Chapter 2 - The regulations
Structure of the chapter
2.1
This chapter sets out the evidence received by the
Committee. Firstly it identifies the alleged practices targeted by the regulations
and examines evidence about the extent of the claimed abuse that the regulations
attempt to address. Finally the chapter considers how well the regulations
address the problems and the other issues raised during the inquiry.
Practices targeted by the regulations
2.2
The regulations are designed to prevent superannuation
fund members using various strategies to avoid tax, inappropriately access
social security benefits and facilitate estate planning. They also prevent
small funds from providing defined benefits and pensions. The next section outlines
the nature of the targeted strategies in turn, and considers how the regulations
address such practices. It then turns to the issue of small funds providing
defined benefits.
Accumulation
funds - preventing the use of forfeiture arrangements
2.3
Forfeiture arrangements[2] may be used by
members who, on retirement, have large balances in the superannuation fund and
cannot bring the full amount under their reasonable benefit limit (RBL).
Provided the governing rules of the superannuation fund include a forfeiture of
benefits provision, the member takes only a benefit large enough to remain
under the relevant RBL. They forfeit the remaining (excessive[3]) amount of
their benefit and it is distributed amongst the other members of the fund for
their future superannuation benefits. In a self managed superannuation fund
this would usually be a spouse or other associate of the member.[4]
2.4
Items 1 to 3 of Schedule 1 of the regulations are
intended to prevent the use of such forfeiture arrangements for tax avoidance
purposes by accumulation superannuation funds. Existing regulation 5.08
requires minimum benefits to be identified and maintained in a superannuation
fund until they are cashed, rolled over or transferred for a given member's
benefit. Also, minimum benefits cannot be used to pay temporary incapacity
benefits. Therefore, these benefits cannot be forfeited for the benefit of
another member of the fund.
2.5
The regulations aim to prevent forfeiture by amending
subregulation 5.04(2) so that all benefits in an accumulation fund become
minimum benefits and the restrictions outlined in the previous paragraph will
apply to them. Additionally, Schedule 1, item 3 inserts two new subregulations to regulation 5.08 to provide
exceptions to the rules regarding the treatment of minimum benefits.
Accumulation
funds - preventing contributions from being allocated to reserve accounts
2.6
Reserve accounts are common in superannuation funds.
They assist the trustees of accumulation funds in smoothing the risks
associated with the fluctuation of investment returns. By maintaining a
reserve, trustees have a pool of funds available to provide reasonable
crediting rates in years where investment returns are poor or even negative.
Defined benefit funds use reserve accounts as a buffer against the fluctuation
of investment returns. However, rather than smoothing crediting rates they are
used to ensure that the funds have sufficient assets to cover all benefits held
by the fund in the event of a decline in the value of the superannuation funds
investments.
2.7
The strategy targeted by the regulations involves the
trustees of accumulation funds accepting contributions from an employer and
allocating the amount to the reserve account rather than allocating the amount
to a member. This strategy has two effects. Firstly, by contributing to a reserve
account rather than to an individual members account, the employer is able to
claim a tax deduction for the entire amount of the contribution made to the
superannuation fund without being restricted by the aged based deductible
contribution limits.[5]
2.8
Secondly, by allocating the contribution to a reserve
account the members of the superannuation fund have not received a
superannuation contribution from their employer. The result is that the members
do not have any surchargeable contributions and there is no superannuation
surcharge liability.
2.9
New Division 7.2 in the regulations requires
contributions to be allocated to members of accumulation funds. The Division is
intended to prevent the practice of allocating contributions directly to
reserve accounts or deferring the allocation of a contribution to a member's
account to avoid the superannuation surcharge. It is also intended to ensure
that all accumulation funds have efficient and timely administration procedures
in place for dealing with contribution money.[6]
Defined benefit funds and
pensions - preventing pension strategies and improving prudential requirements
2.10
As pensions are payments that occur over a future,
sometimes very long, timeframe the value of a pension is calculated using
actuarial calculations. These calculations make assumptions on future
investment returns, indexation of the payments, life expectancy of the member
and reversionary beneficiaries (if applicable) and expectations of the
underlying assets being sufficient to meet future payments. By manipulating
these assumptions, a member can have a pension whose value for RBL purposes[7] is below the
pension RBL but supported by, in some cases several million dollars in assets.
This reduces the tax the member pays on the superannuation benefit as it will
not have an excessive component and it also receives the full rebate available
to superannuation pensions under section 27H of the Income Tax Assessment Act 1936. It may, subject to the pension
being a complying pension and satisfying the income and assets tests for the
age pension, allow the member access to the age pension and its associated
concessions.
2.11
This strategy can also be used as a method of
transferring assets to the members children (estate planning), provided they
are a member of the fund, without being subject to the capital gains tax
provisions. When the member dies, depending on the provisions in the
superannuation funds governing rules, the trustees may be able to credit the
unused portion of the pension into the accounts of other members of the fund,
usually the spouse or children in the fund. This avoids realising assets for
capital gains tax purposes as would occur with a distribution from the members
estate.
2.12
There is a separate, more fundamental issue that the regulations
seek to address. That is, whether small funds are suitable vehicles to provide a
reasonable amount of guaranteed income for an indefinite but guaranteed period.
In relation to small superannuation funds, there are three key concerns about
the ability of these funds to guarantee such pension entitlements.[8] The first is
the lack of an employer sponsor or other intermediary who is obligated to
contribute extra money if the fund experiences a period of poor investment
returns to the extent that it may jeopardise member entitlements. The second is
the lack of risk pooling and the third relates to the management of investment and
liquidity risks.
2.13
The lack of risk pooling in these small funds is
especially pertinent in relation to mortality risk. A pension for an individual
may be paid for a day or far beyond their life expectancy. Consequently there may
be too much money in the fund or not enough. In larger funds with pooled
arrangements, there is greater certainty that deaths will occur in a more predictable
manner which enables a closer estimation of
future benefit liabilities. Additionally, the unused entitlements of
shorter-lived members can be used to ensure the benefits of longer-lived
members.
2.14
To date, small funds have been able to offer defined
benefit pensions (lifetime and life expectancy pensions) in the absence of risk
pooling by determining the rate of the pension based on an actuarial
calculation to ensure the underlying funds are at least sufficient to meet the
income stream offered. An actuary is required to annually certify to this
effect. In the event that the funds become insufficient, the pension must be
recalculated.
2.15
One way that small funds address the risks involved is
to maintain high investment reserves, which may remain after the death of the
member. While this can ensure that the fund has a buffer against periods of
lower returns, it raises the issue of whether it is appropriate for the
concessional superannuation environment to be used to build up funds that will
not directly be used to provide income in retirement.
2.16
Additionally, unlike in large defined benefit schemes
where outstanding funds remain in the pool to balance risk, reserves in small
superannuation funds are used for the benefit of other members who are in many
cases related to the deceased member. In effect, members of self managed
superannuation funds are able to enjoy the benefits of a pension from the fund
while they are alive and to pass the remaining assets to their family after their
death. This option is not available in other funds. Therefore, it is claimed
that from a competitive neutrality standpoint the regulations provide for a
more level playing field between funds.
