Budget changes for superannuation
- On 09/10/2020
- budget, superannuation
The October Budget
The global pandemic totally disrupted our annual budgetary process. The government was forced to make many fiscal decisions on the run and the regular May budget was deferred for five months due to the unprecedented uncertainty surrounding the economy.
Over the last six months, our government has taken many expensive interim steps to lessen the impact of the population crashing into an economic recession. JobSeeker, JobKeeper, rent and mortgages freezes, and the superannuation Early Release System (ERS) all helped the country tread water while government worked out how to fight against both the health and economic consequences of COVID.
Not surprisingly, a record Budget deficit has been created to kick-start the economy and help us out of recession. Many of the key measures were pre-released so there were no major surprises. The emphasis, correctly, is on reducing unemployment over the next few years.
The environment is unique in modern times – we will have low population growth and no international tourists for up to two years. Further, government debt will be high for more than a decade and there will be less pressure on future governments to bring it down. Fortunately, our strong superannuation industry will play a major part in the recovery.
Nonetheless, we will have a two-tier economy for some time, with most sectors firing but some struggling to survive. Areas under stress include discretionary retail shops, airlines and travel agents, CBD cafes and restaurants, CBD offices, exporting wineries (due to Chinese drop off in sales), and any business connected to events.
Some of the Budget forecasts look ambitious. It forecasts strong 3% real GDP growth in 2023/24, yet we will have one million fewer people, and much of our past GDP growth has come from net migration. Wages will be low, yet household consumption is projected to leap as people start spending. The trend is -2.6% in 2019/20FY, -1.5% in 2020/21FY, then a jump to +7.0% in 2021/22FY.
While the tax cuts and business incentives have been the prime focus of the Budget, what would life be without something on superannuation! Budgets have incorporated annual superannuation changes ever since the introduction of higher taxes on lump sum withdrawal and retirement benefits in 1983. There was some media speculation about the changes that might be made this year but none of the key predictions were met – there was no commentary on the right level of SG contributions; no extension of the ERS (though there has been much lobbying by social groups to extend this); nothing on using super to help young Australians enter the housing market; and no release of the Retirement Income Review’s report.
However, this year, we did get Your Future, Your Super¹. This package has four key elements described by the government as:
- Your superannuation follows you
- Empowering members
- Holding funds to account for underperformance
- Increasing transparency and accountability.
Collectively, the government expects these changes to save consumers some $17.9 billion over the next decade.
All these changes will impact on the super industry.
Government strategy for superannuation
Following the recommendations of the Productivity Commission (PC) and Royal Commission (RC), the government has a full agenda to improve efficiency in the superannuation and retirement system. It appears to be spreading change over time so that it can be implemented at a digestible pace.
There was some tidying up of legislation for recent announcements – the cap on SMSF members will grow from 4 to 6; the minimum pension payments on an account-based pension have been halved for the 2020FY just passed and the current 2021FY; the Eligible Rollover Funds will all be wound up.
The Your Future, Your Super package is the third one to deal with default (MySuper) superannuation arrangements following the previous work done on Protecting Your Super and Putting Members’ Interest First.
We understand the Your Future, Your Super legislation will be prepared over the next few months with implementation from July 2021.
Many of the changes made to default superannuation will be extended later to Choice products (those selected by members) as the government targets excessive fees and poor performance throughout the superannuation industry. This extension should be introduced as soon as possible to ensure that there is no “gaming” of the system.
Separately, the government will review the retirement sector, and we anticipate that the report of the Retirement Income Review will be released soon, now that the Budget has been delivered. The Retirement Income Covenant has been deferred to July 2022, largely to allow time to legislate for the PC and RC recommendations. We expect extensive consultation on the retirement framework as we suspect the Retirement Income Review has exposed several areas of concern.
Finally, the government is likely to hold a review of life insurance in superannuation at some stage.
Your super follows you – “stapling”
This initiative was developed by the PC and then endorsed by the RC. The government has adopted this after considering several models. It claims the model chosen is the most efficient, though many in the industry question this.
From July 2021, when someone takes a new job, the employer will log onto the ATO portal and find the member’s existing superannuation fund. It will then pay SG contributions into that fund. If the employee has more than one fund, it will go into the one with the largest account balance.
Only if there is no existing superannuation fund for the employee and they make no choice from the ATO site will the employer pay into their own nominated default fund.
From July 2022, it is intended that payroll systems will be linked to the ATO and the process will be automatic.
This process is an improvement on the PC’s so-called “Best-in-Show” which would have dislocated the whole industry. This structure will leave all current members in their existing fund, so any transition will be slow and measured. In fact, funds will have higher retention rates and average balances will grow more quickly.
Further, those members entering the superannuation system for the first time and unable or unwilling to choose a fund will still join under the current default arrangements, partly protecting the existing award system.
