Aussie Super - too generous?

Mercer consulting released a report this week which concludes that:
...current tax concessions on superannuation in Australia are not generous when compared to retirement systems in eight other countries, considered to have the best pension systems in the world (Australia, Canada, Switzerland, Netherlands, Denmark,  Sweden, USA and UK).

The report may be downloaded here.

It shows:  

• after tax retirement benefits provided to Australians are lower than five of the eight countries for an individual on average earnings, with a 9% employer contribution over 40 years

• Australia is the only country that taxes employer and self-employed contributions, and it is also the only country where employees don't receive a tax deduction for contributions.  

• Australia is also one of only three countries that taxes income earned by pension and superannuation funds. The other two are Denmark and Sweden. Australia is, however, one of only two countries that does not tax retirement income.  You can read the Fairfax commentary on this here.   In Australia  contributions and earnings are reduced by taxes over a person's working life and  this has a direct impact on the final benefit received by retirees, and in many cases increases the likelihood of people receiving an age pension

• Recent changes to contribution caps leave Australia third last on this measure.

The main conclusion: whilst the Australian superannuation system benefits higher income earners the most, the design of the whole system is reliant upon all those people's taxes paid both during their working lives and on the income earned by their superannuation funds. Amendments to the system made in order to fill a budgetary hole may jeopardise the ability of the system to fund pension benefits into the future.

Super Election

Cartoon by Nicholson from "The Australian" newspaper: www.nicholsoncartoons.com.au

Be prepared for a lengthy debate about Superannuation in the lead up to September's federal election.  A government with falling revenues and big promises (Gonski education reforms, National Disability Insurance Scheme, an ever burgeoning health budget) needs to find the money to pay for the policies from somewhere. Already, we know the following:-

The ALP Government is considering proposals to make changes to the tax treatment of superannuation.

In Parliament on Monday 4 February 2013, Opposition Leader Tony Abbott called  on Prime Minister Julia Gillard to join him in ruling out any ''unexpected adverse changes'' to superannuation arrangements, ''now or in the next Parliament''.

Senator Nick Sherry (former Superannuation Minister from 2007-2009) was reported in the Australian Financial Review (6 February 2013) urging the government not to change the way it taxes super and consider other ways to raise revenue, including cuts to contributions to generous public service super.   He said the current tax treatment for super was “appropriate” though he did add that there were areas within the super system that require attention:

1. the current retirement access age for super of 60 should be raised to 67, which is what the pension access age will climb to over the next decade. (The retirement access age allows people to work part-time and draw down their super at the same time.) and
2. the government’s contribution to military super should be cut from about 28% and public sector super from 15.4% and said there was “no justification” for such a level of contribution “above the community standards”.

In response to that, Prime Minister Julia Gillard has said Labor would “never” introduce a new tax on super lump sums. Instead, the speculation now is that Cabinet's expenditure review committee is examining higher tax rates on super contributions and earnings instead, with a goal of identifying new revenue sources without targeting any one income class.  Unions have urged cabinet to target the top 10 per cent of income earners, arguing that those high earners receive one-third of the existing tax benefits. 

Commentary on the speculation abounds.  The Australian newspaper ran this editorial on 7 February:

The changes smacked of a tax grab on wealthy people motivated by the politics of envy, not considered amendments to shore up the system's long-term viability. The Henry review's recommendations on superannuation, at hand for more than three years, have been comprehensively ignored. Further curbs to superannuation tax concessions will not provide the torrents of revenue the government hopes. Savings from withdrawing tax concessions - routinely put at about $30 billion - are a mirage that assumes contributions continue even if the concessions are withdrawn. Discouraging further contributions to Australia's $1.4 trillion private savings pool will ultimately cost the government money - perhaps not the Gillard government but future governments and ultimately future taxpayers. Superannuation helps defray the long-term cost of the age pension, which at about $35bn a year is by far the largest burden on Australia's taxpayers.

On Friday 8 February the Association of Superannuation Funds of Australia warned:

decreasing incentives for individuals to put super at the forefront of their retirement planning risks creating bubbles in other sectors if investors turn to, for instance, property investments.

And further, Robert Gottliebsen wrote on Friday 8 February that the Treasury has made errors in their calculations of the actual subsidy represented in superannuation concessions which together with inflated projections of returns on investment (7%) have led the Commonwealth government to "muck up the sums", revealed by the Self Managed Superannuation Fund Owners Alliance.  Gottliebsen contends that the real concessions lie in property: "and they can't be touched".  Read it here.

What to do?

We don't yet know the specific policy nor its timing.  There is a question over whether any proposals could be legislated prior to the coming election.  

