1 What is the role of a financial planner when advising a client about retirement planning?

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1 Questions with Guided Answers by Graeme Colley 2013 Reed International Books Australia Pty Limited trading as LexisNexis. Permission to download and make copies for classroom use is granted. Reproducing or distributing any material from this website for any other purpose requires written permission from the Publisher. Chapter 12: Investing in Superannuation 1 What is the role of a financial planner when advising a client about retirement planning? The role of a financial planner at this stage of retirement planning is to determine a client s needs to meet living expenses during retirement as well as any dependants in the event of the client s death. Once this has been determined, the financial planner has the job of working out whether a client s investments including superannuation will be sufficient to meet those retirement objectives. 2 Describe the regulatory environment for superannuation and role of each regulator of superannuation funds. Superannuation is regulated in Australia by many government organisations which have an impact on the regulation of the operation of superannuation funds, investments, members of funds and third parties who interact with the funds. However, the three lead organisations regulating superannuation are the Australian Prudential Regulatory Authority (APRA), the Australian Taxation Office (ATO) and the Australian Securities and Investments Commission (ASIC). The Superannuation Complaints Tribunal is also an important regulator. Australian Prudential Regulation Authority APRA prudentially supervises the superannuation, insurance, banking and related industries. Its role in relation to superannuation is essentially to identify actual or potential problems which may pose a threat to members entitlements. This includes the management of superannuation funds, approved deposit funds (ADFs) or RSAs and their ability to deal with or avoid problems under the Superannuation Industry (Supervision) Act 1993 (SIS Act) and RSA legislation. Australian Taxation Office The ATO has a number of roles in relation to superannuation, including the traditional role of tax collection which is imposed on the income of superannuation funds under the income tax legislation. It is also responsible for legislation for the superannuation guarantee, co-contributions, the lost members register and supervision of self-managed superannuation funds, under the SIS Act. Currently there are a number of proposals being considered by the government under the StrongerSuper reforms which will expand the responsibility of the ATO. Information about the StrongerSuper reform proposals can be accessed from: < Financial Planning in Australia 5e Questions: Ch 12 Page 1

2 Australian Securities and Investments Commission ASIC is responsible for consumer protection and market integrity. In the superannuation industry, this means ensuring consumers receive adequate information to make informed decisions about the superannuation products and services on offer. ASIC may also prohibit people or organisations from providing superannuation products and advice where that information is found to be incorrect or misleading. The role of ASIC is proposed to expand if the StrongerSuper reform recommendations are implemented. 3 What is the function of the Superannuation Industry (Supervision) Act 1993 and the Income Tax Assessment Act 1997 as they relate to superannuation funds? Superannuation is regulated by many rules and regulations which are designed to control the operation of a fund and anyone who has an association with the fund. The main reason for the considerable amount of legislation is due to the significant amount of money invested in superannuation as well as the taxation concessions provided by the government at each stage of the retirement savings cycle. The principal legislation that applies to superannuation and financial planning is the Income Tax Assessment Act 1997 (Cth) (ITAA 97), the Corporations Act 2001 (Cth) (Corporations Act) and the SIS Act. The Income Tax Assessment Act The aim of the ITAA 97 is to tax various transactions relating to the operation of superannuation funds, ADFs and RSAs. This includes imposing tax at the contribution, accumulation and payment stages of a fund s operation. Regulation under the ITAA 97 is done by: regulating the amount of contributions that can be made to a superannuation fund, ADF or RSA on a concessional and non-concessional basis; taxing the income, capital gains and contributions of a superannuation fund, ADF or RSA; and regulating the taxation of lump sums and income streams made to members of superannuation funds, ADFs and RSAs. A superannuation fund that is regulated under the SIS Act and complies with the operating standards gains access to tax concessions available under the ITAA 97. The income of a complying superannuation fund generally pays tax at the rate of 15%. It is possible in rare instances that the income of a superannuation fund can be taxed at 45% if the relevant transaction that earned the income is not on an arm s length, commercial basis. Capital gains on investments held by the fund for longer than 12 months receive a one-third discount to the 15% rate and, in effect, are taxed at 10%. Fund income includes income from investments, taxable capital gains and taxable contributions made by employers, self-employed or unsupported people. Financial planning advice inevitably involves the application of the taxation laws to a client s circumstances. By legally reducing or eliminating the tax on particular transactions relating to Financial Planning in Australia 5e Questions: Ch 12 Page 2

