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What is happening with SMSFs? Part 2

The ATO’s 2017-18 statistical overview of SMSFs provides a first look at the impact of the significant superannuation changes that took effect on 1 July 2017. 

The primary source of data is 2017–18 SMSF annual returns. The key limitations associated are their frequency (annual) and their currency – the returns are not due until a long time after the end of the financial year. However, the ATO has used 2018–19 information for registrations, wind-ups, total populations, demographic data, estimated total SMSF assets and asset allocation, and auditor contravention reports (ACRs).

Part 1 of this article can be viewed here. It includes a granular examination of the costs of running an SMSF.

 

In the 2017-18 financial year, SMSFs made an average return of 7.5% compared with the 8.5% return for large Australian Prudential Regulatory Authority (APRA)-regulated funds. This continues the strong run of positive returns for SMSFs and according to this data over the last three years, comparable performance to the APRA funds.

The SMSF Association has highlighted the difficulties in comparing return data, particularly due to definitions and member cohorts. The impact of COVID-19 will be interesting to watch over the coming reporting years.

Asset allocation in tax returns

(Editor's note: we have previously explained the shortcomings in the ATO asset allocation statistics, especially the reporting of 'Overseas assets' (see here and here). The data only represents direct investments in foreign stock exchanges when most Australians hold their foreign assets through listed and unlisted funds).   

The below graph details the asset allocation of SMSFs in the ATO returns as at 30 June 2018.

While this is some time before the COVID-19 pandemic, our understanding is that the asset allocation of SMSFs has not changed significantly between 2018 and 2020.

Therefore, going into the pandemic, SMSF asset allocation held a significant proportion invested in listed shares and cash. The key drivers for this asset allocation include:

  • Tax preferences for domestic equities – fully refundable franking credits increase the after-tax return for domestic equities, especially for those in retirement phase.
  • A desire for liquidity to pay pensions in retirement – this is especially relevant to the SMSF sector where 42% of funds are in retirement phase.
  • Cognitive biases that drive allocation to assets trustees understand, especially blue-chip Australian companies.

A positive for the sector is that many SMSFs should be able to navigate through this pandemic from a better starting point than some of their counterparts.

Using an SMSF to meet pension requirements

The older cohort of investors requires more liquid assets to service their retirement living expenses. The benefits of the popular financial advice about holding two years of income in cash should bear fruit for many SMSF trustees.

A risk commonly raised in discussions on SMSFs is limited recourse borrowing arrangements (LRBAs). There is no doubt that in the current economic climate, where rental incomes may be reduced or suspended, some SMSFs with property may be facing unexpected risks. However, from a broader picture, the 2017-18 statistics highlight a flattening of LRBA growth and an acceptable level of LRBAs.

The graph below details the asset allocation of SMSFs by fund phase. When SMSFs enter the retirement phase, they are generally doing so without LRBAs and by holding more liquid assets, especially shares.

Growth, establishment and wind-ups

A significant takeaway in the ATO statistics is the increase in establishment balances for SMSFs in the last two years. It highlights that the majority of SMSFs were set up with an appropriate balance. The SMSF Association attributes some of this increase to the behavioural changes resulting in individuals establishing SMSFs with larger amounts due to the expected lower contribution caps allowed after 1 July 2017.

Promisingly, the 2017-18 statistics show the majority of SMSFs are being set up with a balance in excess of $250,000. Some SMSFs have been established with lower balances while expecting future contributions and roll-ins to be received within a short time frame.

In the five years to 2018, the number of SMSFs grew by an annual average of 2.9%. On average 28,490 new funds were established annually. However, the statistics show FY18 was the highest year on record for wind-ups.

Early indicators suggest that the number of SMSF registrations has been increasing. The number of SMSF registrations received between July and December 2019 was 11,558. This compares to 10,954 for the same period the previous year, representing an increase of 5.5%. SMSF registrations for January and February 2020 were 3,246 compared to 2,807 SMSFs registered during the same period last year, an increase of 15.6%.

Contributions and benefit payments

In 2016–17, total contributions to SMSFs were $41.8 billion, while total SMSF benefit payments were $46 billion. These were both significant increases over the previous financial years, most of which can be attributed to a behavioural change resulting from the anticipation of the superannuation reforms taking effect on 1 July 2017.

