Many investors who work with financial advisers to plan and prepare for retirement will eventually derive income from one or more of three so-called retirement pillars. This pillar framework, as first described in a landmark World Bank report in 1994, helps answer key questions about the role of governments, institutions and individuals in pension provision.1
The pillars as they relate to Australia's retirement system can largely be broken down to the
The age pensionopens new window is paid from tax revenues to individuals currently at least 65 years and 6 months old. The qualifying ageopens new window will rise until 2023, at which point individuals will need to be at least 67 years old to access the age pension.
The age pension is intended as a safety-net source of retirement income, but for many retirees it's a meaningful portion of that income. The age pension is means-tested for both incomeopens new window and assets;opens new window clients with higher income and assets may receive no age pension. Payment ratesopens new window are indexed twice yearly, in March and September.
Workers age 18 and older who earn at least $450 per month, before tax, receive an employer contribution of 9.5% of ordinary-time earningsopens new window into their designated superannuation fund. The employer contribution is scheduled to rise gradually beginning in 2021 until it reaches 12% in 2025.
The Superannuation Guarantee's importance to Australia's retirement system is underscored by the government's efforts to enshrine in legislation the objective of superannuation: To provide income in retirement to substitute or supplement the age pension.
Salary earners can also make tax-deductible super contributions. From 1 July 2017, the "less than 10% rule" was abolished. As a result of this change, individuals who make a personal super contribution can now claim a personal tax deduction for the amount of the contribution on their tax return.
Self-employed individuals and small business owners can make tax-deductible super contributions and in some cases transfer proceeds from the sale of a business into a superannuation fund without incurring capital gains tax.
All super members can contribute from after-tax earnings or from sales or transfers of investments such as shares or property; these are generally described as non-concessional contributions.
1 The World Bank has more recently evolved its three-pillar framework into a more extensive "five-pillar" framework incorporating additional inputs such as social insurance schemes and non-financial factors such as family support. However, the original three-pillar framework remains the most commonly referred to in pension system literature and public policy discussions.
For-profit retail funds and nonprofit industry funds hold the assets of more than four out of five investors in Australia's superannuation system.
Retail fund investors are typically drawn to the funds' wide range of investment options and ability to customise investment portfolios with the help of a financial planner. Industry fund investors are often attracted by their funds' nonprofit motivation and by their alignment with the industry in which they work.
Retail funds leverage the distribution systems of the large, for-profit institutions with which they're typically aligned. Operated mostly by wealth management subsidiaries of banks or life insurance companies, they offer a wide range of investment options to attract and retain superannuation business. These include specialised investment options for investors and advisers seeking to customise their portfolios, diversified funds targeting a range of investor risk profiles, and default options that qualify under the MySuper regime.
Industry funds are often the recipients of investments into default fund arrangements specified in industrial relations agreements. As such, they're the most common destination for newly joining members in industries that operate on a collective bargaining basis, such as the health care, construction, hospitality and retail sectors.
The origins of industry funds go back before the 1992 introduction of the Superannuation Guarantee, under industrial relations agreements to accept mandated contributions from workers in specific industries. They are typically owned and controlled jointly by trade unions and employer representatives in a particular industry.
Public-sector funds include those provided for employees of federal, state and local governments. The funds are multi-employer in nature in that they typically cover a range of entities and offer portability of benefits for members who change jobs within the same arm of public administration.
Public-sector funds include a small number of very large funds that have operated since well before the introduction of the Superannuation Guarantee. While public-sector funds represent a significant proportion of current system assets and member accounts, their market share is expected to decline as other industry segments grow.
Corporate funds are single-employer "in-house" schemes in which employers assume direct responsibility for pension provision. The number of corporate funds has declined dramatically since the introduction of mandatory Superannuation Guarantee contributions (1992), Choice of Fund regulations (2005) and the Registrable Superannuation Entity licensing regime (2006).
Most employers elect to outsource their superannuation provision to a retail or industry fund. Only 24 stand-alone corporate funds remained in June 2018, compared with 4,510 in June 1997. Nevertheless, employers still play a critical role in selecting superannuation providers for their workers, and as such are a crucial distribution channel for both industry and retail funds.
