Using retirement money to solve today’s problems
- On 27/03/2020
- COVID-19, retirement, superannuation
Fixing short-term cash flow
The impact of COVID-19 has turned the world upside down. In economic terms, the impact was first marked by a rapid and large fall in global share markets. The bellwether Dow Jones Index dropped by 37% over 40 days to 23 March, not only ending a lengthy bull market but foreshadowing a recession! It has since been followed by high volatility and upheaval in all economies.
In Australia, the government has had the twin objective of minimising damage to the economy whilst curbing the spread of the virus and minimising the expected death rate. Unfortunately, these objectives clash and we have had compromise and uncertainty over the last month. This confusion is not surprising given the need to develop policy on the run as there has not been time to optimise solutions in an ever-changing crisis.
One of the contentious decisions made is that of expanding the definition of compassionate grounds to allow members to access some of their superannuation benefit. Effectively, eligible members can access a tax-free withdrawal of $10,000 up to 30 June and a further $10,000 in the three months from 1 July. This is intended to support those most impacted by the economy’s shut-down from COVID-19. Those eligible are:
- Anyone unemployed
- Those receiving various other social security payments (jobseeker payments, youth allowances, farm household allowances)
- Individuals who in the period from 1 January 2020 have:
- been made redundant
- had their working hours reduced by 20 per cent or more (presumably measured by income), or
- acted as sole trader, had their business suspended or experienced a reduction in business turnover of 20 per cent or more.
The application is administratively cumbersome as members must apply to the ATO (online via myGov) which will determine the merit of the application and then notify the applicant and the trustee of their fund. The trustee must then pay the member without delay. Still, this access to funds is far simpler and more streamlined than the current financial hardship process (which required 26 weeks on unemployment benefit first).
Impact on cash flow
Treasury has estimated that up to $27 billion will be withdrawn from the system as a result of these changes, which is approximately 1% of all assets held in superannuation. While that appears to be manageable, the impact will vary by fund. Rice Warner’s estimates for the industry is in the range $40 to $50 billion as we expect the level of unemployment has grown since Treasury first modelled this.
Some industries have been hit very hard, particularly tourism, retail shopping (apart from supermarkets), and hospitality. Some funds have a high portion of members from these industries so they will bear a disproportionate share of the impact – and will be felt in several ways:
- They will pay out large unplanned benefits (resulting in members capitalising investment losses).
- Many members with small balances will exit the fund completely.
- The cash flow from SG contributions will be significantly reduced from sudden high unemployment.
While most funds will have strong cash flows and cash balances, the withdrawals will reduce cash for reinvestment in assets with depressed market prices. For the 25% of funds which will lose up to 10% of their members, a reassessment of cash flow, liquidity and asset allocation will be critical.
Impact on members
Many people will suffer financial hardship over the next six months and the chance of taking $20,000 tax-free from their superannuation will be extremely appealing. There will be some downside, but most members will gloss over these issues, for example:
- Those who end up exiting the fund will forfeit their life insurance.
- The withdrawals will come at a time when asset prices are low, so the members will be capitalising losses rather than waiting for a rebound.
- Many members will not make up the withdrawal later and that will result in lower retirement benefits (up to $120,000 for a twenty-year-old according to ISA figures).
As was the case in the GFC, the government has halved the minimum pension withdrawal requirement for the 2020 and 2021 financial years. The objective is to provide flexibility for pensioners to hold more money in superannuation until the markets have recovered.
The decision is quite arbitrary. Most pensioners have already drawn 75% of their 2020FY pensions, so the adjustment is more than it need be for this year. Further, the dollar amounts to be drawn in the 2021FY have already been cut simply by the fall in the likely market value on 1 July.
While any flexibility is always welcome (particularly as corporate dividends will be low next year for all but the large mining companies), the decision does allow those with very high balances to hold high assets longer in a tax-privileged environment. The top 100 SMSFs hold $79 billion and the decision will ensure they will hold about $2.5 billion extra in their funds for at least another year.
Implications for funds
Given these risks, as COVID-19 continues to progress through our population and economy, superannuation funds are needed now more than ever. While superannuation is for retirement, these are unusual times with unique circumstances, and we all need to play a part. Importantly, this will mean that funds will need to go above and beyond to engage members. In doing this, and by providing the tools and information that are required to make decisions, funds will ensure that irrespective of short-term volatility, the retirement of members remains healthy.