2.17
Item 10 inserts new Divisions 9.2A and 9.2B into Part 9
of the Principal Regulations, which contain prudential requirements for the
Financial Management of Funds. Division 9.2A will require that all new defined
benefit funds, or defined benefit funds that admit new defined benefit members,
are to be of a sufficient size to pool member benefits to satisfactorily manage
mortality and investment risks. The division will also prevent small defined
benefit funds from being established, or from accepting new members.
2.18
A new defined benefit fund must now have at least 50
defined benefit members. Likewise, an existing defined benefit fund can only
admit a new defined benefit member, or convert an existing member to a defined
benefit member, if it will have at least 50 defined benefit members after
accepting or converting the defined benefit member.
2.19
Similarly, Division 9.2B is intended to restrict the
provision of defined benefit pensions to funds that supposedly are of
sufficient size to satisfactorily manage the investment and mortality risks of
providing those pensions. It provides that a regulated superannuation fund that
has less than 50 members must not provide a defined benefit pension. The
Division will apply to new superannuation funds established after the
commencement of the regulations, where the governing rules of the fund provide
for the payment of a defined benefit pension, and to existing superannuation
funds, where the governing rules are amended after the commencement of the
division to provide for the payment of a defined benefit pension. It will not
apply to certain specified public sector superannuation schemes.
2.20
These so-called '50 member rules' effectively prevent
small funds such as Self Managed Superannuation Funds (SMSFs),[9] small APRA
funds and small corporate funds from offering defined benefit pensions to their
members.
2.21
If the governing rules of an existing superannuation
fund set out the terms and conditions of the defined benefit pension prior to
the commencement of the regulations, the new division will not apply. However,
if the governing rules are amended to specify a term or condition of the
pension, prior to the commencement of that pension, then the new division will
apply.
Transitional
arrangements
2.22
The Committee notes that on 25 June 2004, the effect of the regulations was modified
by the Superannuation Industry (Supervision) Amendment Regulations 2004
(No. 8), Statutory Rules 2004 No. 155. These new regulations do not alter
the substance of Statutory Rules No. 84, but they provide a transitional period
to ensure that small superannuation funds are able to continue to provide
defined benefit pensions to those who were members on 11 May 2004 and who
retire or attain age 65 before 1 July 2005, if the first pension payment is
made within 12 months after the day when the person became entitled to the
pension.
2.23
Additionally, the Government will conduct a review,
headed by the Treasury, and in consultation with the Australian Government
Actuary, the Australian Taxation Office, industry and other stakeholders, into
the safety and tax avoidance risks of defined benefit pensions. The review will
examine the continued demand for complying defined benefit pensions and whether
such a product can feasibly be provided by a small fund in a manner that is not
detrimental to the integrity of the retirement income and tax system. It will
be finalised by April 2005.[10]
2.24
Submissions were generally dissatisfied with the regulations,
with only two submitters supporting the changes. Of those who were opposed,
several recommended that the regulations be disallowed and the remainder sought
either amendments to the regulations, or changes to the underlying superannuation
industry supervisory regime which would enable the regulations to be withdrawn.
2.25
Submissions and evidence to the inquiry raised two
issues. First, the extent to which the problems are in fact widespread or serious,
and their impact on taxation revenue. Second, the extent to which the
regulations as drafted address those problems appropriately. The Committee will
consider these issues in more detail below.
Extent of abuse in the superannuation system
2.26
Submissions from industry groups were unable to
quantify the extent to which the above strategies are being used and most reported
that they had no knowledge of such strategies.[11] They
suggested that, if they are occurring, they are by no means widespread throughout
the small funds industry.[12]
2.27
The Institute of Actuaries of Australia pointed out
that what may appear at the DIY fund level to be abuse of the system is, in
reality, an attempt to comply with conflicting elements of different pieces of
legislation.[13]
Mr deLancey Worthington, Managing Director of Actuarial Solutions, illustrated
the point with the following example in relation to defined benefit pensions:
There is the SIS legislation, which is worried about the
security of members benefits, and, as far as the SIS legislation is concerned,
the more reserves the better. Then there is the tax legislation. It is worried
about the fair allocation of tax concessions and the collection of tax revenue.
It requires the actuary to calculate the liability on a best-estimate
basis. You can think of that as being roughly a 50 per cent probability level.
It is the amount that on average is required to meet the pension payments.
However, the SIS legislation, which is worried about the security of members
benefits, says there has to be a minimum of a 70 per cent probability that the
assets will be sufficient. So the difference between the 70 per cent level and
the 50 per cent level results in reserves, and the tax legislation says those
reserves are taxable at 15 per cent on their investment earnings. This
situation does not arise for allocated pensions and growth pensions. It arises
only for defined benefit pensions.[14]
2.28
A number of witnesses attempted to provide the
Committee with estimates about potential
abuses in the system by examining their pension portfolios.[15] They
concluded that only relatively few pensions (between 2 per cent and 5 per cent)
with a pension purchase price in excess of $1 million, appear potentially to be
being used for the purposes of such tax avoidance or estate planning. While
acknowledging that opportunities for abuse do exist, the Committee was told
that very few people take advantage of this.[16]
2.29
Further, Mr Worthington
argued that lifetime pensions provide higher taxation revenue than do allocated
pensions and growth pensions.[17] In part this
is attributable to their longer term than other pension types and also to the
fact that their larger reserves are capable of generating greater earnings
growth as they accumulate over time.
2.30
However, by contrast, officers from the Treasury and
Australian Taxation Office told the Committee that the arrangements targeted by
the regulations were increasingly the subject of promotion in the
superannuation and financial planning industry.[18] They said
that, in the last few years, the benefits that could be obtained were regularly
included in the conference programs of lawyers, financial planners and
accountants. For example, the following quotations are taken from papers
presented to the Committee by the Treasury. In relation to defined benefit
pensions:
... the annual value of the life time or life expectancy pension
can be made to be a moveable feast, depending on the design of the pension.[19]
And in relation to vesting
entitlements and benefit assignments:
The use of superannuation funds which provide non-vested
entitlements, enabling reallocation of wealth between family members on an
intergenerational basis, is a well established concept at the small end of the
market. It operates not just as a method of reducing exposure to penal RBL
excess benefits tax. It also has the capacity to deliver enduring benefits to
families as wealth creation vehicles which are subject to concessional rates of
tax for lengthy periods.[20]
Additionally:
Finding yourself with an RBL problems [sic] at the end of the
accumulation phase of a well performing Self-Managed Fund is careless, because
there are planning tools available to permit a fund member to limit the extent
to which they find themselves with benefits which are in excess of the
reasonable benefit limits.
