Posted In: tax and quantitative, Wealth Management Administration
In the “Compare the Pair” television advertising campaign, run by Industry Super, two ladies are poolside, discussing their superannuation. One has an industry super fund the other has retail super. A counter ticks over until industry lady’s balance shows much higher than retail lady’s. The difference is explained by lower fees and the application of compound interest. The main message is that a small change in reducing costs now can make a big difference in retirement – which is especially relevant for younger people where the length of time to retirement magnifies the impact .
So, imagine the same poolside picture, but this time the amount applied in savings, through reducing costs, is twice or even three times as much.
By reducing costs even more, the retirement nest-egg would be significantly higher than in the original example. Not many people realise that this can easily be achieved by all superannuation funds now by looking at another significant cost factor, not currently under the microscope – tax.
Right now, superannuation funds can reduce tax exposure significantly for their members by implementing tools that alert those managing the money before they do something to cost the fund more tax.
Reducing costs has become more important in the current economic climate. Even though Australian markets have recovered somewhat and superannuation funds are now in their eighth year of positive returns- it’s not all good news. Interest rates remain at record lows, markets remain uncertain and investment managers are under continued pressure to prove they can outperform index funds. It is in this type of current low return environment that ALL costs in superannuation funds continue to be scrutinised by investors – there is a growing number of baby boomers who are eyeing their retirement savings and noticing each dollar that is not going towards their nest egg.
With anecdotal evidence from the superannuation industry showing that Gen X is now starting to take a more intense interest in their superannuation returns, it is only a matter of time before Gen Y and Millennials become more aware that even a little saving now will go a long way towards their retirement funds in the far future. This is why the “Compare the Pair” advertisement, highlighting the impact from the difference in costs, has sent such a potent message and it’s why we should look beyond the obvious cost savings, such as member fees.
According to the Australian Taxation Office and the Australian Bureau of Statistics, the Superannuation industry in Australia has $2.3 trillion dollars invested on behalf of nearly 15 million superannuants. So, a reduction in costs of just one quarter of a percent equates to nearly $6 billion a year. Currently much more than that $6 billion is being unnecessarily paid by retirees through excess payment of taxation.
Preventing excess tax payments for Superannuation funds, through a cost-management strategy, is easily achieved through simple tax management techniques, as part of the investment process. These tax saving opportunities are available to the Superannuation fund as an Australian tax paying entity and result in direct dollars to the Superannuation member’s retirement balance.
There are two main rules that can be managed which can optimise billions of dollars for superannuation members each year. The first is via tax savings that can be made through the management of Capital Gains tax. This tax rule was first introduced by the Hawke/Keating Government in 1985 and modified to the current discounted capital gains tax by the Howard Government. This tax rule entitles a superannuation fund to one third discount if assets are held for more than 12 months before any are sold. Billions of dollars each year can be retained for superannuants by preventing assets being sold too early and therefore not receiving the 33.33% discount on the sales proceeds before calculating the tax.
The second opportunity that superannuation funds have, to save on taxation for future retirees, is through the management of dividend income and imputation credits. Again, Australians have the Hawke/Keating Government to thank for the dividend imputation legislation change which was introduced to prevent excess taxation. Because the tax for Australian company profits has already been paid at the corporate tax rate, when the profits are distributed as dividends to shareholders they should not be taxed again.
For superannuation funds, franked dividends are a very tax efficient form of income, provided they are carefully managed. An example might demonstrate this, but does require your patience to work through it as it is not so simple. A superannuation fund that pays 15% tax rate on income, receiving $1.00 of franked dividend, results in a tax credit for the fund i.e. for each dollar of income from a franked dividend the superannuation fund is actually entitled to a credit from the tax office rather than having to pay tax on that income.
Working through the calculation, the superannuation fund receives a $1.00 fully franked dividend, but the company paying the dividend has already paid out 30c in tax. So, to work out the tax for the fund, first a refund of the 30c tax already paid needs to be taken into account, then $1.30 is taxable at the rate of 15% tax. This equals 19.5c tax (the result after applying the 15% tax rate) payable, but since 30c tax has been paid already, the tax payable should be reduced by the 30c resulting in a 10.5c rebate. Just think that through – a superannuation fund earning a $1 fully franked Australian dividend actually gets a tax rebate or “negative” tax of 10.5c. There are not many investments that give the investor income and doesn’t require a tax payment but puts tax back into the investor’s hands.
Food for thought, but this is only achievable if the dividend is eligible for the franking (an arrangement in Australia that eliminates this double taxation effect on dividends).