Investment managers will tell you that "governments in desperate need of revenue will always fiddle with superannuation tax concessions, irrespective of sensible calls by the industry for certainty and confidence" see the view from the Institute of Chartered Accountants.  See also our October 2012 blog post SMSFs - the less change the better.

For retirees - it's irrelevant.  For those nearing retirement it's an uncertainty.  For those aged 40 and younger it's a disincentive to participate in voluntary contributions into superannuation as participants can't have confidence in the system, its longevity and its relevance to the participant over the longer term.  However, we also know that the under 40s are not really the major contributors to superannuation because of the other life expenses such as houses, school fees and other children's expenses .  

We shall observe closely and provide updates as appropriate particularly with a view to SMSFs.

Bringing it home

Industry is coming back to the USA.  Some call it “insourcing” or "onshoring".

Yesterday Apple CEO Tim Cook announced a $100 million investment returning the manufacture of Mac computers to the USA in 2013: “We’ve been working for years on doing more and more in the United States.” He added that he hoped it would spur on more U.S. manufacturing. “The consumer electronics world was really never here. It’s a matter of starting it here.”  Whether this is the start of something bigger or an attempt at good PR in Washington, the Apple announcement comes on the heels of GE’s recent reintroduction of its appliance manufacturing assembly lines to its Louisville Kentucky “Appliance Park” which had been languishing since the 1980s decision to shift manufacturing to China.  The GE initiative is costing $800 million and CEO Jeffrey Immelt said, “I do that because I think we can do it here and make more money.”  The Atlantic Magazine December 2012 contains a fascinating article on the topic entitled “The Insourcing Boom”.

Global economic factors are now in play:-

·         Oil prices are three times what they were in 2000, making cargo-ship fuel much more expensive now than it was then.

·         The natural-gas boom in the U.S. has dramatically lowered the cost for running something as energy-intensive as a factory in the USA. (Natural gas now costs four times as much in Asia as it does in the U.S.)

·         In US dollars, wages in China are some five times what they were in 2000—and they are expected to keep rising 18 percent a year.

·         American unions are changing their priorities. Appliance Park’s union was so fractious in the ’70s and ’80s that the place was known as “Strike City.” That same union agreed to a two-tier wage scale in 2005—and today, 70 percent of the jobs there are on the lower tier, which starts at just over $13.50 an hour, almost $8 less than what the starting wage used to be.

·         U.S. labor productivity has continued its long march upward, meaning that labor costs have become a smaller and smaller proportion of the total cost of finished goods.

The compressed and ever shortening product cycle, coupled with the adaptation of "mature" products such as dishwashers and water heaters to include computer software to improve efficiency and functionality also drives changes to factory processes.  Factories take a while to settle into a new product, a new design. They face a learning curve. But models that have a run of only a couple years become outdated just as the assembly line starts to hum. That, too, makes using faraway factories challenging, even if they are cheap.

GE is rediscovering that how you run the factory is a technology in and of itself. The R&D that can happen there, if you pay attention, is worth a lot more to the bottom line than the cost savings of cheap labor in someone else’s factory. GE’s appliance unit does $5 billion in business—and today, 55 percent of that revenue comes from products made in the United States. By the end of 2014, GE expects 75 percent of the appliance business’s revenue to come from American-made products like dishwashers, water heaters, and refrigerators, and the company expects that its sales numbers will be larger, as the housing market revives.

What’s happening in factories across the U.S. is not simply a reversal of decades of outsourcing. If there was once a rush to push factories of nearly every kind offshore, their return is more careful; many things are never coming back. Levi Strauss used to have more than 60 domestic blue-jeans plants; today it contracts out work to 16 and owns none, and it’s hard to imagine mass-market clothing factories ever coming back in significant numbers—the work is too basic.

Appliance Park once used its thousands of workers to make almost every part of every appliance; today, every component GE decides to make in Louisville returns home only after a careful calculation that balances quality, cost, skills, and speed. Appliance Park wants to make its own dishwasher racks, because it can, and because the rack is an important part of the dishwasher experience for customers. But Appliance Park will likely never again make its own compressors or motors, nor is it going to build a microchip-etching facility.

Manufacturing employment will never again be as central to the U.S. economy as it was in the 1960s and ’70s—improvements in worker productivity alone ensure that. Back in the ’60s, Appliance Park was turning out 250,000 appliances a month. The assembly lines there today are turning out almost as many—with at most one-third of the workers.