Strategies include the reserving, or setting aside, of
investment returns earned by the fund, and the non-vesting of certain kinds of
superannuation benefit standing to the credit of the accumulation account of
the member of the fund.[21]
2.31
Treasury's aim is to 'nip in the bud' any growth in
this area:
Clearly the arrangement was likely to become much more popular with
higher wealth individuals. ... The government has acted early to stop the spread
of an arrangement that was promoted to provide benefits beyond that which the
ordinary person could consider reasonable.[22]
2.32
As regards the impact that the arrangements would have
on taxation revenue, Mr Trevor Thomas, General Manager, Superannuation,
Retirement and Savings Division, Department of the Treasury, told the Committee
that the Government has acted before the proliferation of the arrangements
would have given rise to significant revenue costs. This is due to the fact
that most small superannuation funds are currently in the accumulation stage
rather than the benefit payment phase where the cost to revenue could be
expected to be considerable if the arrangements were allowed to continue. The
Government was concerned that the promotion of the strategies, in conjunction
with the increase in the number of retirees and with larger account balances,
would over time create a significant risk to revenue.[23]
2.33
As the Australian Taxation Office data does not
currently allow separate identification of the amount of tax collected from
excess benefits, no quantification of the cost to revenue is available. Additionally,
in relation to the loss of revenue resulting from the practice of RBL
compression, ATO data would only reflect the post arrangement circumstances and
in the absence of account balance information,
the ATO has no way of establishing how much taxation revenue is foregone as a
consequence.
2.34
The Department of the Treasury provided the Committee
with comparative scenarios between allocated, market linked and lifetime
pensions. The data clearly showed that the income taken from a lifetime pension
can be considerably less than the minimum required to be taken under each of
the allocated and market linked products.[24] Because of
the low pension payment, over time this results in a significant build-up in
the fund in nominal terms which is not apparent with the other two pensions. Additionally,
the lower income taken can allow the recipient access to the age pension and
its attendant concessions.
2.35
In each case, the balance remaining in a small fund at
death is available for payment to dependants tax free or to the estate. How the
estate distributes the death benefits will determine the tax outcomes. The
larger the amount remaining in the fund at older ages, the greater the
likelihood that a significant amount will remain on death. If beneficiaries are
also members of the fund, there is the possibility that monies will be
transferred to their accounts and remain in the accumulation phase attracting
concessional tax treatment for a further 30 years or more.
2.36
According to the Australian Government Actuary, about
75-80 per cent of the initial investment for small funds paying defined
lifetime pensions is expected in real terms to be applied to retirement income.[25] That is, the
expected residual value for these products is about 3 to 5 times that for the
other products. Almost 25 per cent of the initial investment is expected to
remain in the fund on death.
Committee comment
2.37
The Department of the Treasury and the Australian
Taxation Office were asked to provide both an estimate of the number of
individuals who were exploiting the defined benefit pension rules to achieve
estate planning ends and the cost to revenue of this activity. While the
agencies gave a general warning of the problem, they were unable to provide any
figures in response to this request.
2.38
The Committee notes the difficulties inherent in
producing quantitative data in relation to alleged abuses of the system.
Consultation
2.39
Several witnesses were concerned at the lack of government
consultation with the industry prior to the announcement on budget night of the
changes in the regulations. Mr McDougall, Chief Executive Officer, SISFA,
stated that contrary to past practice, when industry consultation had been very
good, the measures were announced in the budget without any prior discussion.[26] Mr Tony
Coles, Manager, Superannuation, Retirement and Savings Division, Department of
the Treasury told the Committee that:
It has long been government practice that you do not consult on
integrity measures. There is a perceived integrity concern in relation to these
arrangements, and so you address the law clearly and decisively.[27]
Extent to which the regulations address the issues
2.40
The Investment and Financial Services Association Ltd
(IFSA) told the Committee that it is the close relationship between members and
trustees of certain small superannuation funds that may enable the targeted strategies
to be used.[28]
As these can only work where dealings within the fund are not at arm's length,
to the extent that such behaviour is occurring, the amendments will
particularly impact on self managed superannuation funds.
2.41
The industry submissions were supportive of measures to
address the use of contrived arrangements to avoid tax, but they argued that
the regulations are not appropriately targeted to achieve their stated aim. They
suggested that some of the regulations will target large as well as small
funds, and additionally, in many places they are poorly drafted and ambiguous.[29]
2.42
Many believe that a blanket ban on defined benefits
provided from small funds is inappropriate. For example, Mr Davison,
Superannuation Policy Adviser, CPA Australia, said:
... to address the system would have made more sense than to
disrupt the retirement plans of many people approaching retirement who had
quite often funded for many years towards using a particular structure in their
self-managed fund to move into retirement. To be fair, the new growth pensions
and market-linked income streams will provide people access to the pension RBL
and to social security, so those options are available in the future. But we
believe there is clearly a need for defined benefit type pensions within your
self-managed funds-one, the more term-certain type products and, two, products
for those who are after a smoother type of income stream throughout the life of
their retirement. If we actually address the system instead of putting on a
blanket ban, we should be able to continue to operate those sorts of structures
without detrimentally affecting the system as a whole.[30]
2.43
The Committee was told that those who wish to abuse the
system will continue to find ways to do so despite the regulations.[31] Furthermore,
the regulations will have an adverse impact on many bona fide arrangements,
such as:
-
some funds will incur higher compliance and
other costs;
-
members will have less flexibility in taking
their retirement benefits; and
-
some employers are likely to reduce their
support for superannuation which will result in lower retirement benefits for
employees.
2.44
The Institute
of Actuaries of Australia
suggested that the regulations do not address the root causes of the problem,
but they impose limitations on some types of funds, whilst allowing others to
be restructured or redesigned.[32]
2.45
The Committee will consider these arguments and other
issues raised in relation to each of the practices that the regulations seek to
address below.
Forfeiture
arrangements
2.46
As regards the regulations that prevent people from
forfeiting their benefits, witnesses and submissions were concerned that other legitimate
arrangements would be affected. In particular, witnesses commented on the
potential impact of the regulations on employee retention schemes.
Vesting
scales
2.47
Superannuation is said to vest in a member when the
member becomes legally entitled to it.[33] Some employer
sponsored superannuation funds have progressive vesting scales to encourage
employees to stay with the organisation. In such a fund a member is entitled
only to a proportion of the employers contributions (other than mandatory
contributions) in the early years of employment, and entitled to all employer
contributions only after a set period (eg five or ten years).
2.48
Witnesses thought that the requirement that
contributions are vested in a member will retrospectively affect legitimate
arrangements that were agreed with a member on joining a fund several years
beforehand.[34]
Although regulation 5.08 sets out exemptions to the rules regarding the
treatment of minimum benefits, witnesses were concerned that these were
unclear.[35] Mr
Ward, Institute of Actuaries of Australia stated that:
... in regard to vesting, the regulations use very strange words.
The new regulations say that minimum benefits are all of the members
benefits. I really do not know what that means. Is it all the benefits that
can be provided if the member were to resign today or is it his death benefit?
I do not know.[36]
2.49
He also suggested that there would be few cases where
the exemptions contained in the regulations would apply:[37]
The exemption applies when there is a written agreement between
the employer and the employee that sets out particular vesting rules. In our
experience it is extraordinarily rare for that to occur. The vesting rules are
normally set out in the funds governing rules, set out in the member booklet
and in the product disclosure statement. If anything, there is an agreement
between the member and the trustee; the employer is not really involved in that
agreement.