With the release of the 2017-18 statistics, we now have a reversion to the norm.

  • Total contributions to SMSFs peaked at $41.1 billion in 2016–17 before dropping 58% to $17.4 billion in 2017–18.
  • The decline in contributions was most pronounced for member contributions, which peaked at $33.9 billion in 2016–17 before dropping 66% to $11.6 billion the following year.
  • Total SMSF benefit payments decreased by 15% from $44.3 billion in 2016–17 to $37.7 billion in 2017–18.

The decline in contributions was most pronounced for member contributions, likely due to many SMSFs using their three-yearly contribution bring-forward rule in the previous financial year.

Unfortunately, the statistics don’t detail the amount of money that moved from retirement phase into accumulation phase because of the Transfer Balance Cap (TBC). The data relating to the retirement phase is recorded once all members of the fund receive at least one pension payment.

However, we can see some of the impact in the type of benefit payment taken by SMSF trustees, as lump sums more than doubled in the financial year.

In the 2017-18 financial year, there was a significant increase in lump sum withdrawals from SMSFs. As SMSFs moved money into accumulation phase and the TBC took effect, they took the opportunity to withdraw funds as a lump sum to keep a larger amount in retirement phase. If lump sums were taken from the retirement phase this would create debits to their TBC.

Transition to retirement income streams were also out of fashion in the 2017-2018 financial year. This can be attributed to the loss of tax exemption status for these income streams.

In the 2016-17 year, $31 billion was paid out in income stream payments. In the 2017-18 year, this fell to $20 billion.

 

Franco Morelli is Policy Manager at the SMSF Association. This article is general information and does not consider the circumstances of any investor.

 

13 Comments
Trevor
July 07, 2020

If you are getting a decent return using ONLY Australian-owned and based companies
then I don't see what the problem is. Why would you bother with an 'overseas ' company
where you don't know the people running it [ I almost typed 'ruining it' by mistake ...but then
realised that THIS is often closer to the truth and worth including! ] and have even less control
than you have with a local company ? You could even claim to be meeting your 'social
obligations' by employing your fellow Australians......pity about the car industry though !
Fortunately we are not short of local companies with overseas-investments , so you can get
'diversification' without straying into unknown territory. There is NO OBLIGATION to take on
risk and uncertainty....simply to satisfy some-one-else's idea of what constitutes the best
portfolio structure. The OBLIGATION is to provide the best return you can safely and
responsibly manage. So , ATO advice and dissection aside , who cares as long as you are
able to produce a reasonable return with reasonable effort and reasonable risk ?

John Dakin
July 07, 2020

An eminently sensible proposition, which I follow myself in asset allocation for my SMSF

John
July 07, 2020

In retirement, once the tax free $1.6m TBC has been exceeded, taxes on additional funds outside superannuation can be lower than the SMSF's 15%. If less than $1m is invested outside @ 4.5% average return (realistic for a mix of bonds, local and international shares) the income tax payable on the $45k earnings can be less than if those investments were inside super, but excess to the TBC. Some SMSF administrators charge extra fees for balances above (say) $2m, another reason to invest excess funds outside. Many of us accumulate shares outside super. e.g. ESPP shares and employer stock grants usually have to be owned by the employee, not within a trust like an SMSF. Why trigger CGT just to move them in-specie inside super, only to pay higher taxes on future earnings than if they were kept outside?

Franco Morelli
July 01, 2020

Agree with a lot of the comments here. The SMSF Association is now working with the ATO to get more granular asset data, much like we did with expenses.

Frank Nichol
July 01, 2020

We have 38% of our share investments in the asx in the form of Australian Listed investment companies that deal only in offshore assets, and find this an easy way to address the asset allocation requirement.

RobG
July 01, 2020

Domestic vs International assets is simplistic based primarily on the place of listing. Many of our biggest and best Australian listed companies EARN the vast majority of their income offshore so it is an arbitrary distinction on "domicile", rather than "sources of income". Examples - CSL/RIO/FMG/BHP, Cochlear/Resmed and the list goes on - they are, effectively, international investments.

