SMSF or Self Invested Personal Pensions (SIPPs): setting up and running them The fee-free plain English approach that we couldn’t find so had to write

Watching the Obama government fiddle around with the various creditors in Chrysler (and in other government bailouts where political calculations are coming into play in Australia and the UK) it’s pretty obvious that there is ‘political risk’ coming back into investment in a big way.

It is something that Bill Gross at Pimco was also keen to stress in his latest podcast, “2+2=4″, that equity and debt holders may be looking at a highly regulated future where the ‘dead hand of government’ plays a significant role in setting future growth rates and income distributions (no doubt Mr Gross would be horrified by this oversimplification).

Another way to look at it is simply that the debt being run up in stimulus packages may create an irresistible temptation for governments to tap funding sources which currently might appear to be protected.

One obvious group of people who are being ’stuffed’ in the current environment are holders of cash, with interest rates of .5% in the UK or a (comparatively) generous 3% in Australia, perhaps a realization which may play a small part in the recent market runup.  In a future environment it may be that holders of non-inflation protected assets are also going to get stuffed.

As someone I know puts it more succintly, “the older generation are going to get stuffed somehow.”

However one other obvious source for governments to target are Super funds and pension funds.

As Kris Sayce puts it well in ‘Money Morning’ with regard to Australia:

“perhaps the biggest giveaway is the $1 trillion held in private superannuation accounts. At the moment these balances are almost untouchable by the government. It is up to the fund managers and trustees of the funds to decide where the money is invested.

That is a position that no government will allow to remain for too long. Not when there is a $300 billion public sector debt to be paid off. And a $100 billion public sector pension liability to be financed.

Not to mention all the increases in welfare payments that will arise in the next few years.”  

Given the time horizons involved we should all be thinking about what the government might do to get their hands on it to pay their bills. Mr Sayce’s view is that there may be inducements from the government to “swap their defined contribution super plans in return for a defined benefit government pension”, however we probably need to consider other possibilities as well. For example:

• could the government change the tax rates on super funds from 15%?
• could the government set maximum super fund sizes?
• could the government change the cap on non-concessional contributions (currently $150k)?
• could the government change the preservation age (the age most of us can access their super) – it’s been suggested that preservation age move to 67 by the interim Henry Review?
• could the government further target temporary residents (it is already taking their unclaimed super within 6 months of them departing Australia)?
• introduce tax on super income streams after preservation age (60), currently for most people there is no tax if the cash was taxed ‘going’ in).

From the government’s point of view there are  two risks:

1. loss of votes amongst a segment of the population that is getting larger (retirees)
2. reducing the savings rate (pretty much what it wants to do at the moment anyway and of course a mandatory super contribution level in effects sets a savings rate the government can fiddle with as well)

The level of risk overall should a key factor (especially for wealthier individuals given the budget changes to super) in whether you choose to put your money into the superannuation sandbox or operate outside it.

Posted under Risk, investment strategies

Whilst the more visible mass layoffs at banks like Citigroup, RBS and HBOS grab the headlines, there have also been some subtle changes at banks which are equally designed to shore up their balance sheets.

This time however they’re looking to you, the customer, to do it.

In Australia we usually hold the cash component of our super fund in St George term deposits (St George is soon to merge with Westpac).

The way that St George configures term deposits is, of itself, of some interest as the “12 month term deposit”, if you read the fine print, actually translates into an ‘indefinite deposit’ if you fail to give the bank “Notice” during a 14 day maturity window at the end of the term deposit. Put simply, if you don’t tell the bank that you wish the term deposit to mature at that point they will simply re-invest it for the identical term at whatever the prevailing interest rate is at that time. 