2.50
However, the IFSA states that it is clear that
on-market, arm's length arrangements are not the target of these measures, and
the regulations and explanatory note make a clear distinction between SMSF
practices and legitimate vesting and reserving
practices in arm's length superannuation funds.[38] It notes that
APRA's modification powers under section 328 of the Superannuation Industry (Supervision)
Act can provide relief where arrangements meet the spirit but not the letter of
regulation 5.08(2).
Response from the Treasury
2.51
Mr Tony
Coles, Manager, Superannuation, Retirement
and Savings Division, Department of the Treasury told the Committee that there
is a great diversity in the market and it appears that the exemptions set out
in the regulations have not captured all the circumstances where there might be
bona fide employment vesting arrangements in place.[39] However, the
regulator has the power to issue modification orders on an individual or a
class basis to deal with these arrangements. APRA is considering issuing a
modification declaration to address the circumstances where vesting
arrangements are set out in one or more constituent documents other than those specified
in the regulations.
Allocating
contributions to reserve accounts
2.52
The regulations require that contributions are
allocated to members of accumulation funds. Two issues were raised in evidence:
it will create difficulties where employers have been meeting fund expenses;
and it will not prevent surcharge avoidance as there is no specification that
contributions must be allocated to the member for whom the employer is claiming
a deduction. These issues are considered further.
2.53
According to the Institute of Actuaries of Australia
(IAA), many employers have been willing to meet some or all of the expenses of
running a superannuation fund for employees, rather than have these expenses
withdrawn from member accounts.[40] In its experience
larger funds already have been notionally allocating such contributions amongst
members for surcharge reporting purposes. It considers that if other funds are
not following this practice, then the problem lies with the ATO audit process
and/or a lack of clear explanation of these requirements to trustees.
2.54
The IAA says that the regulations will create
considerable initial and ongoing administrative costs for many funds as they
change their practices to comply. Further costs will be incurred to amend trust
deeds and Product Disclosure Statements and provide explanations to members.
The Institute states that some employers will be required to breach agreements
with employees specifying that expenses will not be deducted from member
accounts.
2.55
Accordingly, the effect of the regulations will be that
if employers are prepared to continue meeting expenses (including the cost
increases from the regulations), then members will see higher contributions
going into their accounts with higher expenses coming out. At best, the member
will be no better off. However, if employers are no longer prepared to meet
expenses in this way and hence reduce their overall level of contributions,
members will receive lower benefits.
2.56
The IAA suggests that the regulations should be amended
so that any contribution that is used to pay an expense or insurance premium
within 12 months does not need to be allocated to members.
2.57
As regards Division 7.2 of the regulations which
requires contributions to be allocated to members, the CPA Australia was
concerned that there will continue to be scope for avoiding the superannuation
surcharge because the provisions do not specify that contributions are to be
allocated to the person they are meant for:
An example in the regulations where there is still a problem
with what is being suggested is to do with surcharge avoidance-having
contributions allocated within 28 days of the contributions going into the fund
and having them vest 100 per cent in the person concerned. The problem with
that is that it does not actually say that the contributions have to be
allocated to the person they are meant for. I can still allocate them to the
spouse or whoever it is I want to allocate them to and avoid the surcharge in
that way. All it has done is change when I am allocating it. It is not changing
who I am allocating it to and it is not keeping those contributions in the
members hands that they were actually being made for. The easy or better
solution to that would have been to change some of the tax rules to deny the
deductibility if the contributions are not given to the right person. So even
just in terms of that simple change, what is in the regulations is not enough
to get us over the hurdle of solving the surcharge issue.[41]
Response
from the Treasury and the Australian Taxation Office
2.58
Officers from the Treasury and the Australian Taxation
Office (ATO) told the Committee that the person to whom the contribution is
allocated is the person for whom a tax deduction must be claimed.[42] Mr Mathew
Hanscombe, Director, Government Initiatives, said that the ATO has already made
it clear in public statements that contributions that are not allocated to
members within their employees age base limits are not deductible. There are
clear statements to this effect on the record.[43]
Small
defined benefit funds and pensions
2.59
Generally witnesses and submissions were most concerned
about the impact that the regulations would have in preventing small
superannuation funds from offering defined benefit pensions.
2.60
The Committee understands that the regulations are
primarily targeted at very wealthy people who are using defined benefit
pensions from small funds. For example, Mr Bill Stanhope, Senior Policy
Manager, Investment and Financial Services Association Ltd (IFSA), said that it
is an issue for Australians who have more than the pension RBL, and are by
definition, already millionaires in superannuation.[44] Mr Bloore
told the Committee that it is larger asset holders who use defined benefit
pensions more than people who retire with $300,000 to $400,000 in their
superannuation fund.[45]
2.61
However, not all witnesses held this viewpoint. For
example Mr Watson, Director PricewaterhouseCoopers told the Committee that 93
per cent of people with a defined benefit pension that the company certifies,
have assets of less than $500,000:[46]
We believe that the overwhelming majority of mums and dads
legitimately use their DIY funds to provide an
income stream in retirement, and in some cases, an income for their spouse
and/or children on their death.[47]
2.62
A distinction between small corporate funds and self
managed funds is that any reserves in an SMSF are not available to a widespread
membership, and in a single member fund, they pass either to the individual or
to their estate.[48]
The SMSF fund member / trustee is still able to retain effective control of the
assets in reserves.
2.63
Mr Worthington
suggested that the reserves required to pay a defined benefit pension on
average comprise about 20 per cent of the assets of the fund.[49] He told the
Committee that the tax on the investment earnings of the assets contributes to
the tax system whereas an allocated or growth pension is fully tax exempt. It
is only the income tax on the actual pension payment that makes any
contribution to the tax system. In this way, Mr Worthington argued, allocated
and growth pensions are a drain on the tax system, but defined benefit pensions
with a purchase price of less than $1 million contribute to the economy through
taxation.
2.64
According to Mr Graeme
McDougall, Chief Executive Officer, Small Independent
Superannuation Funds Ltd (SISFA), the regulations will significantly reduce the
number of income stream options available to small superannuation funds in
terms of their ability to provide retirement streams themselves without
purchasing a retail product outside of the fund.[50] He told the
Committee that the market linked pension that will be available from 20
September 2004 is no replacement for the fixed term or life expectancy pensions
that were previously available to all superannuation funds.
2.65
To force people to go outside of their small
superannuation fund to purchase a retail product will be anathema for some:
A number of clients have expressed the concern that their
superannuation pensions (apart from allocated pensions) will now be forced to be
provided by institutions only. Generally, our clients have established their
DIY funds with the view that they have a say in the assets that they purchase,
when and how they are purchased and how those assets are used to provide income
streams, for them in their retirement, assets to support their spouse in their
demise and the residual amount to pass to their children. These changes take
away the very things that give people the comfort to use superannuation as an
entity. DIY funds are established by clients predominantly because they wish to
be involved in the provision of their own future, by selecting the assets they
wish to have and how and when it is paid to them and their estates.[51]
2.66
Witnesses were concerned that members of small funds
would be forced to liquidate fund assets to purchase a defined benefit retail
product. This would incur capital gains tax as well as fees and charges to be
paid to the income stream provider.[52] These costs
would be in addition to the self-managed fund's own operational costs and would
reduce the income available to the retiree.