This means a superannuation fund is only eligible to receive that tax rebate if shares are held a sufficient amount of time (45 days, to be exact, on an ordinary shares) prior to the dividend being declared. If a share is sold within the 45 days the franking credit is lost. It may seem like a simple rule to adhere to – hold on to the shares for 45 days. Not so easy with all the trading and activity that goes on within a superannuation fund across multiple managers.
Tens of thousands, or even hundreds of thousands, of dollars are being lost through excess taxation when this money could have been safely kept to boost retirees balances. It is the responsibility of superannuation funds to maximise the after-tax benefits for their members and this includes understanding and managing the Australian Taxation rules around the selling and holding of shares to the maximum benefit of their members.
Investors are scrutinising many costs around the operation and management of superannuation and expect their super fund to manage these costs, such as members’ fees, investment fees paid to managers and others (some funds are so cost conscious they scrutinise stationery costs down to the last paper clip).
Recently an Australian Financial Review Columnist Sally Patten provided insight into the APRA approach to fund trustees regarding insurance costs and the need to ensure they are acting in the best financial interest of their members.
The management of tax and all other costs are equally important to deliver an optimal outcome for members.
Despite all of this, the fact remains that one of the most significant costs to members and their end retirement outcomes is the unnecessary excess payment of tax. As the Federal Government ‘s Superannuation Industry (Supervision) Act 1993 states, it is the fiduciary duty of superannuation funds to always act in the best interest of their members and to try to maximise the investment returns for their members after fees and taxes. So, isn’t leaving this low-hanging fruit to drop on the ground in fact a shirking of the fund’s duty to their members?
One could argue that these taxation rules are difficult to understand and therefore it is difficult to manage maximum efficiency around this tax. But, it simply isn’t good enough to only focus on fees because tax is in the “too hard” basket. There are tools and methods available in the Australian market today that make it easy for all superannuation funds to maximise the application of all available tax advantages on behalf of their members.
One such tool, GBST’s Tax Analyser, is already helping some of the leading Australian superannuation funds, including Australian Super, CBUS, Mercer and Unisuper, to actively manage their tax position and provide the optimal outcome for members, by providing the tax impact information to the managers before they sell a share.
Denis Orrock of GBST said: “It seems so simple for Superannuation Funds and their Trustees to actively manage their fund tax positions however it is too often pushed to the too hard basket, funds going the extra mile are seeing improved performance and returns to members. Surely that is the ultimate measure”.
“UniSuper has long been an advocate of the benefits of effectively managing tax outcomes, being the initial pilot partner for the GBST Tax Analyser. At UniSuper we believe that managing the Fund’s taxation position efficiently is of significant importance and therefore tax considerations are imbedded in all aspects of our investment processes, ultimately delivering meaningful value to our members.” comments Dharmendra Dayabhai, Head of Portfolio Analysis and Implementation at Unisuper.
“The management of taxation as part of the investment process is extremely important to ensure that we can maximise the returns to our 2.2 million members,” AustralianSuper Head of Investment Operations Peter Curtis said.
AustralianSuper has been a leader in implementing tax management strategies into its investment processes and was the first user of GBST’s pre-trade Tax Analyser, having integrated it with their internal investment systems four years ago. It is a signatory of the Voluntary Tax Transparency Code and is committed to ensuring the highest possible standards of integrity and transparency are applied to all of its tax affairs.
Dana Fleming of KPMG, a long-term advocate of how Australian superannuation funds can improve member returns through better after-tax management comments:
“the largest controllable part of superannuation fund’s tax payable is capital gains tax. With nearly all superannuation funds now back paying tax on their realised net capital gains, all strategies that assist in ensuring the 1/3 discount is accessed where possible and deferring the payment date should be closely examined. In conjunction with the active management of franking credits, this can have a significant impact on returns to members over time.”
So, a huge opportunity to reduce costs and increase members’ after-tax returns is waiting for superannuation funds. Reduce those investment taxes which is costing superannuants millions of dollars each year that are going straight to the government’s tax accounts and put them back into the pockets of their members.
GBST (ASX: GBT), provides global technology services to the financial services industry, addressing our clients’ constant needs for innovation, competitiveness and responsive IT that truly enables business. Listed on the Australian Securities Exchange, GBST has offices in Brisbane and throughout Australia, London and New York as well as operations in Hong Kong, Paris and Singapore. GBST can be contacted at www.gbst.com
Kathy Taylor-Hofmann, Business Solutions Executive, GBST Retail Wealth
T: +61 (0)2 9253 6513 M: +61 (0)458 497055 E: firstname.lastname@example.org