All that said, big factories have a way of creating larger economies around them—they have a “multiplier effect,” in economic parlance. Revere Plastics Systems, one of GE’s suppliers, has opened a new factory just 20 minutes north of Appliance Park, across the Ohio River in Indiana, and has 195 people there working in three shifts around the clock. The manufacturing renaissance now under way won’t solve the jobs crisis by itself, but it could broaden the US economy, and help reclaim opportunities—and skills—that have been lost across the past decade or more.

Many offshoring decisions were based on a single preoccupation—cheap labor. The labor was so cheap, in fact, that it covered a multitude of sins in other areas. The approach to bringing jobs back has been much more thoughtful.  

It bodes well for the US economy and we consider it’s a trend for Australian investors to watch closely.

Beware! SMSFs investing in property

From time to time the Tax Office issues “Taxpayer Alerts” intended to be an “early warning” of significant new and emerging higher risk tax and superannuation planning issues or arrangements.  This is published for SMSF trustees and their financial advisers “to exercise care” .

The latest Taxpayer Alert TA 2012/7 published 20 November 2012 relates to self managed superannuation funds (SMSFs) which acquire property in contravention of the superannuation laws.  You can find it in full here.  The ATO is particularly concerned about acquisitions involving limited recourse borrowing arrangements (LRBA) or the use of a related unit trust.

Incorrect structuring of such arrangements may lead to a range of significant consequences for the fund such as:

• Having to include the SMSF loan repayments in members’ assessable income;
• Members having to declare the income and associated deductions from the investment rather than by the SMSF;
• Rendering the SMSF non compliant for tax purposes, leading to the requirement that it include amounts of income from previous years in its assessable income (45% tax rate applied to its income and market value of its assets other than undeducted contributions measured at the start of the income year in which the fund becomes non-complying.  There may also be civil or criminal penalties for trustees);
• The unit trust might incur a capital gains tax liability in relation to the disposal of the property; and
• The Members and the SMSF may be required to include a capital gain in their assessable income on redemption of their units in the unit trust.

Structuring such property acquisitions by SMSFs within the rules is complex and requires great care and knowledge of the Superannuation laws and regulations.  We have done these transactions for clients who have specific knowledge of the property in question together with a clear idea of its likely future performance and who are prepared to very carefully negotiate and structure the requisite documents.  It’s certainly not for everybody.

We also note that residential real estate in Australia would need to rise around 8% from today to reach its all time high (in 2010) and we consider generally that now is not the time to consider such an acquisition within super, with the primary purpose of seeking capital gains.  The Australian equity market by comparison needs to rise by over 50% from today to reach its all time high (2007).  In all likelihood both asset classes will make new highs in the next decade but this comparison shows equity markets have more to gain than Australian residential real estate.  The comparison is different for commercial and industrial property.

We know you won’t find many financial advisers in Australia taking this line –there are many spruikers out there offering to SMSFs the prospect of property investments using LRBA or related unit trusts.  Be warned!

SMSFs - the less change the better

Cartoon by Nicholson from "The Australian" newspaper: www.nicholsoncartoons.com.au

Rumours  abounded prior to the recent Mid-Year Economic and Fiscal Outlook (MYEFO) that Treasurer Swan was looking to fill a hole in the Budget by attacking the superannuation industry one way or another. Changes to capital gains tax had been mentioned by various commentators.  We saw the significant labour union and industry super figure in Bill Kelty come out and make a strongly worded statement via the weekend papers that the government should "be very careful" when tinkering with the superannuation system.  As it's turned out the only measure to hit  self-managed funds is the increase in the SMSF levy from $191 to $259, which equates to around $32 million a year in extra revenue.

An additional pleasing measure for self managed fund trustees and their advisers to know about is the government's move to amend the law as it relates to the tax exempt status of fund income earned on investments used to support pensions.

The government decision overturns a draft ruling made by the Tax Office last year and will allow the pension earnings tax exemption to continue after the death of a pensioner until the deceased member's benefit has been paid out of the fund.

Andrea Slattery, CEO of the SMSF Professionals Association of Australia said on 22 October 2012:

This is excellent news for the thousands of SMSFs in the pension phase which could otherwise have faced significant capital gains tax bills on the payment of death benefits.

The new law will apply for the 2012-13 tax year.

Trustee Penalties - Self Managed Super laws

The Government has released draft legislation which introduces administrative consequences and penalties for trustees of self managed superannuation funds (SMSFs) and the accompanying explanatory material which will apply from 1st July 2013.