2.67
In addition to the increased costs, there may be
difficulties for the fund trustees in purchasing a retail product that matches
the benefit design of the superannuation fund. According to Mr Heffron,
Institute of Chartered Accountants in Australia, there are only about four providers
of these types of product in Australia:
So there is not much competition in the marketplace in any case
at the moment, which is one of the reasons-there are several other reasons-why
they look relatively expensive compared to taking your DB lifetime pension from
your own fund.[53]
2.68
In some cases the small superannuation fund's assets may
be in the form of a business real property investment which other members of
the fund are operating.[54]
A lot of these self-managed funds are structured around a block
type of asset, like a property that a business is using, and it is generating a
good income. It is generating an income a lot higher than they could get if
they went out and bought some fixed interest securities. But they will be
forced to sell that asset, because it is so blocky, when someone retires and it
will have consequences not only for the person who is retiring but also for the
remaining members. They are losing that asset and are not able to use it within
the fund, and also there will be the capital gains tax on the asset at the time
it is sold.[55]
2.69
There is also the issue that people do not wish to relinquish
leftover funds to a retail provider if they die early:
Talking to people about taking lifetime, life expectancy
pensions, they are not concerned about additional tax costs if they have tax to
pay within their small funds and things of that nature. If they die and there
is money left in the fund, they are happy if that money gets allocated to other
members in the fund. They are happy that there is surcharge on that and they
are happy that that is creating RBL issues for the other people within the
fund. They just do not want to see their pool of money potentially being lost
within the life companies. Nobody that they know is going to benefit. If anyone
is going to benefit, it is the life companies at the end of the day.[56]
2.70
However, Mr Stanhope, Senior Policy Manager, Investment
and Financial Services Association (IFSA) argued that the regulations create a
level playing field so that, with the introduction of the complying growth
pension (term allocated pension) retirees can access largely the same assets
from an allocated pension fund or from a self-managed superannuation fund:[57]
The real need that retirees seem to have to control their assets
in a self-managed fund, to get access to growth assets, can be met just as much
inside a self-managed fund as it can in an on-market fund through a combination
of allocated pension and term allocated pension to build up the right kind of
tax, social security and annual income profile that retirees want.[58]
2.71
The IFSA considers that the recognition of market
linked income streams will provide a solution for many retirees whose total
superannuation assets lie somewhere between the social security assets test
threshold and the pension RBL.[59] This solution
could be effected through an SMSF, a Small APRA Fund or a retail fund.
Consequently, the IFSA does not believe this group will be unduly affected by
the regulations preventing small funds from offering a defined benefit income
stream.
2.72
The IFSA and the Association of Superannuation Funds (ASFA)
both support the change, although the ASFA commented in its submission that
outcomes similar to those expected by introducing the regulations may have been
achievable through other, less disruptive measures.[60]
Response from the Treasury
2.73
Mr Tony Coles, Manager, Superannuation, Retirement and
Savings Division said:
One of the major criticisms of these measures was that we were
forcing people into the arms of the life companies. One of the issues was that
these funds should be able to provide their own pension within the fund. We are
allowing the small funds to continue to provide their own pension within the fund.
So there will not be, supposedly, the impact of excessive fees or charges
imposed by the life companies; they are just not there, because it is provided
within the fund.[61]
Committee
response
2.74
The Committee notes that small superannuation funds are
still able to provide complying allocated pensions, and from 20 September 2004,
a complying market linked pension. Therefore they are not left with no pension
option. However, if retirees desire the security of a lifetime pension, their
only option under these regulations is to purchase one from a retail provider.
2.75
Additionally, the Committee notes the evidence from the
IFSA that term allocated pensions, complying fixed term income streams and
allocated pensions all pass a remaining superannuation balance to an estate on
early death. Both allocated pensions and term allocated pensions can be offered
through an SMSF or a Small APRA Fund.[62]
2.76
In what follows the Committee discusses the major
issues raised in evidence concerning the provision of defined benefits by small
funds:
-
the transitional arrangements;
-
social security assets test;
-
reasonable benefit limits; and
Risk pooling
2.77
The IFSA claimed that the underlying rationale for the
50 member rule in the regulations is sound:
... defined benefit arrangements are based on the principle of
pooled risk, and below a minimum pool size there would be no real risk pooling.[63]
2.78
However, other witnesses rejected this argument about
risk pooling. They suggested that a defined benefit fund can operate
effectively irrespective of the number of members.[64] The Committee
was told that all funds are subject to investment risk and this can generally
be controlled by an appropriate investment strategy. The Small Independent
Superannuation Funds Association Ltd (SISFA) disputed the idea that funds with
fewer than 50 members would not be financially viable in terms of their ability
to pay defined benefit pensions.[65]
2.79
Several witnesses used examples of funds comprising
differing proportions of defined benefit and accumulation style members to
support their argument that the number of 50 members is an arbitrary amount and
does not necessarily make a lot of sense.[66] For example, Mr
Lorimer, Director and Chair, Small
Independent Superannuation Funds Association Ltd (SISFA) told the Committee:
As far as defined benefit pensions are concerned, the
requirement under the regulations is simply for any fund that pays a defined
benefit pension to have 50 members-not 50 defined benefit pension members but
rather 50 members. ... conceivably you can have the situation of a fund with 50
members, only one of whom is in receipt of a defined benefit pension and the
other 49 are accumulation style members. It seems absurd to us that that size
of fund is in a better position to pay a defined benefit pension than a
single-member fund. It is ridiculous.[67]
2.80
Furthermore witnesses were concerned that the regulations
are unclear and poorly drafted. For example, Mr
Ward, Institute
of Actuaries of Australia,
said that:
One of the first things that struck me when I read the new
regulations was: what on earth do these regulations mean? They use terms that
I-a person who has been involved in the industry for 30 years-found very
confusing and difficult to interpret. There are already two different
definitions of a defined benefit fund in the regulations, depending on what
purpose we are dealing with. There are effectively different definitions for a
defined benefit member. And now we have a new set of regulations which imposes
in effect a limit of 50 defined benefit members for any fund that wants to
provide defined benefits, be they lump sums or pensions. We now have another
regulation which imposes a 50-member limit-not 50 defined benefit members but
50 members-which restricts funds with less than 50 members from providing
defined benefit pensions. So I am totally confused. I do not know whether a
defined benefit pensioner is actually a defined benefit member under the
definitions in these regulations. I am even concerned that an accumulation
style member who has insurance cover is actually classified as a defined
benefit member.[68]
2.81
Some witnesses also took issue with the idea that the
non arm's length relationship between trustees and members in a self-managed
fund was a factor in these funds' ability to provide legitimate
retirement income streams:
In our view, there are enough regulatory and prudential
requirements embodied in the income tax and superannuation laws to ensure that
any superannuation fund, large or small, notwithstanding any relationship between
trustees and members, is able to pay these sort of benefits.[69]
2.82
However, Mr Ward
from the Institute of Actuaries