3 superannuation, a client should end up with a greater amount to live on in retirement. This would ordinarily be greater than if the investments had been made in the client s name. The Corporations Act As the name suggests, the Corporations Act has the role of regulating the registration of corporations and any related matters. This includes the incorporation and regulation of public and private companies, company documents and the provision of financial advice. In relation to superannuation funds, the Corporations Act regulates corporations which are trustees of a superannuation fund, disclosure relating to investments, and the issuing of Product Disclosure Statements to new members of funds and on commencement of superannuation pensions. In addition, the Corporations Act regulates financial planners, their licensees and the provision of financial advice to members of superannuation funds. The impact of the Corporations Act on a financial planner relates to the requirement that a person who provides financial advice is required to be licensed. In addition, any information or advice provided to a client about their situation or a financial product is required to be consistent with the requirements of the law and as approved by the licensee. The Superannuation Industry (Supervision) Act The principal legislation that impacts on the day-to-day operation of a superannuation fund is the SIS Act. The Act is split into two broad categories, one which relates to the prudential operation of the fund and the other which provides rules relating to the day-to-day operation of the fund and for the payment of benefits. In practice, prudential standards require superannuation funds to have adequate computer systems and processes for decision making that minimise the chances of the fund failing. For example, most superannuation funds would have a number of committees relating to investments, audit, administration, communications and governance which oversee the risks associated with the management of the fund. The SIS Act also has a number of operating standards which allow the regulator, APRA and the ATO to exercise control and supervise security over superannuation savings by: approving who may be a trustee of a superannuation fund; approving certain superannuation funds that meet particular standards relating to: contributions and benefits; accounting and actuarial practices of funds; transfers of benefits between funds; solvency of funds; investment of fund money; reporting to members and others; retaining records; requiring superannuation funds to have a prudential framework ; and imposing penalties on funds and other parties who do not meet the provisions of the legislation. Financial Planning in Australia 5e Questions: Ch 12 Page 3

4 4 What are two methods to estimate how much a person may require in retirement? There are a number of methods used to estimate a reasonable amount a person could be expected to live on comfortably during his or her retirement. One method is to base the amount required as a proportion of income earned immediately before retirement and calculate its equivalent value based on the time that the person is expected to be retired. Another method is to estimate the amount required to satisfy a person s lifestyle needs during retirement and discount those costs to an estimated retirement date. Irrespective of the calculation used to determine how much will be required, the result will provide an estimate of a lump sum that a person should have by the time he or she retires to meet their retirement objectives. What constitutes an adequate income in retirement has been, and will continue to be, widely debated. However, as a rough guide, a person will require about 15 to 20 times his or her income just prior to retirement. As an example, a person who is expected to retire with an income of $100,000 pa will require between $1.5 million to 2 million to live on in retirement. 5 Provide three advantages that a retail fund has in comparison to a self-managed superannuation fund. Your answer should have any three of the following: Retail Superannuation Funds Offered to the general public No limit as to the number of members Trustee is required to be approved by APRA Required to meet a net tangible asset test Reports about a member s benefit and the fund operation are required to be published Self-managed Superannuation Funds Not available to the general public and generally limited to closely related parties such as family or business associates Limited to a maximum of four members No requirement for the trustee to be approved, provided they meet various standards in the SIS Act No requirement for a net assets test to be met No requirement to report to members in most situations 6 Which party is liable for the risk associated with benefits in a defined benefits superannuation fund? A contribution made to a defined benefit fund is in relation to all members of the fund as a group rather than as individuals. In the case of a defined benefits fund, the contributing employer is required to obtain an actuarial valuation of the fund which lets them know whether an amount equal to the superannuation guarantee minimum amount is being contributed for employees. The liability is with the employer at all times, as the benefit is defined in terms of the fund s trust deed and it is the employer that tops up the fund to ensure the benefits being provided are adequate. Financial Planning in Australia 5e Questions: Ch 12 Page 4

5 7 Describe the tax concessions for superannuation contributions that are available for employers, employees and individuals. Employer contributions An employer is permitted a tax deduction for superannuation contributions made for employees or, in certain circumstances, previous employees. Contributions made by an employer for employees are concessional contributions and are subject to the concessional contributions caps. There are basically three categories of contributions paid by an employer in respect of an employee. An employer may have a liability to pay superannuation under an industrial award or workplace agreement, for purposes of the superannuation guarantee legislation and as required under a salary sacrifice agreement. Personal contributions to superannuation by employees and individuals Superannuation contributions made to a complying superannuation fund by any individual may fall into a number of categories. Where they have not claimed a tax deduction for the contribution, it will be a non-concessional contribution. In some circumstances, non-deductible contributions may be eligible for the government s co-contribution which is paid to the superannuation fund. If an individual makes a contribution for their low income spouse, he or she may be eligible for a tax offset against the amount of personal tax payable. An individual may be eligible for a tax deduction for superannuation contributions where certain conditions exist. The deductible contributions are concessional contributions and are taxed in the superannuation fund. 8 What are the advantages of salary sacrifice to superannuation? Many employees make agreements with their employer to have part of their salary paid for various purposes before tax has been deducted. This is referred to as salary sacrifice and can be tax effective depending on the individual s circumstances. The most common salary sacrifice arrangements are for motor vehicles used wholly or partly for private purposes and superannuation. An employer may be liable to pay fringe benefits tax on some salary sacrifice payments. For example, salary sacrifice to motor vehicles is subject to fringe benefits tax while contributions to a superannuation fund are not. For a salary sacrifice arrangement to be effective for tax purposes, an employee must have an agreement with their employer to give up the right to a part of their future salary and wages. In return for giving up salary and wages, the employer makes a payment or provides goods and services of an equivalent value. For example, the employer may purchase or lease a motor vehicle for the employee or make contributions to a superannuation fund on his or her behalf. All tax-effective salary sacrifice arrangements must operate prospectively and cannot have a retrospective effect. For example, salary and wages, holiday pay or long service leave to which an Financial Planning in Australia 5e Questions: Ch 12 Page 5