The Cooper Review had found that the existing penalty regime applicable to trustees of SMSFs limits the Commissioner of Taxation’s (the Commissioner’s) ability to achieve optimal regulation of the SMSF sector. It concluded that additional tools (both punitive and educational), in conjunction with its existing powers are required to give it more flexibility to deal with non-compliance with the law. In exposure draft stage, the legislation gives the Commissioner powers to issue rectification directions, educational directions and administrative penalties to individual trustees and directors of corporate trustees who contravene the SMSF rules.

Currently, the Commissioner has the following options to rectify non-compliance:-

• making an SMSF non-complying for taxation purposes;
• applying to a court for civil penalties to be imposed. A person may also face criminal penalties for more serious breaches of the law;
• accepting an enforceable undertaking in relation to a contravention; and
• disqualifying a trustee of an SMSF.

These could all lead to members suffering a penalty arguably disproportionate to the breach. Applying current penalties can be costly and time-consuming. The Commissioner is unlikely to use the existing range of powers except in cases of significant non-compliance with the law. The absence of graduated penalties results in a number of SMSF trustees avoiding sanction for contravening conduct by simply rectifying the conduct when it is detected. This may be appropriate in certain circumstances, but the Explanatory Memorandum to the draft legislation states "it is not appropriate that trustees can continue to contravene the law and for their actions to have no consequences".

The new legislation will allow the ATO to levy penalties upon the trustee (i.e. personally payable by the individual person who committed the breach) and which must not be paid or reimbursed from assets in the SMSF. These penalties could range from monetary fines (up to $6,600) through to attending educational courses that relate to their responsibilities as a trustee.

It is intended that the range and type of remedy and penalty will give the ATO greater flexibility and additional tools to regulate SMSF trustees.

This is going to become a greater issue in the context of SMSFs taking a greater proportion of the superannuation industry in Australia.  Disaffected investors are moving into SMSFs at a great pace as the big listed funds are looking at woeful performance results.  Robert Gottliebsen wrote recently:

In a vast number of cases individuals have found they are able to tailor their investments to their own needs and slash their costs. The strong performance of bank deposits has been a major factor in self managed funds doing well.

From minor amounts a decade ago, self managed funds have captured an incredible 35 per cent of the market and look set to take half of all superannuation. 

Opportunities from QE3?

Chairman Bernanke and the FOMC have acted strongly in their announcement of “QE3” overnight.  An immediate share market rally is expected by many, some argue that it’s been already priced in.  A complex web of domestic and international influences should be considered by Australians in making their investment decisions.

Commentators vary in their response to the Fed’s announcement ranging from Goldman Sachs’ view that “further stimulus represents a clear signal that economic growth remains stalled” to UBS’ strategic view essentially ignoring QE3 and taking steps to position for a pullback in stock prices post-easing and as the fiscal cliff approaches toward the end of the year.

Karen Maley writing in the AFR said today:

Critics argue that QE3 will undoubtedly affect the prices of assets, such as shares and commodities, but will have no effect on US employment. The Fed is able to affect asset prices because when it buys US Treasuries and mortgage-backed securities, it effectively removes these assets from the market. That pushes up the price (and reduces the yield) on those ‘safe haven’ assets. (Incidentally, it also pushes up the price, and reduces the yield of other ‘safe haven’ assets, such as Australian government bonds, which boast a triple-A rating.)

But QE3 won’t encourage businesses to borrow more money to invest and hire new workers, because companies are worried about feeble demand for their products. And QE3 won’t encourage consumers to spend more, because they’re worried about their job prospects, and banks remain extremely reluctant to lend to debt-laden households.  By pushing up their cost of living, QE undermines the living standards for millions of low- and middle-income households. The wealthy – who own large share portfolios – get a benefit from rising equity markets, but most people end up worse off financially.

By targeting mortgage bonds in his latest round of QE3, Bernanke is clearly trying to spread the benefits of QE3 to the US middle classes – for whom their house is their important asset. But with an estimated one in seven US households underwater on their mortgages, and with a mountain of foreclosed houses yet to hit the market, it’s unlikely that a marginal reduction in US mortgage rates will provide much of a boost to home prices, or spur activity in the embattled housing sector.

Back in March 2012 we wrote about Investing in a QE World.  In that piece we explained what QE is and how it has been implemented by the major central banks.  Since that time we have observed the European ECB and Bank of England response.

The Economics editor of the Guardian reflected on 6 September 2012:

In one important respect, QE did the trick, because without it there is no telling what would have happened to the global economy in the winter of 2008-09. By the summer of 2009 there was clear evidence that the decline in output had bottomed out. Fears of a Great Depression 2 were scotched.

