Why you'll probably pay more tax in an industry super fund

Read the full blog here.

Ever wonder how taxes impact your super funds, especially pulled super funds? Get ready to unravel the intricacies of super fund tax treatments and their potential downsides on your balance. This episode offers a deep dive into the realm of unitised products, exposing how capital gains tax liabilities can shrink your super balance, even if you don't sell. We’ll explore alternative direct investment ownership options within super, like a wrap platform or a self-managed super fund, that can shield your balance from these negative impacts. 

We won't stop there. We'll also discuss the power of direct investment ownership, including the potential to adopt evidence-based low-cost index investment methodologies, and ethical investing. Plus, we extend our heartfelt thanks to Stephen for suggesting this episode's topic. We invite more such meaningful interactions because, after all, this podcast is for you. Don't forget to share the knowledge and rate us on your listening platform. Until next week, goodbye.

ASK ME A QUESTION ON YOUTUBE: https://www.youtube.com/watch?v=ACnxmEP8vv8

If this episode resonated with you, please leave a rating on your favourite podcast platform. It helps me reach more incredible listeners like you. Thank you for being a part of this journey! :-)

Click here to subscribe to Stuart's weekly email.

SPECIAL OFFER: Buy a one of Stuart's books for ONLY $20 including delivery. Use the discount code blog here.

Work with Stuart's team: At ProSolution Private Clients we encourage clients to adopt a holistic and evidence-based approach when making financial decisions. Visit our website.

IMPORTANT: This podcast provides general information about finance, taxes, and credit. This means that the content does not consider your specific objectives, financial situation, or needs. It is crucial for you to assess whether the information is suitable for your circumstances before taking any actions based on it. If you find yourself uncertain about the relevance or your specific needs, it is advisable to seek advice from a licensed and trustworthy professional.

Transcript

Speaker 1: 0:00

Hi, this is Stuart Weems and welcome to the Investor Pulley podcast. My goal is to give you simple, easy to understand strategies, insights and tips to help you master the game of building wealth, and in this episode, I'd like to talk about pulled super funds and how their tax treatment or really how they treat their tax liabilities that can have a negative impact on your super balance. But before I get into it, I'd just like to shout out to Stephen, who emailed me the idea for this topic, so I appreciate you sharing your ideas and, of course, if there's anything you'd like me to write about or commentate on, I can't promise to do so, but let me know. Anyway, let's talk about pulled super funds, and pulled super funds are really kind of unitized super funds, much like the industry super funds, and so what I wanted to talk about is how they deal with taxation liabilities and what negative impact that can have on your balance longer term, and then talk about some direct investment ownership options that you can have within super not only self managed super fund, but probably my favorite, which is a RAP platform.

Speaker 1: 1:04

Okay, let's talk about pulled super funds. So a pulled super fund is really like a unitized investment where the super member effectively buys units in the chosen investment option, such as balance growth typical sort of mixed investment options that most super funds provide. And so what the super fund needs to do? At the end of the day, the super fund must estimate the value of these units, and in order to do that, what they need to do is take the market value of the underlying investments and make adjustments to those figures to account for various expenses, including transaction and selling costs. They've got to take into account any tax credits or any accrued income that might have occurred, and then also take into account any taxation liabilities, including taxation on unrealized capital gains. So really, the unit price must really reflect the value of what you can sell your investment at. So if you decided to roll over your super at the end of that particular day, net of taxes and so forth, what is that balance worth?

Speaker 1: 2:03

Of course, the notable drawback here is capital gains tax liabilities, that is, they're deducted from your super balance even though you haven't sold. Now, of course, as a unitized product. They have to do that Because if people withdraw their money and they don't net off taxation liabilities, the remaining members in that super fund will pick up the bill, and that's not fair. But we know, to maximize investment returns we should try and minimize investment turnover, which is buying and selling investments, and if we minimize investment turnover, that obviously minimizes transactional costs but also minimizes paying taxation liabilities. Now, obviously a pulled superannuation arrangement doesn't really allow you to achieve that, because your balance is reducing if you haven't divested or sold any of your investments. So the solution to this disadvantage is to use an arrangement that allows you to maintain direct investment ownership within super, and so this really allows you to avoid your balance reducing if you haven't actually sold your investments, and in fact you can purposely try to minimize turnover, which will obviously reduce taxation liabilities and therefore maximize your super balance. And in fact, if you can hold on those investments until retirement, it's entirely possible you'll avoid paying any capital gains tax Because, as we know, once a balance moves into pension phase, it attracts a zero rate on investment returns, both income and capital gains. And so by having that direct investment option, you've got the potential to continue to hold on to an investment for 20 years, whatever it might be, and avoid paying any tax, which obviously is a pretty attractive option. Now, if you have a self-managed super fund, you can further delay paying tax if you use a registered tax agent to lodge their tax return, of course. So super funds have to lodge their return at the end of February following the end of the financial year, so eight months after the financial year. So if you have a self-managed super fund that crystallizes a really large once off to capital gain, you've got another eight months before you actually pay that tax, whereas if you were in a pooled arrangement, that tax would be deducted from your super balance as soon as the gain was crystallized and look, it's worth benching, although it's not particularly related to tax.