Superannuation Guarantee (SMSFs) comprise groups of no more than four members. Typically formed on a household basis by more affluent investors in their latter working years or in early retirement, SMSFs hold more than a quarter of all super system assets, the greatest among all fund types. They provide greater autonomy around investment selection and management while performing most of the functions that collectively oriented funds do, such as accepting employer and member contributions, receiving rollovers from other accounts and paying pensions.
|Account type||Total assets (in billions of dollars)||Number of funds||Number of member accounts (in thousands)||Average account balance (in thousands of dollars)|
*Total includes other Small Australian Prudential Regulation Authority Funds, single-member approved deposit funds and life office statutory funds not reflected in "Type of fund" categories in the table.
Source: Australian Prudential Regulation Authority Annual Superannuation Bulletin, January 2019.
Your clients may have more options among the different types of super fund than they realise. How many choices they have will depend on their employer as well as their income.
|Type of fund||Industry||Retail||Public sector||Corporate||Self-managed|
|Employee in a specific industry|
|Employees of a single employer||No||No||No|
For some investors, an employer's super contributions alone may not finance a suitable retirement.
All investors' situations are different, of course. And the appropriate level of superannuation contributions as a matter of policy remains open to debate. You nonetheless want your clients to know their options.
Employers pay the
The Superannuation Guarantee contribution regime applies to all employed Australians aged 18 and older who earn at least $450 per month from a given employer. Contributions need be applied only to a maximum of $54,030 in quarterly earnings for the 2018–19 income year.opens new window
Instituted in 1992, the Superannuation Guarantee began with mandated contributions of 3% to 4% that have been increased over time. It is scheduled to be increased further beginning in 2021 until it reaches 12% in 2025.
For some individuals, employer contributions and any age pension for which they may be eligible are unlikely to provide sufficient income to maintain pre-retirement lifestyles in retirement. So, many Australians make additional
Superannuation Guarantee contribution rate over time (in percent)
Both contributions to super and their earnings are taxed, but at lower rates than many investors' marginal tax rates. High-income earners, with combined income and super contributions exceeding $250,000, pay an additional tax on contributions, known as the Division 293 taxopens new window.
Employers' Superannuation Guarantee contributions are taxed at 15% when received by the investor's super fund. The taxes are deducted from the employer's gross contribution, so 85% of the contribution goes into the member's account.
Investment earnings are taxed at 15% during super's accumulation phase but are tax-free after age 60 if the member has an account balance of less than $1.6 million, has retired or satisfied another "condition of release"opens new window and has transferred the money into an account-based pension. Earnings are tax-free at age 65 even if the member hasn't retired, as long as the other conditions have been met.
There is no upper age restriction on mandated employer contributions; some restrictions are in place for personal contributions for individuals over age 65opens new window.
Salary earners can make additional super pre-tax contributions in lieu of take-home pay; these are generally described as "concessional" or "salary sacrifice" contributionsopens new window. In the financial year ended 30 June 2018, the maximum concessional contribution is $25,000, to be indexed over timeopens new window in line with average weekly ordinary time earnings. This cap includes the employer's Superannuation Guarantee contribution and any additional amount contributed by the member through salary sacrifice. All of these concessional contributions are taxed at 15%, as are any earnings they generate.
Beginning 1 July 2018, individuals with superannuation balances of less than $500,000 on 30 June of the previous financial year may be entitled to make additional concessionalopens new window. These would be limited to the value of previously unused concessional contributions, with the unused amounts available for up to five years.
All super members are eligible to make additional after-tax, or non-concessional, contributions from earnings or sales/transfers of investments such as shares or property. These contributions and their earnings are not taxed. The maximum non-concessional contributionopens new window is capped at four times the concessional contribution cap, so $100,000 in the fiscal year ended 30 June 2018. It, too, will be indexed over time in line with average weekly ordinary time earnings.
Under a so-called "bring-forward" provisionopens new window, individuals below age 65 may be able to make up to three years' worth of non-concessional contributions – up to $300,000 at the current maximum – in a single financial year. The bring-forward provision makes allowances through 2018–19 for previous years when the annual non-concessional contribution cap was higher.
No non-concessional contributions are allowed in financial years when the investor's total superannuation balanceopens new window is $1.6 million or greater on 30 June of the previous financial year.
Your clients can report nonpayment, late payment or incorrect payment of the Superannuation Guarantee at the Australian Tax Office websiteopens new window.
The approximately 10% of Australia's working population who are self-employed aren't covered by the Superannuation Guarantee. However, they can access broadly equivalent tax concessions by claiming a tax deduction on non-concessional contributionsopens new window made from their after-tax income or other income.