in Australia
told the Committee that the defined benefit income stream from a self-managed
fund is very different in nature to that paid from a life office, a corporate
fund or a public sector fund:
I think this is one of the difficulties with the payment of
lifetime pensions from single member funds. Where you have a corporate fund or
a public sector fund with a defined benefit pension, then you effectively have
a guarantor. Where you have a payment from a life office, you have a guarantor
who is effectively covering the risk. In a self-managed fund you do not have a
guarantor and therefore you have the choice of maintaining reserves to protect
against the event of poor investment experience or living longer than your life
expectancy. But that inherently involves some deferral of receipt of income,
but you have to set the income stream lower in the first place in order to do
that. I would say that the defined benefit income stream from a self-managed
fund is a different beast to that paid from a life office or a corporate fund
or a public sector fund. It could be that it is better to look at the nature of
the beast and redefine the beast in a manner which is more acceptable and
avoids some of these difficulties that we have in trying to make a square peg
fit in a round hole by getting actuaries to try to chip around the edges of it.[70]
2.83
The Committee notes the research provided by the Department
of the Treasury that showed that a defined benefit pension has lower income
streams, pays lower tax, has access to greater age pension payments and also
provides a residual significantly higher than other accumulated and growth
pensions.[71]
Response from the Treasury
2.84
Officers from the Treasury told the Committee that 50
members is a number that already exists in the Superannuation Industry
(Supervision) legislation.[72] It is in the
arm's-length equal member representation rules. While the number is used in a
different context, Mr Trevor Thomas, General Manager, Superannuation,
Retirement and Savings Division, said:
In a different context, certainly, but there is less confusion
if it is linked to something that is already known to people in SIS. Fifty provided
a reasonable pooling system, which, as Mr
Martin has said, gives some degree of
comfort. Obviously we could have gone for a higher number-200 or something like
that-which is also mentioned in SIS, but that is substantially higher and the
government was not convinced that it was justified to go to that level.[73]
2.85
Additionally, Ms
Erica Lejins, Senior
Adviser, Superannuation Retirement and Savings Division, clarified for the
Committee that if a fund is paying a defined benefit, it must have 50 defined benefit
members.[74] However,
if the fund is paying a defined benefit pension, it may have 49 accumulation
members and 1 defined benefit pensioner member:
Importantly, the 50-member threshold for a fund paying a defined
benefit pension may provide for somewhat less pooling. However, it does provide
a practical implementation mechanism. Importantly, it does ensure that the
trustees and members of the fund are at arms length and that these
arrangements are genuine.
2.86
Mr Peter Martin, Australian Government Actuary,
explained how the additional risk pooling from 50 members can provide greater
stability for a fund:
A fund paying a pension to a male aged 70 will ask itself what
its cash requirements are going to be in 10 years time .... The answer is that it
will be paying either zero pensions in 10 years time or one. There is a good
chance that it will be paying one, but there is a good chance that it will be
paying zero. It cannot predict confidently what level of pensions will be
payable in 10 years time-it is going to be nought or one. But if a fund with 50
members is asked the same question it can predict confidently that in 10 years
time it will be paying between 30 and 40. So it can get a good feel for its
cash flow.[75]
Transitional
arrangements
2.87
The Committee received evidence about the transitional
arrangements in the Superannuation Industry (Supervision) Amendment Regulations
2004 (No. 8) 2004 [Statutory Rules, 2004, No. 155] that modify the effect of
the regulations of the Committee's inquiry. These regulations ensure that
retiring members of small superannuation funds are able to continue with their
plans to commence a defined benefit pension through their fund between 11 May
2004 and 1 July 2005.[76]
2.88
The SISFA told the Committee that these regulations do
not provide a transitional period, but rather are an ineffective attempt to
grandfather existing arrangements under the main regulations.[77] This is
because a draft superannuation determination (SD 2004/D1) issued to clarify
when an SMSF can provide a defined benefit pension, takes a very narrow
interpretation of what constitutes a fund's governing rules. Mr Lorimer
told the Committee that as a consequence, there will virtually be no fund in
the marketplace that would be in a position to satisfy the grandfathering
arrangement:
It is such a ridiculously narrow interpretation and one, it is
probably fair to say, which would not accord with what the industrys
mainstream view is of what constitutes a funds governing rules. So it is an
ineffective grandfathering provision. The transitional period is similarly a
very limited one. It only applies to people who are in existing funds, and
there is only a very short time for them to make up their minds whether they
want to retire and those sorts of things.[78]
2.89
Mr Watson,
Director, PricewaterhouseCoopers, told the Committee that for most retirees the
trust deeds reflect the requirements of the existing law, which is framed in
terms of the pension being indexed between certain amounts and sets out the
general terms and conditions.[79] It is not
until the person actually gets to retirement that they decide the level of
pension and the exact terms, and it is set at that point. There would be very
few trust deeds that meet the conditions in the Determination, other than
defined benefit corporate funds where the employee entitlements have to be
prescribed in the trust deed specifically so that when the employee commences
employment they know exactly what the terms and arrangements are when they
cease with the employer.
2.90
The Institute of Chartered Accountants in Australia
noted that the transitional regulations will not assist people who have planned
for their retirement by using an SMSF that they have not yet established:
They know that they are going to get a certain benefit from
their corporate fund or their master trust down the track, and their intention
was to set up a DIY fund in order to run their retirement, but now they are not
being given the opportunity to do so and take a DB pension, which may have been
the plan that was in place all along.[80]
Response from the Treasury and the Australian Taxation
Office
2.91
Mr Trevor Thomas, General Manager, Superannuation,
Retirement and Savings Division, Department of the Treasury, told the Committee
that under the transitional regulations that are in place, those people who are
retiring before 1 July 2005 are in essentially the same position as they were
before the budget announcement and the making of the regulations [Statutory
Rules 2004 No. 84].[81]
2.92
The transitional arrangements are intended to assist
those people who had a clear intention to retire within their small fund.[82] The
Government considered that there were constraints in drawing a line in the sand
to assist those who may not have finalised their plans to enter into the
transitional arrangement to the extent that it becomes a mechanism to avoid the
intention of the law.
2.93
Additionally, the transitional arrangements ease the
requirement in the regulations that there are specific pension details in place
for the period of the transition.[83] During this
period, trust deeds can be changed in a manner sufficient to set up a defined
benefit pension through an SMSF.
Small
corporate funds
2.94
The Institute of Actuaries in Australia (IAA) was most
concerned about the effect that the restrictions will have on small corporate
funds. It suggests that longevity risks which may be associated with small
pools of pensions, are only relevant to a very few corporate funds. The vast
majority of these have benefit designs whereby mortality risks can be
controlled by an appropriate level of insurance.[84]
2.95
Furthermore, the IAA asserts that small defined benefit
funds are usually associated in the corporate sector with multinational
employers who sponsor defined benefit funds around the world, and with
executive schemes of (generally large) Australian companies. This means that
the overall risk profile for members is reduced because these funds are small
in relation to the size of the employer.