Bowen pre the last election said Australians had too much of their investments in Australia - really had no idea what he was talking about.

And never forget, owning an offshore listed entity/fund/etf brings into play another variable - foreign exchange risk when probably 99% of Aussie Retiree Liabilities are all in A$'s

Dane
July 01, 2020

Hi Rob,

Australia's market cap represents around 2-3% of the total global investable universe. Most investors in any country exhibit home bias, as you tend to gravitate towards what you know. But to have the majority (often >50%) of your equities exposure in the ASX is questionable. If you're a US investor and tilt towards local stock, the difference is their market represents ~60% of the total universe. Plus add to this the highly concentrated nature (both stock/sector) of our local market and the cyclicality of the sectors that dominate (banks/resources). Adds further impetus to consider diversifying beyond our borders. Global markets also provide exposure to broader sectors (i.e. tech) the ASX just doesn't have. Countless studies have shown the benefits of reducing home bias from a risk/return perspective. Yes, investing in offshore assets introduces currency risk but unhedged equities tend to have a lower correlation so there are diversification benefits. You can always hedge part of your exposure directly/indirectly.

What I don't understand is why you would run an SMSF if you're predominantly investing in listed securities and cash. Can easily do this via a retail fund, saving yourself on costs plus the time spent undertaking trustee responsibilities.

Rob
July 01, 2020

Dane

Sorry - missed the point. In a heartbeat CSL for example, could be listed in the US. No change in the business but, all of a sudden, is an "international" stock. That is why it is simplistic - look at the business, not the domicile.

As to SMSF, I am perfectly happy to invest onshore or offshore. Why would I invest via a Retail or Industry Fund when my costs are less than 1/3 of theirs and I can move in an instant vs days?

Ramani
July 01, 2020

The discussion about the 'overseas assets' label highlights a common draw-back of grouping things to signify their class. Overseas could refer to assets, ownership, manager domicile, even currency of accounting. Is BHP overseas or not?
ATO being a revenue collector (and to a lesser extent other things such as SMSF regulator, disburser of government handouts, administrator of Auskey - embedding tensions from conflicts: if a SMSF trustee was sub-optimal in legal tax minimisation, would the ATO highlight it?) designs labels fit for its main purpose.
The picture can get more muddled if assets are funded from local or overseas borrowings usually with limited recourse which links them more closely than without recourse. Add derivatives, matters are mud-clear.
In analysing data, best to use the stats noting their ambiguity and limitations.
Even at the individual SMSF level where granular information is available, working out exposure to overseas presents definitional difficulties. Money's fungibility has its blind spots!

Jack
July 01, 2020

It's ridiculous that the ATO continues to publish data that says SMSFs allocate only 2% to overseas assets. I heard this number quoted in a webinar last week. Do people think SMSFs don't invest in global ETFs, global LICs, global unlisted funds, Magellan, Platinum, Fidelity and hundreds of others?

SMSF Trustee
July 01, 2020

Jack, none of those assets are 'overseas assets' in terms of the purpose for which the ATO collects data. They're funds that are available in Australia on Australian platforms. That's what the ATO data is showing, the small amount of assets actually held by the SMSF on overseas platforms.

That makes the ATO data less than useful for understanding the asset allocation of SMSFs - something Graham Hand has written about a lot - but it's not 'ridiculous'. They collect data for a certain purpose and share it. That's a good thing.

Tony Reardon
July 01, 2020

I lean more towards Jack's position. I worry about asset allocation in our SMSF and I consider that we hold 24% in Australian equities and 15.5% in international equities. However all of the international holdings are in local managed funds, listed funds and ETFs which leaves all of the difficulties of dealing with currency exchanges and overseas tax offices to the managers.
Whatever other statistics the ATO provides, if they purport to provide statistics comparing the investment mix of SMSFs as compared to large APRA regulated funds, they are being, if not downright misleading, at least ingenuous in ignoring this issue.

SMSF Trustee
July 01, 2020

But Tony, the ATO doesn't purport to do that. People take their data, try to use it that way, and then complain that it doesn't give them what they're looking for. The ATO purports to provide data based on tax information, not on investment principles.

The article says this, with links to previous articles that explain these very points.

 

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