Leaving aside the somewhat misleading nature of a ‘term deposit’ with an indefinite term (which has always been the case at St George) what has changed with the onset of the credit crunch is that it has suddenly got considerably more difficult to give them the Notice in the form in which they require it…

“You are able to continue to send a signed fax to Fixed Terms with a copy of your passport and drivers licence, outlining your request.  A contact number is required in order for our staff to make a verbal confirmation of the request received.  The Bank’s decision to implement these additional safeguards is to protect your funds and personal information.  As your security is of the utmost importance to us, if we are unable to contact you or identify you once contacted, the request will not be actioned.”

So, for ‘personal security’ reasons you can no longer inform them, in advance, that you wish the deposit to mature as specified in the term (we used to be able to do this by email or using phone banking) and in their online banking system whilst you can extend or vary the term you cannot mature it.

They actually now require verbal instruction to mature a term deposit using their phone banking service.  Bad luck if you’re on holiday or you happen to overlook the maturity statement they provide you in the mail … or if, like us, you happen to be travelling in a different timezone expect to spend some time late at night making sure your term deposit matches the term you agreed in the first place.

Naturally, the real motivation here is likely to be that many clients will overlook the fine print, and the bank will end up with some percentage of term deposits renewing when their owners in reality had the intention of moving the money to a better return elsewhere.  As interest rates fall this is a good thing to keep an eye on.

Posted under Risk, Setup

Whether you put money into a SIPP or SMSF, in the back of everyone’s mind is the question (especially with voluntary contributions) of whether it makes sense to lock your money up in this way.

In Australia the point comes to the fore more with voluntary contributions as superannuation is compulsory at 9% of salary (so it’s not as if you have a choice on salary as to whether you contribute or not).

The Australian government made contributions compulsory in 1992 – if ever the UK government does the same buy an index fund or better still buy stock in a fund manager – estimates put the ‘new’ savings engendered by this move in Australia at 62c on the dollar.

The key point is obviously that you cannot access the money contributed to pensions/super until ‘preservation age’ (in Australia 60 years of age for most people who are not close to retirement).

Want to take the holiday of a lifetime before 60 on this money – you can’t.  Want to give a lump sum to a child – you can’t.

There are some exceptions for hardship, so if you’re starving in a garrett at 55 you will probably be able to get access to your super before preservation age, but that’s about it. If you die relatively young (although it would have to  be abnormally young – average life expectancy in Australia is now about 80; for the UK it’s 78) this could prove seriously annoying.

Some other more governmental / political risks might be:

• between now and your retirement the government in its wisdom decides to change preservation age. In 1997 the Australian government pushed back the ‘preservation age’ by a whole 5 years from 55 to 60. Presumably the thinking behind this, as with much of the government’s rationale, was to stop people cashing in their super relatively early and then relying on State benefits in the later stages of life. What are the chances of this happening again? Probably relatively high…. But bear in mind that last time they did it they ‘tapered’ the results so that those close to the previous preservation age could still obtain most of their superannuation at close to the old figure of 55 years old
• the government decides to change the tax rate on super from the current 15% level (in Australia). However if they did this it would be unlikely to be retrospective so it would only affect ‘future’ income and not the balance you had already built up. You could hope that perhaps you would be able to transfer the fund offshore and still retain the benefits but who knows. Against this you need to balance the significant difference in tax rates on money in super funds and money outside super. At the average income in Australia (around $49,000) you are paying a marginal tax rate of 30% for everything over $30,000 and 40% over $75,000. Against this, a tax rate of 15% for money in your super fund looks pretty attractive (if at some stage of your life you’re earning less than $30,000 it might be worth keeping your money outside a super fund - you pay the same tax rate of 15%).

A perhaps more common scenario is where a new investment opportunity arises which if you were not self managing your super/pension you could not take advantage of this because you were constrained by the options on offer from your managed fund.  With the new ability to even buy property in a fund there is a lot of freedom, although you cannot borrow, so if you are fond of margin lending to finance your share portfolio you can’t do this in a SMSF. All in all though, having a self managed fund does not greatly restrict your options, assuming you are a relatively conservative investor.

Posted under Risk, Setup