2.96
The IAA was also concerned that the regulations will
impose additional costs for employers in providing different types of benefits,
and possible industrial relations issues as the same classes of employees will
become entitled to different benefits.[85] Ultimately
it considers that there is a danger that employers will decide to provide the
minimum in benefits and will not go beyond their strict legislative
obligations. The IAA asserts that this is not consistent with encouraging
saving for retirement.
2.97
Additionally, Mr
Ward told the Committee that the regulations
created difficulties for corporate funds that were intending to close and
transfer to a master trust before 30
June 2004.[86] For many
employers who wanted to provide the same benefits to their employees in another
structure, that was no longer possible as the master trust arrangement was
considered to be a new fund and the transfer could not happen unless an
exemption from the Australian Prudential and Regulatory Authority (APRA) was
obtained:
In a number of cases, those exemptions were obtained, but it
took so long that the transfer was delayed, and went past 30 June, which meant
that the fund has incurred considerable additional costs, another APRA levy,
more audit fees and more administration fees. This has had a significant
adverse impact on some of those funds. It has also created some problems for
some employers who have got a small fund. They are currently providing defined
benefits for their employees. They may no longer be able to provide the same
benefits for a new employee who joins. That means they have to set up a
different structure of superannuation for their new employees. Again, it might
be possible to get an exemption from APRA. I am certainly aware of at least one
case where that exemption has not been forthcoming.[87]
2.98
Mr Stanhope from the IFSA considers that in the above
circumstances APRA should use its modification declaration powers under section
328 of the Superannuation Industry (Supervision) Act to ensure that the regulations
do not have unintended consequences.[88] He told the
Committee that initial discussions with APRA in relation to this have been
positive.
2.99
However, Mr McDougall,
SISFA, considers that small corporate funds were targeted by the regulations
rather than becoming inadvertently caught up by them:
I cannot help but think that one of the triggers for it to come
up with this wonderful figure of less than 50 was as another tool which APRA
were using to get rid of these small corporate funds that they have been trying
so hard to get rid of for so long. That is another issue which is not in our
area, but we know that that is an actual case.[89]
Response from the Treasury
2.100
The Committee notes the evidence from Ms Erica Lejins, Senior
Adviser, Superannuation, Retirement and Savings Division, that both the
Australian Prudential Regulation Authority and the Australian Taxation Office
may exempt funds from the 50-member rule in circumstances where there are
adequate arrangements in place to fund future pension benefits and the trustee
and members of the fund are at arms length.[90]
Social
security asset test
2.101
Complying defined benefit pensions are currently exempt
from the social security asset test which has allowed wealthy individuals, in
some cases, to access Centrelink entitlements. However, PricewaterhouseCoopers
points out that the asset test and income rules for social security are
effectively the same for DIY funds and for life office annuities and so the regulations
will not prevent the mischief from occurring:
Thus the same outcomes can be achieved either through a DIY fund
or by purchasing a life office annuity, so banning life-time and fixed term
income streams from DIY funds simply moves the problem from one area to
another. Banning these income streams from DIY funds delivers life offices a
competitive advantage in this regard.[91]
2.102
The Department of the Treasury and the Australian
Taxation Office were asked to provide an estimate of the additional cost to
revenue and additional call on social security that could arise when a small
fund paying a defined benefit pension was unable to meet part or all of its
obligations and the retiree is forced to resort to social security. Because the
bulk of self managed superannuation funds is currently in the accumulation
phase and not paying pensions, the agencies found it difficult to provide data.
2.103
Several submissions[92] consider that
recent changes made to the superannuation regime more generally will of
themselves significantly reduce the level of abuse in relation to defined
benefit pensions. These changes tackle the specific issues rather than the more
broad-brush approach of the regulations. They are:
-
the reduction in the social security asset test
exemption from 100 per cent to 50 per cent for new pensions. This will
significantly limit the ability of those with large superannuation benefits
from accessing the old age pension; and
-
the introduction of market linked growth
pensions which will enable retirees to take a complying pension that is not a
defined benefit pension.
Reasonable
benefit limits
2.104
Witnesses considered that, to the extent that there is
a problem, it does not lie with avoidance of the Reasonable Benefit Limits (RBLs),
but with the formula used by the Australian Taxation Office (ATO) for
calculating the value of a pension for RBL purposes.[93] They told the
Committee that the pension valuation factors used by the ATO considerably understate
the true value of the pension, giving rise to an RBL value which is often lower
than the actual purchase price of the pension.
In this regard, the current actuarial requirements under SIS
regulation 9.31 arguably permit the commencement of a defined benefit pension
at an inappropriately low level relative to the capital supporting it. This has
the potential for an 'artificially' low RBL value and/or unreasonably high
benefit reserve to be achieved. This is as a result of the regulation requiring
the actuary to express an opinion that a fund has a 'high degree of probability'
(i.e. 70% probability) of being able to pay the defined benefit pension. The
requirement is a minimum one, meaning that a higher degree of probability could
possibly be applied, with a lower level of pension as a consequence.
The potential to manipulate this position could be addressed by
amending regulation 9.31 to require defined benefit pensions to be commenced
with no greater than a high degree [70%] of probability.[94]
2.105
Consequently, according to witnesses, it is both
unreasonable and unfair to apply a blanket ban to DIY funds when it is the
government's own formula which is at fault and the regulations will not solve
the issue. In addition these regulations will not change how defined benefit
pensions are valued for RBL purposes:
In fact, under the new Regulations, if a retiree is willing to
purchase a life office annuity through their DIY fund, and use the proceeds to
provide a life-time pension from the fund, they would still achieve the same
low RBL valuation ... since the new Regulations do nothing to change how a
life-time pension is assessed for RBL purposes.[95]
2.106
The pension valuation factors used to calculate the
capital value of a pension are, according to CPA Australia, 10 years out of
date and appear to be out of line with life expectancies.[96] Mr deLancey Worthington,
Managing Director, Actuarial Solutions, commented that if the pension valuation
factors were recalculated using the latest life tables and a rate of return of
approximately nine per cent, then on average,
they would increase by 37 per cent. The higher factors would result in higher
and more representative values being assigned when calculating the capital
value of a superannuation pension for RBL purposes.[97]
2.107
Another solution proposed by witnesses was that a
pension be assessed on a purchase price basis:
That is the methodology that is used for growth pensions,
allocated pensions and defined benefit term pensions. It is also the method
that is used for life office annuities. So it would bring consistency across
the board. It would also remove the ability for people to compress their RBL.
It would also remove the ability to add undeducted contributions to remove an
RBL problem.[98]
2.108
Accordingly, if this occurred, the 95 per cent or so
people who are within their RBL would not be affected. In fact, according to Mr
Worthington, they would gain an advantage from the change:
At the moment, because the amount of pension that they purchase
results in an RBL value of only 57c in the dollar, to satisfy the so-called
50-50 rule to meet their pension RBL they may have to commit two-thirds of
their retirement money to purchasing a lifetime pension and then only one-third
goes into the allocated pension. It is not a 50-50 split of assets; it is a
50-50 split by RBL value. If we changed it to purchase price, those people
could do a 50-50 split by the amount of money that they are retiring with and
they could actually have more money in the allocated pension where they have
access to the capital. They would be happier.[99]
Estate
planning
2.109
Any residual left from an annuity after the death of
the recipient is generally kept by the retail provider. Any residual remaining
after death from a DIY defined benefit pension remains within the fund and can
be distributed to the beneficiaries. The regulations target the incentive for
DIY funds to use the concessional superannuation taxation structure to maximise
a recipient's estate after death, rather than for genuine retirement income.