6 employee is entitled prior to or at the time of entering into the arrangement cannot be salary sacrificed. Under the tax law, an employee is entitled to salary and wages when work is performed and not when it is paid. The ATO policy on tax-effective salary sacrifice arrangements is published in Taxation Ruling TR2001/10. 9 Discuss the rules for non-concessional superannuation contributions. Non-concessional contributions Non-concessional contributions are generally amounts contributed to the superannuation fund that are not tax deductible. They include personal after-tax contributions, contributions made for a child under 18 or for someone s spouse. Non-concessional contributions are not taxable in the superannuation fund where a person has quoted their TFN. However, where the TFN is not quoted, the fund is required to refund personal contributions. There is no limit to the amount of non-concessional contributions that can be made to the superannuation fund. However, in some situations if a single contribution exceeds the person s nonconcessional contributions cap, the fund must refund any excess. The non-concessional contributions cap is $150,000 or, where the person is under age 65, the non-concessional contributions cap is $450,000 over any consecutive three-year period. The three-year period is triggered in the first year where non-concessional contributions of more than $150,000 are made to superannuation and includes the following two years. Amounts in excess of a person s nonconcessional contributions cap are taxed at a penalty rate of 46.5%. 10 Who is an employee for purposes of the superannuation guarantee legislation? An employee is taken to be a person who works for an employer in the traditional sense in a master servant relationship. However, the meaning of employee is extended to include: contractors who are engaged principally for their labour; directors of companies; members of parliament; and artists and sportspersons. 11 What are the consequences if a person has contributions that exceed the concessional contributions cap? While there is no limit on the amount the contributor can make to superannuation, if a person s concessional and non-concessional, contributions are in excess of the relevant caps, then a penalty tax of 31.5% could be applied to the excess concessional contribution and 46.5% could be payable on excess non-concessional contributions. The tax payable on the excess is in addition to the tax payable on concessional contributions of 15%. Amounts in excess of the concessional contributions cap are carried over to be counted against the non-concessional contributions cap for the fund member. Financial Planning in Australia 5e Questions: Ch 12 Page 6

7 12 What is the importance of an investment strategy for a superannuation fund? The SIS legislation requires trustees to make investments in line with an investment strategy which takes into account the objectives of the fund. Trustees must notify members about the investment objectives and the investment strategy. Financial planners would not usually be involved with formulating the investment strategy of APRA regulated funds; however, they are usually involved with assisting with investment strategies and asset allocation for self-managed superannuation funds. An investment strategy for the fund consists of the following three elements: that the investment objectives and strategy are recorded in the minutes of the trustee meetings; that the trustee carries out the investment strategy and invests the money of the superannuation fund money; and that the trustee outlines the details of the final investment strategy and objectives to members in the regular fund report. Where smaller superannuation funds such as self-managed superannuation funds are involved, an investment strategy is a relatively straightforward matter. A very simple example could be: a rate of return that exceeds the rate of inflation by at least 2% per annum over a specified period; or to obtain a rate of return which does not fall below 5% over any one year. Many funds have much more complex arrangements for investing fund money. This may depend on the ages of fund members and whether they are receiving or are about to receive benefits. In some cases, members may be given a choice of investments which will influence the type of investment strategy decided on. Where a financial adviser provides financial advice in relation to a fund, then the licensee usually the financial planning group that employs the planner may impose more stringent rules and require much more comprehensive information be provided to a client. 13 What are the financial implications of a superannuation fund having in-house assets? A superannuation fund is prohibited from making more than a modest level of investment, such as loans or leases of fund assets, with associates of members, trustees and their relatives (referred to as related parties ). These investments are called in-house assets. The rule ensures that most of the fund s investments are made on commercial terms and, if the related party experiences financial difficulty, members will not lose all of their benefits in the fund. The maximum value of a fund s inhouse assets is not permitted to exceed 5% of the market value of the fund s total assets. Where a superannuation fund breaches the in-house asset 5% rule, the trustees must take action to correct the position, otherwise they will expose themselves to penalties under the SIS Act. Prior to a fund investing in an in-house asset, the trustees are not permitted to acquire the asset unless the fund will continue to meet the 5% rule after the asset has been acquired. Financial Planning in Australia 5e Questions: Ch 12 Page 7