Since 1 July 2017, a similar facility has been available to employees whose employers do not allow voluntary salary sacrifice contributions to be made through payroll deductions.
This means that all Australian wage and salary earners now have the ability to enjoy equivalent taxation benefits on their voluntary superannuation contributionsopens new window beyond the employer Superannuation Guarantee rate.
The websites of the Australian Taxation Officeopens new window and the Australian Securities & Investments Commissionopens new window provide further discussion around super contributions including government co-contributionsopens new window and the low-income tax offsetopens new window.
How individuals most effectively access their superannuation benefits for retirements that could last decades has drawn considerable attention within the government and industry. We look at product types and drawdown strategies in more depth elsewhere.
While a standard for retirement income products is debated, many individuals choose to draw down from account-based pensions to finance their retirements. It's important that they understand the mechanics of doing so.
As its name suggests, preservation ageopens new window is the age until which superannuation benefits are "preserved" for use in retirement. In other words, workers can't access the money in their super accounts before preservation age except in limited casesopens new window including financial hardship, permanent incapacity or terminal illness. With the exception of some legacy contributions accrued before the late 1990s, opens new window all superannuation contributions and earnings are preserved, including those associated with the Superannuation Guarantee, after-tax contributions, rollovers and salary-sacrifice contributions.
A historic preservation age of 55 is being raised gradually. By 2024, preservation age will be 60 for all workers born after 1 July 1964.
|Date of birth||Preservation age|
|Before 1 July 1960||55|
|1 July 1960 – 30 June 1961||56|
|1 July 1961 – 30 June 1962||57|
|1 July 1962 – 30 June 1963||58|
|1 July 1963 – 30 June 1964||59|
|From 1 July 1964||60|
Source: Australian Taxation Office
Upon certain conditions of releaseopens new window, chief among them retirement at or after preservation age, individuals can access part or all of their super benefits. It's important to note that individuals must be permanently retired and have reached preservation age, or have attained age 60 and ceased gainful employment, to fully access superannuation benefits. Individuals not permanently retired can access part of their super benefits through the "Transition to retirement" (TTR) facility.opens new window
Upon reaching age 65, workers have full access to their superannuation benefits whether they're retired or not.
Individuals who have begun to draw down on their super accounts must do so by at least a minimum percentage of assets annually, ranging from 4% for the youngest retirees to 14% for the oldest.
|Age||Minimum withdrawal percentage|
|95 and older||14%|
Source: Australian Taxation Office
The "Contributing to super" section discusses taxation of super upon contribution and during the accumulation phase. At withdrawal, super benefits are tax-free, whether taken as a lump sum or as part of a qualifying income stream, provided they are taken after age 60 (and that the member's total balance is within the $1.6 million transfer balance capopens new window ). Benefits accessed between preservation age and age 60 (for the years that those dates still differ) are subject to taxes, at rates typically lower than most marginal tax rates.
Many individuals will have both taxable and tax-free super owing to legacy taxation rules. Your clients' super funds can determine how much of an account is taxable or tax-free; this information is generally available on members' annual benefit statements.
The TTR facilityopens new window, offered by most major super funds (though not compulsory) allows individuals who have reached their preservation age to access some of their superannuation benefits before age 65 while still working. TTR can be appealing because it allows individuals to reduce working hours while maintaining their income level. During this period they remain eligible for employers' Superannuation Guarantee contributions.
Initially intended to encourage older workers to stay in the workforce part-time, TTR was quickly identified as a tax arbitrage vehicle for higher-income earners to increase super account balances without reducing work hours or take-home pay. (New or increased salary sacrificed contributions were taxed at 15% rather than income being taxed at a marginal tax rate, with tax-exempt super benefits restoring the income lost through salary sacrifice.)
TTR remains a popular strategy for some retirees who work beyond their preservation age, even though recent regulatory changes have limited the tax-arbitrage opportunity.
Prior to retirement, super accounts are considered in accumulation phase, and contributions and earnings within the account are taxed. Upon retirement at or above preservation age, individuals can transfer money from their accumulation phase super accounts to retirement phase accounts, which are tax-exempt. The government caps these transfer balances at $1.6 million. The Australian Tax Office provides guidance on the transfer balance capopens new window on its website.
