Financial System Inquiry to reshape superannuation system

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Financial System Inquiry (FSI) final report

The final report of the Financial Systems Inquiry, released on Sunday, has made a number of recommendations that could shape the superannuation system for years to come.

Among the 44 recommendations are banning direct borrowing by superannuation funds, extending choice of super fund to all employees, a legislated purpose for the superannuation system, a review of MySuper and a competitive process for default super funds, new retirement income products and reform of super fund governance.

Likely the most controversial superannuation recommendations is the ban on borrowing by superannuation funds, including SMSFs. For more detail see: Ban SMSF Borrowing: Financial System Inquiry final report.

Extend choice of super fund to all employees

The final report of the Financial System Inquiry recommends that the Government amend the Superannuation Guarantee Act to remove provisions denying some employees the ability to choose the super fund which receives their superannuation guarantee contributions.

“As a general principle, the Inquiry believes everyone should be able choose the fund that receives their SG contributions,” says the final report.

A “significant minority” of employees, some have estimated 20%, do not have Super Choice.

The Financial System Inquiry panel says that the introduction of SuperStream and growing use of superannuation clearing houses removes some of the concerns that full Super Choice would place an administrative burden on employers.

Create legislated objective for superannuation

The Financial System Inquiry final report recommends the Government “enshrine in legislation” that the primary objective of superannuation is:

To provide income in retirement to substitute or supplement the Age Pension.

This would “provide a framework for evaluating the efficiency and effectiveness of the superannuation system,” and “contribute to greater long-term confidence and policy stability through agreed objectives, against which superannuation policy proposals can be assessed.”

Currently, according to the Financial System Inquiry, the superannuation system does not have a consistent set of policies with a common goal.

“The absence of agreed objectives contributes to short-term ad hoc policy making,” says the final report.

This flawed policy imposes additional costs on superannuation savings and “undermines long-term confidence in the system.”

“The lack of an agreed policy framework also increases the cost of the superannuation system to Government because tax concessions are not being efficiently targeted at meeting the system’s objectives.”

The final report also considers the establishment of a “publicly funded independent body to assess the superannuation system’s performance and report on superannuation policy changes.”

Review MySuper, create competitive default super fund process

The Financial System Inquiry recommends that by 2020 the Productivity Commission hold an inquiry into the effectiveness of MySuper, and the Government then consider implementing a competitive process to determine the default super fund for employees.

The panel is concerned that super fund fees are too high and the superannuation system “has been unable to realise the full benefits of scale.” However MySuper will not be fully implemented until 2017, after which the Productivity Commission should conduct an inquiry.

There are a number of different ways in which a competitive process could be designed, but effectively superannuation funds would bid to be allocated new and existing members.

Similar systems already exist in Chile, New Zealand and Sweden.

“Employers would no longer be required to select default funds for employees, and there would be generally no need to specify default funds in employment contracts, including awards,” said the Financial System Inquiry final report.

Improve retirement phase of superannuation

The Financial System Inquiry recommends that superannuation fund trustees pre-select a ‘comprehensive income product for retirement’ (CIPR). The super fund member would be aware of the CIPR option while they were working and on retirement would “either give their authority to commence the pre-selected option or elect to take their benefits in another way.”

Features of the CIPR would include “a regular and stable income stream, longevity risk management and flexibility.”

The Financial System Inquiry final report says CIPRs would “better meet the needs of retirees, including those who are disengaged or less financially sophisticated, and provide a more seamless transition to the retirement phase of superannuation.”

SMSF trustees “should not be required to design or offer CIPRs because the trustees are the fund’s members.”

Reform super fund governance

The final report recommends that the SIS Act be amended so that public offer APRA-regulated super funds are mandated to “have a majority of independent directors on their trustee boards.”

“Requiring a majority of independent directors, with an independent chair, would strengthen the governance of superannuation funds. The Inquiry is not convinced by arguments that independent directors would have a negative effect on superannuation returns.”

The Government should also “introduce civil and criminal penalties for directors who fail to execute their responsibility to act in the best interests of members, or who use their position to further their or others’ interests to the detriment of members.”

Of course these are recommendations of the Financial System Inquiry panel and not, necessarily, Government policy. The Government is conducting a consultation process on the final report and will be responding to the report sometime in 2015. The Government may introduce some of the recommendations sooner, but based on the Henry Tax Review and Cooper Review is unlikely to accept all the recommendations.

Taxation of superannuation

The Financial System Inquiry panel also makes some ‘observations’ that the “Tax White Paper should consider.” These include “aligning the earnings tax rate across the accumulation and retirement phases” and “options to better target superannuation tax concessions to the objectives of the superannuation system.”

The final report says that “superannuation tax concessions are not well targeted at the objectives of the superannuation system,” and increase the cost of the system to the Government.

“Tax concessions contribute significantly to policy instability and undermine long-term confidence in the superannuation system”

The final report says that “around half” of the changes to superannuation over the previous 10 years have been changes to the targeting and equity of these tax concessions.

Of particular focus for the Financial System Inquiry is the different tax rates applying to accumulation phase (15%) and pension phase (0%).

This difference creates a “tax boundary that limits pension product innovation and acts as a barrier to funds offering whole-of-life superannuation products,” can “contribute to sub-optimal investment strategies in the years approaching members’ retirement” and “provide an opportunity for tax arbitrage.”

Options to resolve these issues include aligning the tax rate applying to accumulation and pension phase, reducing the non-concessional contributions cap and an additional tax on income from superannuation accounts with “balances above a certain limit.”

More consideration of changes to the taxation of superannuation will be included in the Government’s Tax White Paper.

The Government is accepting submissions on the Financial System Inquiry final report until the 31st of March 2015, detail on how to make a submission is available on the Treasury website.

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