The structure will reduce multiple accounts and give continuity of membership, which should help with member engagement and education. Life insurance arrangements will be improved from the lower movement of members between funds.
One disadvantage is the breakdown of the corporate super arrangements where members of larger companies belong to tailored arrangements. This structure will break down over time as new employees will not join the fund without making a conscious Choice decision – and few will do so unless the employer fund has generous benefits.
Some commentators are concerned about members being locked into underperforming funds for extended periods. However, that should be addressed by separately weeding out underperforming funds.
The change will bring stability of membership for funds and, overall, fees should fall from the smaller number of accounts being managed. Administrators will have lower revenue, but their costs will fall as contribution reconciliation will reduce significantly.
Most members are unengaged for much of their careers. When they do take an interest in their superannuation, it is difficult to evaluate differences between funds. To address this, the government will set up an interactive online tool administered by the ATO but using data from APRA.
APRA uses the technique recommended by the PC to compare funds. It will provide material to the ATO site and this will be updated quarterly so that it is contemporary. The comparison will be consumer-focused – though it will apparently ignore life insurance, retirement products, and service standards.
The site will rank funds by fees and investment performance. Further, underperforming funds will be highlighted. People entering the workplace are likely to select those funds ranked highly and members of underperforming funds might switch into better rated funds too.
The public site will focus on past performance – even though ASIC requires every issuer of a financial product (including superannuation funds) to warn that such performance may not be repeated in future. It suggests issuers provide warning comments such as “past performance is not a reliable indicator of future performance” or “future returns may vary”.
Without understanding the risks being taken by the fund, and the investment philosophy, the ranking can only be indicative. This is important as Australian funds have been successful for many years by taking calculated risks to achieve extra-performance. It would be a backward step if funds became risk averse.
The performance will be measured over 8 years (even though most balanced funds target CPI + x% over 10 years). That means that any changes to a product will take some time to flow into the published returns. Ironically, new members are not exposed to the past performance but always receive investment material based on it.
While investment performance is the key factor in building a strong retirement benefit, there are other benefits in superannuation such as life insurance or exposure to growth assets. These factors will not be directly ranked.
The benchmarking could well lead funds to change their MySuper focus to products designed to avoid failing the test. This might then also preclude passing the test by a large margin as funds de-risk investment strategies. Funds might develop low cost, indexed investment portfolios with minimal engagement services and life insurance.
Such funds could then encourage members of MySuper products to shift into Choice products with asset allocations and investment strategies likely to give higher long-term returns.
Finally, a fund with high asset-based fees and a low dollar fees could look attractive to a new entrant. However, over time, the product might become less attractive as fees rise. As members might not revisit the comparison site, they could end up paying higher fees through ignorance.
Funds whose MySuper product is deemed to be under-performing must advise members of this status in October following the end of the financial year – which should encourage a run of members leaving the fund! If they are under-performing two years running, they won’t be able to accept new members into the default MySuper product.
Funds identified as non-performing on the heat map are those which return > 50 bps a year below the benchmark over the longest period for which APRA has statistics (currently 7 years but moving to 8 by the time of launch). It is not clear how many funds currently fail.
The public ranking will accelerate the winding up of many funds. We trust there will be an orderly transition for the members as the funds seek appropriate “destination partners”.
Meanwhile, it will be difficult to turn around investment performance quickly. After all, only 10% of a ten-year performance changes each year. It will be easier for underperforming funds to start a new investment strategy and dump the history. How will APRA then rank them without any relevant measurable history?
Increasing transparency and accountability
The government argues that it needs to curb discretionary expenditure as MySuper costs have risen since the product was introduced.
Trustees will need to consider all costs and affirm they are made in the members’ best interests. There is no materiality threshold so funds will need to categorise expenses carefully, noting they can be audited by APRA.
There will now be annual (online) meetings of members for the trustee to explain how the fund has performed over the last year and to answer member questions. The fund will provide members with an annual report and other information such as the annual outcomes test, marketing expenditure, political donations and sponsorships.
There are grey areas around promoting the fund – how far should funds go in building fund awareness or in advertising for new members?
Some industry funds invest indirectly in the New Daily newspaper. Will this cost meet the best interest duty?
Implications of changes
There are several likely impacts from this legislation:
- Industry consolidation of funds will speed up.
- “Stapling” will lead members to stay with funds for longer durations, leading to higher retention and potentially improved engagement over time
- Life insurance will be more stable through higher retention (though the government will look separately at life insurance in super in due course)
- The ATO Comparison site will become the industry norm for consumers rather than the comparisons used by research houses.
- There will be new low-cost indexed MySuper products, many offered by today’s underperforming funds.
Finally, the increased regulation will encourage financial advisers and accountants to recommend SMSFs for their clients to move them out of the highly regulated APRA regime. Of course, fees and performance will not then be benchmarked at all.