The age pension is available to individuals who have reached qualifying ageopens new window and aren't disqualified through an income testopens new window or an assets test.opens new window Some individuals won't receive an age pension because of the income and assets tests, making their superannuation benefits crucial to their retirement planning.
Investors in super fall into two categories: those who choose and those who don't.
Those who choose, whether on their own or with the help of their financial adviser, must first choose their fund and then their specific investments.
Those who don't choose have their super contributions invested by default with the super fund of their employer's choice and in that fund's low-cost, diversified
Individuals who aren't assigned to a super fund through an industrial agreement and who don't opt to participate in a self-managed super fund have dozens of public-offer funds dozens of public-offer fundsopens new window from which to choose. Most of these individuals invest in either a retail fund or an industry fund.
Once a member has chosen a super fund, the next question is which investment strategy to adopt. Many super funds create predetermined investment mixes catering to risk tolerances. The investor chooses from, say, a conservative, moderate or aggressive portfolio and doesn't need to think about it further unless his or her risk tolerance changes, as the investor ages, for example. Some super funds allow members to choose their own underlying investments to create a portfolio of securities across one or more asset classes such as shares, bonds, property and term deposits, and to manage the mix between these asset classes by themselves.
Members can alternatively choose to invest in the default option that is intended for members who don't choose – MySuper. This will typically be the largest investment option offered by the funds in terms of assets and member numbers.
The Cooper Review, a 2010 government review of the superannuation system, led to the creation of MySuper products intended to serve as the default investments for individuals who don't make an investment choice. The first such products were introduced in 2013. By mid-2017 all members' default balances had been transferred to a MySuper product, in part to ensure that members weren't left in more expensive default products.
As at 30 June 2018, MySuper assets totalled more than $677.5 billion, accounting for more than 38% of all superannuation assets held by entities regulated by the Australian Prudential Regulation Authority.opens new window
MySuper, with diversified investment strategies and standard fee and performance disclosure requirements, allows for a like-for-like comparison across products, helping to ensure your clients weigh up the relative advantages and disadvantages of competing offerings. MySuper products additionally must provide a standard level of life and total and permanent disability insurance, with members being able to opt out or apply to purchase additional coverage.
The majority of MySuper products have a single diversified portfolio with strategic allocations to growth assets such as shares and property generally in the vicinity of 60% to 75%. A smaller proportion of MySuper products offer a more dynamic life-cycle option.
More than a quarter of all MySuper options are offered on a life-cycle basis, with exposures to more risky assets reduced automatically as members move between age segments over time. Many of these options have only two or three phases of in-built asset allocation changes; more tailored target retirement date "glide-path" designs, popular in many developed nations, remain relatively uncommon in Australia.
Many Australians take advantage of the opportunity to manage their own retirement accounts. The self-managed super fund (SMSF) has become the largest industry segment by assets, with nearly $750 billion as at 30 June 2018.
While the segment affords significant autonomy, it also requires investors and their advisers to become well-versed in matters such as portfolio construction, retirement income streams and taxes.
Because SMSFs are used most widely by older, more affluent investors, advisers are well-placed to provide guidance not only around saving and investing, but also around preparing for and entering retirement. A universe of nearly 600,000 SMSFs suggests a significant opportunity for specialists who cater to this group.
SMSFs, private funds regulated by the Australian Taxation Office, are typically established on a household basis. They can have up to four members who are also fund trustees. Because they can be expensive to set up and operate, SMSFs are most cost-effective for investors with larger balances.
They can be popular with older investors who may become more engaged with planning for retirement as they near it. These older investors, having reached peak earnings years, and perhaps having paid off mortgages and seen children leave the nest, may be better positioned than others to make concessional and non-concessional contributions on top of the Superannuation Guarantee to boost their super accounts.
Advisers may provide significant guidance to SMSFs, but investors themselves are ultimately responsible for their decisions.
SMSFs can do most of the things that collectively oriented funds do, such as accepting employer and member contributions, receiving rollovers from other superannuation accounts, paying pensions, and providing a vehicle for transferring external assets including proceeds from the sale of private businesses.
They also place significant responsibility on the investors who serve as fund trustees and subject them to rules similar to those that govern larger super funds. For example, SMSF investors – on their own or with an adviser – need to determine a long-term investment strategy, research and manage investments, and budget for the professional services they'll need, including an annual audit by an approved SMSF auditor.
An Australian financial services (AFS) licence is required to provide financial advice to SMSFs.