And yet, QE was supposed to be a temporary measure, with the process reversed once the global economy returned to normal. Far from that happening, central banks kept on buying bonds. The Bank of England is on its fourth round of QE; the Fed is about to embark on its third. Despite an unprecedented stimulus, the global economy is losing momentum

Is it all bad, though? Before answering this question, Australian investors need to consider the following six interlinked areas:-

1. The Australian dollar:  Our earlier post set out the critical issues for our dollar including commodity prices and demand from foreign sovereigns.  Devaluation of the US Dollar inflates the value of ours – this correlation must be watched closely mindful of the negative effects on Australian producers & exporters of a high dollar.
2. Commodities prices: (especially iron ore) but also metals including gold and silver – to a very large extent these are determined by demand for our commodities from China.   Slowing global demand for our commodities particularly iron ore and other mining exports will be the greatest influence on our domestic economy for the near future.  The recent price falls in the iron ore price and its partial recovery will be pivotal.   The speed with which change in this sector can occur is exemplified by Fortescue  this week which is now in a trading halt as the company approaches its banks to waive lending conditions.  Watch this space – China is key.
3. Shares: There will undoubtedly be winners in equity markets in Australia and overseas.  The challenge is in picking suitable stocks (or ETFs) which sit happily with your risk profile and your proposed holding time.  We all know a trade is different from an investment.  Our summary of the current position is: Expect market volatility between now and the start of 2013 as global issues dominate including further chapters in the European debt crisis, Arab political instability, US presidential elections and dealing with the “fiscal cliff”. Traders may wish to consider income producing stocks including global ETFs. Traders may wish to consider diversification into natural resources funds as a potential hedge against future inflation (see more on inflation below).  Longer term investors may prefer to remain prudent in the face of continued volatility  and uncertainty and stay out of stocks until the start of 2013.   US equities may appear more attractive than Australian shares if you can manage the currency issues.
4. Inflation:  How do you protect your investments against this?  Protecting yourself against future inflation is going to be an increasingly important consideration now.  There are a number of options to consider – ranging from investments in gold, hedged equities, commodities, inflation protected bonds and ETFs.   We consider these options at length and propose specific strategies suited to our clients’ investment profiles and needs.  This is a sophisticated and complex area and we do not make any general recommendations at this point in time.
5. House prices: Australian house prices continue to be considered overpriced by international and historical standards.  Overseas commentators remain negative about future capital growth in the Australian real estate sector.  Domestically, there are mixed messages coming from different markets across the country.  However, the overall trend is that things are tracking sideways, with risks to the downside.  This is no environment in which to recommend investment properties with enthusiasm.  Yet we continue to receive multiple calls weekly from property spruikers wanting to put our self funded retirees into residential real estate investments.  We are currently resisting this trend and do not recommend Australian residential investment to our SMSF clients generally at this time.   We mention house prices now as we are going into a new spring selling season, mindful that supply of housing stock is at record highs, the time it takes to sell a house is also very long in Melbourne and Sydney and the recent volume of mortgage transfers reported by government is at historic lows.  We would not be surprised to see a flat or negative selling season ahead.  This has an effect on the Australian banking sector and bank stocks in particular given the huge focus they have had on domestic mortgage lending over the past decade.  Their massive profitability has ridden the “house price increase” wave and all commentators seem to agree that this ride is over: see Gail Kelly’s recent comments here.
6. Australian interest rates: Expectations are that the RBA will lower interest rates again, and that the immediate future looks like a lower rate environment. This is a further blow to self funded retirees looking to live off their super pensions and those for whom a large part of their super is currently held in bank deposits. Lower returns on investments are the “new normal” and the only thing that will change these returns at this time is increased risk in investments – and that brings greater risk to the downside as well.  Speculative investment within super is not good if you want to rest easy at night.  It may prove good for the hip pocket but then again it may not go well at all.  That’s the risk. Lower rates are reflected in the Australian Bond yield curve, to which we have made reference before.  It continues to be in a negative yield curve – a negative portent for our economy generally.

We haven’t talked in this post about other economic indicators such as unemployment, GDP and PMI.  Neither have we mentioned industrial unrest, wages pressure, political issues such as funding for government spending programmes such as the NDIS, Gonski and the Dental Scheme which are looking like blowing a big hole in the Commonwealth Budget.  These issues are all bubbling away in Australia and whilst we have no doubt on the scale of relativities that we are indeed a fortunate country, there remain risks to our domestic economy which provide significant challenges ahead for us all.

The major message coming from the Fed today is that the US Central Bank is going to continue its active and open ended interventions for as long as it takes to improve the employment market in the USA.  There are big consequences for global trade in all this.