2.110
However, Mr Cohen from PricewaterhouseCoopers told the
Committee that the fact that the DIY fund retains any assets left over after
the death of a member does not represent an abuse of the system - it is just
one of the attractions of using such a fund to pay a pension in retirement.[100] Other witnesses
similarly argued that this feature offers a 'fair go' for Australians who do
not see the value of purchasing a lifetime life office annuity when the life
office keeps the remaining assets.[101]
2.111
Some witnesses suggested that this feature of DIY funds
does not constitute tax avoidance because if the residual is bequeathed to
another member of the same fund, the money stays in the fund in an accumulation
phase under another person's name and cannot be used until the beneficiary
moves into the pension phase. If the residual is bequeathed to a beneficiary
outside of the fund, it will be taxed accordingly.[102] By
contrast, Mr Stanhope suggested that remaining assets in a DIY fund will pass
'pretty much tax-free' to other people.[103]
2.112
Some witnesses provided the Committee with solutions to
overcome perceived estate planning strategies. For example, the Institute of
Chartered Accountants in Australia thought that estate planning advantages
available to small funds could be overcome by the specification of actuarial
valuation criteria as occurs for funds wishing to meet the requirements for the
receipt of a means tested pension or the retention of term certain pensions:[104]
This would give the member the option of a fixed or CPI indexed
income stream aimed at utilising capital over the member's lifetime. This would
need to be implemented in consultation with The Institute of Actuaries
Australia to ensure that the limitations offered by the probability test can be
overcome.
2.113
Mr deLancey Worthington noted that there is a
requirement in the social security legislation that the amount of pension
should repay the purchase price over the term of the pension. He recommended
that this should be included in the superannuation industry (supervision)
legislation. If that occurred, there would be a minimum level of pension that
must be provided in a defined benefit pension arrangement so there would no
longer be cases of people with substantial assets, taking very small pensions.[105]
Response from the Treasury
2.114
The Department of the Treasury believes that defined
benefit pensions provide a disproportionate benefit compared with alternative
products:
A fixed term pension provides a great opportunity for providing
residual capital value. That means that the assets have been used to provide an
income. Also, the concessional tax treatment associated with payment of the
pension-in that about 80 per cent of them put it aside tax free, because they
are supporting the pension, and that is going to be dependent upon how the
actuary values those assets-provides an opportunity for wealth accumulation and
intergenerational fund transfer so that benefits are not being fully utilised
to pay the pension of the retiree. The assets can be there and can be used to
provide benefits and intergenerational wealth transfer to children and so
forth.[106]
2.115
Mr Thomas, General Manager, Superannuation, Retirement
and Savings Division, told the Committee that proposals to amend the RBL
formula are unlikely to resolve the issue of inappropriate estate planning, nor
would they solve the fundamental concerns about the sustainability of small
funds providing a guaranteed benefit.[107] The pension
valuation factors, while somewhat dated, are also used to value lifetime
pensions provided by large public sector and corporate funds. The issue would
need to be carefully considered before any amendment could be made as a change
to the factors could have a significant impact on a much wider range of people
than the membership of smaller funds.
2.116
Mr Coles, Manager, Retirement and Savings Division,
further explained:
In this matter you have to
consider what the formula is. It is the annual value times the pension
valuation factor minus the undeducted contributions plus any residual capital
value. The annual value is subject to some concerns that it can be manipulated,
perhaps, to produce a low annual value for the formula so that the amount of
assets providing that pension is in excess. That is multiplied by the pension
valuation factors which in SIS are based on life expectancy. Important in this
is the amount of undeducted contributions. As was presented to me the other
day, the wealthier you are the less of a reasonable benefit limit problem you
have. The more money you can put into your fund as an undeducted contribution
the lower you can bring the assets, the capital value of the product, below the
RBL.
I guess in considering each of these elements-and I have
excluded the residual capital value because for complying pensions it cannot
have one; it must be zero-we need to identify that it can be subject to
manipulation at the front end. Pension valuation factors are somewhat dated but
there are broader ramifications to fix that for the rest of the community.
Senator SHERRY-Why couldnt you just fix
it or change it for the SMSF funds? Why couldnt you just apply a specific
formula for these funds? Do you have a legal problem with that?
Mr Coles-Conceptually, we looked at the
abuse in relation to these funds. These funds are also conceptually unstable in
providing a guaranteed pension. In weighing that up, and to address the
arrangement early, the government decided to amend the law to fix the abuse-the
fact that non arms-length arrangements were being used inappropriately.[108]
2.117
Additionally, because of the interconnectedness between
taxation, social security and superannuation systems certain changes may have
downstream effects:
If you start playing around with the formula, then there is
going to be a ripple effect throughout the whole treatment of the RBL system.
For example, if you just play with pension valuation factors, you are actually
going to be playing around with the income streams that public servants
receive, the income streams provided by large corporates, such as old BHP
funds-the benefits that they are going to receive in their retirement. If you
try and fiddle around with the residual capital values then that also has
impacts on other parts of the tax act.[109]
Conclusion
2.118
Although many witnesses to the inquiry disputed that
there is abuse of the superannuation system needing to be addressed by the regulations,
the Committee notes Treasury's advice that this is an emerging phenomenon it
intends to 'nip in the bud'.
2.119
The Committee notes the potential of non-arm's length
funds to be used to build large residual balances that can be steadily
increased in the concessional superannuation environment and passed to
beneficiaries, rather than being used for retirement income purposes.
2.120
However, in the absence of detailed statistics as to
the extent of abuse, the Committee accepts that the extent of the abuse and
potential abuse is a matter for some conjecture.
2.121
A number of witnesses expressed concern that the regulations
are not well targeted and that they will have unintended consequences. On the
other hand, the Treasury considers that the issues raised can be adequately addressed
by the grandfathering provisions, the granting of exemptions, and the use of
the modification power under section 328 of the Superannuation Industry (Supervision)
Act.
2.122
The Committee has some sympathy with the views of some
witnesses that the regulations are a 'sledgehammer' rather than a 'scalpel'
approach to removing any potential for abuse.
2.123
However, the Committee is concerned that if the regulations
are disallowed or withdrawn now, a window of opportunity would be created for
the establishment of many more defined benefit funds, and for existing funds
caught by the regulations to tighten their governing rules and trust deeds,
with the intention of exploiting loopholes in the legislation.
2.124
Hence, the Committee believes that the regulations
should not be disallowed but equally believes that they should apply only
temporarily, until the Government's announced Review is finalised and further
advice considered. The Committee recommends that, following the consideration,
new regulations which allow self managed superannuation funds adequate
flexibility to provide a range of pensions but which also more acutely target
any potential abuse replace these regulations.
Senator George Brandis
Chairman