Speaker 1: 4:20

The other major advantage of having direct investments within your super is that you've got full control and transparency over those investments. So that is if you've been listening to this podcast for a while. I talk about an evidence based low cost index investment methodologies that have been proven to yield better returns than active investment options and active and often more costly investment options. So it allows you to employ that sort of methodology when investing your super. Additionally, ethical investing is becoming more popular, and so having that direct control enables people to avoid investments that don't align to their ethical values. So that could be fossil fuel emitters, weapons, child labor, these sorts of activities. So having that direct investment option certainly gives you more control and transparency, not withstanding some tax planning opportunities as well.

Speaker 1: 5:09

So what are the direct investment options for super? So, really there's two. There's a self-managed super fund, which have been spoken about a lot, and then less known kind of rap platform. So a self-managed super fund really is just a discretionary trust specifically created for the sole purpose of providing retirement benefits to members, and of course it's got to comply with Superannuation Industry Supervision Act or the CIS Act, which is all the rules and regulations around super. A self-managed super fund can have one member or can have up to six members, so you can include family members there. Every member either needs to be a trustee or director of the trustee company, and a self-managed super fund has lots of compliance obligations, and I've included a link to a booklet that the ATO has put together that sort of talks about those in great detail. The main compliance obligation involves preparing audited financial statements and filing two returns, a tax return and an annual return, and of course you need an accountant to be able to do that. So that's a self-managed super fund.

Speaker 1: 6:09

A rap platform is like an individual super account that's in your personal name that provides diverse investment options. You know typically manage funds, etfs, lifts of shares and so forth. A good way to think about it. It's like a little bit like an online share trading account. You know where you can log in and you can make certain investments, the accounts in your name. You can deposit withdrawal where you can't withdraw from super, of course but you can certainly make contributions and essentially the RAP provider handles all the administrative tasks. So it's a lot less cumbersome than managing a self-managed superfund and also it tends to be a lot cheaper as well and you don't have that burden of having to sort of worry about contribution limits and meeting all the requirements that a self-managed superfund needs to meet. In fact, the only thing you need to worry about is how and where to invest your monies, and I wrote a blog about RAP platforms a couple of years ago. Again, the link is in the blog on the website, so you can certainly check that out.

Speaker 1: 7:06

So which direct investment option suits you best? Well, of course, I don't know, because I don't know your personal circumstances, but I can talk about generalities and usually I only suggest establish a self-managed superfund if you're interested in investing in unlisted assets, such as direct residential commercial property, unlisted property, trusts, collectibles, these sorts of things. That's, the only way you can invest your super in anything that's unlisted is via a self-managed superfund. But if you don't need unlisted assets, then a RAP platform is almost certainly going to be more cost effective and, as I said, it doesn't come with the compliance burden, so it's a lot more hands off to sort of manage. I guess it's worth noting that self-managed superfunds do provide specific estate planning advantages. So if you have more complex circumstances, like a blended family, special need beneficiary, these sorts of things, a self-managed superfund actually can do some things that other superfunds can't, but that's not that common, I would say.

Speaker 1: 8:07

So, whilst we're on the subject of taxation and returns, it's really important to consider the components of your overall return, which is going to be there's only two components, of course, capital growth and income, and of course, the goal is to maximize your total return on an after-tax basis. So therefore, it's really important then to consider how much income and how much capital growth will I get from my portfolio and then my individual investment options and, of course, holding everything else equal. The more capital growth you have and the less income you have, the better off you are Because, as I said, you'll pay tax on the income each year, albeit at 15% in the superfund, but potentially, if you can delay the capital gain for as long as possible, not only you benefit from the time value of money, but then, potentially, if you're able to delay it until you're in pension phase, you get to avoid the capital gains tax altogether. And so the goal here is really to maximize the compounding capital growth over time and let your pre-tax returns compound and compound until eventually, maybe one day you got to pay the tax, or maybe one day not, anyway. So I looked at some common investment options that people would invest in.

