story to receive CPD points. Simply log on to 23