SMSFs urged to focus on retirement income strategy despite covenant exclusion

The Morrison government recently released draft legislation on the retirement income covenant revealing that it will not apply the measures set out in the covenant for SMSFs.

The SMSF Association said it has thrown, in principle, its support behind the government’s decision to remove SMSFs from the legislative requirement for trustees to develop a retirement income strategy for fund members.

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Commenting on the release of the draft legislation that will introduce a requirement for APRA-regulated fund trustees to develop a retirement income strategy for members who are retired or approaching retirement, SMSF Association CEO John Maroney said the association had raised concerns about the additional cost, red tape, and unintended consequences arising from a requirement for SMSF trustees to formulate a retirement income strategy for members when the trustees and members are typically one and the same.

However, Mr Maroney cautioned the sector on the perils of not properly addressing the expected risks associated with maximising a member’s expected retirement income.

“Just because the law doesn’t require you to have a retirement income strategy, doesn’t mean you shouldn’t have one,” he said.

“It’s not a green light for SMSF trustees to ignore the spirit of a retirement income covenant, as we know from bitter experience that failure to properly address these issues can derail even the best-laid retirement income plans.

“It is still important for SMSF trustees to ensure members are covered by a strategy that balances the objectives of maximising a member’s expected retirement income, managing the expected risks, and providing flexibility to access capital required during retirement.

“However, codifying it in the law that SMSF trustees, who are usually also the members, must do so would impose an additional compliance burden on SMSF trustees and SMSF auditors when there is a strong incentive for SMSF trustees to look after their own best interests.”

Mr Maroney noted that in the draft legislation, outlining the different matters and risks that APRA-regulated fund trustees should address in relation to maximising the expected retirement income of members can act as a useful action plan or blueprint for SMSF trustees.

“It also highlights the importance of specialist SMSF advice to assist SMSF trustees identify and mitigate these risks as well as addressing specific SMSF issues, such as planning for loss of capacity, ensuring there are valid enduring powers of attorney in place, and assessing the ongoing suitability and viability of an SMSF,” Mr Maroney explained.

A change in stance for SMSFs

With the decision from the government to exclude SMSFs, this marks a distinct change from the position paper that was subject to consultation over the past couple of months which was clear that the covenant would apply to “all trustees, including trustees of SMSFs”, according to Smarter SMSF CEO Aaron Dunn.

However, he noted this decision to exclude the SMSF sector appears to be based upon the government not wanting to burden trustees with unnecessary red tape.

This came as recent ATO statistics had pointed to an evolving retirement income picture in SMSFs, with more than two-thirds of all benefits payments taken from more than 400,000 members were in the form of an income stream. These statistics show a far more mature concept of “retirement” within the SMSF sector to other parts of the industry.

However, from the position paper, Mr Dunn noted there did appear to be some disconnect in a number of areas for SMSFs when comparing to APRA-regulated funds. 

“There were a number of concerns raised by industry back to Treasury in respect to the impact of the retirement income covenant, including the potential overlap between retirement income covenant and investment strategy covenant on investment composition and risk which may have caused confusion and/or duplication,” he said.

“The role of advice, in particular with a large cohort of unlicensed accountants seen as the primary ‘adviser’ to the majority of SMSF trustees. 

“With a large amount of reform underway and continuing in 2022, it would pose a challenge for trustees to seek advice to obtain what is necessary and relevant at the appropriate time.”

Furthermore, the role of SMSF auditors and any extended scope of audit is to check compliance with the covenant, which increases the time of complexity of the audit.

Whilst the government has listened to industry feedback regarding some of the inconsistencies and potential unintended consequences, Mr Dunn said the role of a retirement income strategy (as part of a covenant within section 52B, SISA) could still assist in future decision-making about the fund.

This includes guidance material to help with member’s retirement planning, dealing with loss of capacity and the importance of valid enduring powers of attorney.

It can also allow trustees to contemplate appropriate exit strategies for fund members and consider when it would be appropriate to wind up the fund.

“You get the feeling that with the government’s push towards a 1 July 2022 start date, this would be a timeframe too hard to achieve within the SMSF sector – think about the need to allow sufficient time for trustee and professional education, preparation of regulatory guidance, clarity of issues such as the auditor role and ultimately time for trustees to seek appropriate advice,” he said.

“Whilst a transitional period could have potentially worked, it seems the government is content to leave SMSF trustees to their own devices due to the highly engaged nature of these funds.”