Speaker 1: 9:15

I've seen clients invest in either through a self-managed superfund or a RAP platform and had a look at what proportion of income have they delivered over the last 10 years in terms of, or comparison to, their total return. And so Australian shares, for example, delivered 67% in income, international shares delivered 40% in income, and diversified ETFs are diversified ETFs are those that allow you to invest in multiple sub asset classes, all in one particular product. They've actually delivered 71% of their total return in income. Now, of course, we can't construct a portfolio solely just to reduce income or minimize income. We need to have a asset allocation that's going to expose the portfolio to quality returns and also reduce their portfolio's risk but returns.

Speaker 1: 10:04

Another consideration, and I mention this primarily for two reasons. The first one is that self-directed Australians that are either running their own self-managed superfinal RAP platform tend to be too heavily focused on the Australian stock exchange and, as a result, they don't have enough exposure to international markets, and so not only are they missing out on good investment opportunities because the Australian market only accounts for 2% of the global market, so you're really missing out on 98% of what else is out there but also international investments tend to deliver more capital return and less income over time, which is kind of pretty tax effective, as I've been talking about today. The second reason I mention this data is that diversified ETFs are growing in popularity, and there's two benefits of using a diversified ETF. Firstly, the ETF allows you to access various sub asset classes in one single investment, so it's very easy. You don't need to decide how much to put in international markets and so forth, which leads me into the second benefit. You've got a professional manager managing that asset allocation.

Speaker 1: 11:10

Whether it's Betashears or Vanguard, whoever the ETF provider is, they're the ones that sit down with their investment committee and work out how much are we going to put in the Australian market, how much an international market, et cetera, et cetera. So it's a very attractive and simple investment option, but, as I've highlighted here, the big drawback is that 70% or more of its return is going to be delivered in terms of income and, as a result, it's going to crystallize some taxation liabilities. So those people sitting back thinking, well, this is easy. Well, I'm just going to get a RAP platform and put all my money in a diversified ETF. Whilst you're solving one tax problem, you're actually creating another one by doing that.

Speaker 1: 11:47

Now, having said all that, we've got to acknowledge that the best performing industry super funds have delivered double digit returns over the last decade or so. So, even despite their tax inefficiency, the returns have still been really good. They're pretty cost effective, particularly if you have a lower balance, and they're very hands off. It doesn't really require a lot of input from you or a lot of oversight from you in terms of managing your super. So, whilst these negative attributes do exist and I acknowledge that, they're not too a terrible option.

Speaker 1: 12:19

So I guess you're probably asking then, stuart, what is the point of the episode. When would you consider abandoning a pool investment option, so not using an industry fund super fund anymore? And really the investors with the highest super balance industry funds become less and less attractive for a whole host of different reasons, and tax planning is one of them. But probably the most compelling is the fact that industry super funds charge percentage base fees. Now, percentage base fees are fine if your balance is 50,000 and you're paying half a percent in fees. It's not a lot of money in dollar terms. But if your balance is a million dollars, you end up starting to pay you know six $10,000 a year just in investment and administration fees, and that's when it really starts to add up. But also when you have a high balance, that's when these tax attributes and tax treatment start to also become problematic, particularly in dollar value terms.

Speaker 1: 13:11

So I think pooled superannuation arrangements, whilst they aren't perfect and really no solution is perfect, no solution ticks all the boxes I think a really good option to invest your super for most Australians. But for those people with balances north of maybe half a million dollars, they should start to really think about having a direct investment option, if it's not for just the comfort of having that transparency and control over your super or, if it's not for ethical investing and so forth, you certainly should start thinking about it to sort of lower those percentage based fees or minimise those percentage based fees as your balance increases and then deal with those tax attributes in a way that's going to help you maximise your retirement savings over time. So there you go. That's a bit of food for thought for you.

Speaker 1: 13:55

Again, thanks a lot to Steven for giving me this topic and of course, if anyone has any topics that like me to talk about, more than happy to take suggestions on board. Can't always promise to do it, but of course I'm happy to receive those suggestions. And if you enjoy the podcast, just a gentle reminder to certainly share it amongst family and friends and leave a rating or a like on whatever platform you're listening to the podcast on. Thanks again and until next week. Bye for now.