8 14 What rules is a superannuation fund required to meet if it is to be defined as a self-managed superannuation fund? To satisfy the definition of an SMSF, there are a number of conditions that need to be met. The basic requirement is that the fund must have less than five members and the members must also be the trustees of the fund or directors where the fund has a corporate trustee. This contrasts with all other types of funds which are required to have an approved trustee who is a company that is approved and licensed by APRA. 15 Describe the rules that permit a superannuation fund to borrow in limited circumstances. The SIS standards that restrict a superannuation fund from borrowing limit the amount borrowed to cover short-term cash flow needs of the fund and to permit the fund to borrow where it is for purposes of a limited-recourse borrowing arrangement. Money can be borrowed for up to 90 days where the fund is unable to pay a benefit to a member or the borrowing is to pay the superannuation surcharge of a member. It should be noted that the superannuation surcharge ceased some years ago and these days it is unlikely that the fund or one of its members would have a surcharge liability outstanding. The borrowing must not exceed 10% of the market value of the fund s assets. A fund may also borrow to cover the settlement of an investment transaction of the fund where an exceptional event arises that the fund does not have the cash flow to allow the settlement to take place. The borrowing must not exceed 10% of the market value of the fund and it must not be for any longer than seven days. 16 What are the conditions under which a person is eligible for the co-contribution? If a person contributes to superannuation from their after-tax income or their personal savings, they may be eligible for the government s co-contribution. The co-contribution is available for a person who is an employee or for a self-employed person who meets various rules. Employees have been able to access the co-contribution system since 1 July 2003 and self-employed people have been able to access co-contributions from 1 July As a general rule, if the employee/self-employed person earns a total adjusted income of less than $61,920 (2011/12 tax year) and makes superannuation contributions from after-tax income, he or she may be eligible for the co-contribution, which is calculated on the first $1,000 contributed to superannuation. To be eligible for the co-contribution, a person must: earn less than $61,920 (which is the person s net assessable income plus reportable fringe benefits plus reportable employer superannuation contributions); be under 71; make a superannuation contribution to a complying fund; lodge an income tax return for the income tax year in which the co-contribution is being Financial Planning in Australia 5e Questions: Ch 12 Page 8

9 claimed; not hold a temporary resident s visa; and earn at least 10% of their net assessable income plus reportable fringe benefits from employment as an employee and/or from self-employment. With every $1 a person contributes to superannuation from after-tax income, the government matches it with a $1 co-contribution which is paid to the superannuation fund. The maximum co-contribution is $1,000 where a person contributes $1,000 to superannuation and has an income of less than $31,920. For incomes between $31,920 and $61,920, the maximum co-contribution that can be received reduces by cents for every $1 earned over $31, When making a transfer of superannuation benefit from overseas, what issues are required to be considered by a financial planner for his or her client? Before taking any action to transfer the benefit, an individual needs to check with the foreign superannuation fund to see whether the money is accessible and can be transferred to Australia. If it is accessible, then tax may be payable in the foreign country and there may be restrictions on the use of the amount withdrawn. The treatment of the transfer to the Australian complying fund should also be considered. This depends on a number of factors, including the time the person has been in Australia, before receiving the payment and the increase in the entitlement in the overseas superannuation fund since the person became a resident for tax purposes. Any payment made from an overseas superannuation fund to an Australian resident superannuation fund, including the commutation of a pension, may be taxable. However, if the transfer takes place within six months of the person becoming an Australian tax resident, it will be tax free. Amounts transferred after six months can be taxed in one of two ways. This depends on whether the person elects to have the growth in their superannuation benefit since they became an Australian resident taxed in the fund; otherwise, it will be taxed in the person s tax return. If the amount is taxed in the superannuation fund, the tax rate is 15% and if it is taxed in the personal tax return then personal income tax rates will apply. Amounts that are not taxed when they are transferred to Australia are treated as non-concessional contributions in the Australian fund and counted against the person s non-concessional contributions cap. Amounts that are taxed on transfer to Australia are taxable components when they are ultimately paid from the Australian fund. Financial Planning in Australia 5e Questions: Ch 12 Page 9