AFS licensees are able to provide advice to SMSFs on topics including:
The Australian Securities & Investments Commission spells out the licensing requirements for provision of SMSF services.opens new window The Australian Taxation Office provides checklistsopens new window on setting up an SMSF, winding up an SMSF and everything in between.
Investment fees within super are inevitable. From administrative fees paid to the super fund to investment management fees, investors must pay some amount for the services they receive.
But fees eat away at investment returns. All else being equal – such as a fund's specific investments and the prices at which they're bought and sold – a lower-fee fund will outperform a higher-fee fund.
Superannuation investors need to pay attention to a range of fees, some of which are deducted directly from individual accounts and others – largely unseen – that reduce the value of investments:
Administration fees help cover a super fund's operational costs. They may be charged as a dollar value, a percentage of assets, or both. Percentage-based fees may be capped at a given asset threshold; where they're not, a member with a larger balance would pay more than a member with a smaller balance.
Investment fees compensate the experts who manage members' money. Typically expressed as a percentage of assets called the management expense ratio (MER), investment fees can vary significantly from fund to fund.
Performance fees are a subset of investment fees and are becoming more prevalent. Fund managers can be paid more when their performance exceeds a specified goal. Funds that charge performance fees may offset them through lower ongoing investment fees. Some funds incorporate performance fees within the MER while others charge them separately.
Advice fees compensate financial planners for guidance they provide to individuals about their super investments. Planners may charge a flat fee or a percentage fee. Some investments have commissions paid by super funds, but such commissions have recently been banned and only "grandfathered" commissions are still collected.
Other fees include switching fees for changing investment options; buy/sell spreads for transactions; insurance premiums for the cost of insurance provided through a super fund; and exit fees for leaving the fund.
Total fees across funds regulated by the Australian Prudential Regulation Authority averaged around 1.1% in 2016–17, suggesting that a member with a $50,000 balance paid fees of around $550 a year.
Fees must be disclosed in super funds' product disclosure statements, but inconsistencies with how fees are reported make comparing funds challenging. The Australian Securities & Investments Commission offers tips on comparing fees and other super-fund aspects.opens new window Fees aren't the only factor in choosing a super fund, of course. But in its 2018 review of the super system, the Productivity Commission found that higher fees of just 0.5% per year could shave the balance of a typical worker starting work today by $100,000 over the course of their career.
All else being equal, fees reduce investment returns
Superannuation trustees – whether of
Financial advisers are governed by different rules from super fund trustees but are similarly required to act in investors' best interests.
A "best interests" covenant has been part of the superannuation system from the beginning, since the enactment of the Superannuation Industry (Supervision) Act 1993opens new window, better known as the SIS Act.
The currently in-force standard calls for all trustees to "exercise the trustee's powers in the best interests of the beneficiaries." The covenant is broadly understood to relate to members' long-term interests, given the system's retirement objective.
The Australian Prudential Regulation Authority (APRA) oversees super funds' governance, investment management, insurance and outsourcing arrangements, as well as compliance with a range of specific standards around issues such as liquidity, risk management and related-party transactions.
APRA has primary responsibility for administering the SIS Act, which includes a number of operating and fiduciary standards that are mandatory for all funds.
The national securities regulator, the Australian Securities & Investments Commission (ASIC), is responsible for consumer protection aspects of the superannuation system, including disclosure requirements, complaint handling and licensing for funds and service providers offering personal financial advice. These requirements are contained in the Corporations Act 2001opens new window and associated regulations.
Public sector funds are generally exempt from formal APRA supervision and many ASIC requirements, but most opt in to broadly equivalent standards under parallel state or commonwealth legislation.
Despite their dual regulatory structure, funds that serve a large number of members are described by the generic term "APRA-regulated". This is primarily to distinguish the funds from self-managed super funds (SMSFs), which are not subject to APRA supervision but are instead regulated by the Australian Taxation Office, principally to ensure compliance with relevant taxation and audit requirements.
SMSF members are also an SMSF's trustees. In practice, some trustees of a given SMSF may be "active" while others are "passive". They nonetheless must act unanimously and in the best interests of all members.
Financial advisers who provide personal advice to superannuation investors – whether investors in APRA-regulated funds or SMSFs – are covered by the best interests duty of the Corporations Act 2001. In doing so, advisers are required to:
ASIC's Regulatory Guide 175 spells out how certain conduct and disclosure obligations apply to the provision of financial product advice.