SMSFs and Pink Batts – more in common than you think

People can go pretty nuts when government spending is seen as having been wasted.

Pink batts, for example, became bywords for waste (not to mention safety hazards). Mention them in conversation and you can get some strong reactions.

On that basis, we should be equally upset when SMSFs get caught up in financial collapses like Banksia or Trio. There’s a view that it’s just the SMSF members who lose in these situations. But in fact taxpayers lose too because super operates in a concessional environment. The deal is that you agree to save for retirement, and taxpayers subsidise the tax you would have otherwise paid. Anyone on a marginal tax rate of more than 15% gets a subsidy.

Let’s look at the maths for a top marginal tax payer to make it easy (also because they are more likely to become SMSF members):

For every $100 made as a concessional contribution to super, they get $85 invested after contributions tax of 15%.

Had our taxpayer taken this $100 as ordinary income instead, it would have been taxed at a marginal rate of 46.5%, leaving them with just $53.50.

So of our taxpayer’s net super contribution of $85, taxpayers actually funded over $31.50, or a whopping 37%.

Our taxpayer also enjoys concessional tax treatment along the way, with his / her fund paying tax on earnings at 15% instead of 46.5%.

With few exceptions, part of every super fund’s assets reflects an investment by taxpayers. So when SMSFs lose a bundle in the latest financial disaster – and they are always in there – that taxpayer investment, funded by all of us, is lost too.

That’s something which should upset us. We also think this means that taxpayers have a legitimate interest in the investment practices of every super fund – including SMSFs – in order to protect that investment. Not to the extent of dictating investment strategy perhaps, but certainly in terms of constraining excessive risk levels, and excluding investments commonly associated with losses arising from incompetence or fraud.

What would be a reasonable and efficient way to achieve this? You could get most of the potential benefits with a relatively small number of measures:

Winding back the gearing in super rules. These are relatively recent, relating to a clarification of the warrants rules which allowed funds to invest in Telstra warrants. But the clarification went way too far, opening the gearing floodgates to pretty much any asset.

Ban, or impose punitive taxes, on investments in residential real estate and moveable assets (often associated with personal use), akin to the rules on UK SIPPs. In a flash you protect taxpayers from exposure to real estate developments, collectibles, and many other questionable asset targeted at SMSFs.

Ban debentures and other high risk, deposit-style investments offered by non-ADIs. Deposits are a huge exposure of the SMSF segment; retail investors find it hard to assess credit risk; the failure rate of debenture issuers is high.

According to Treasury, “tax expenditures” on super come to $30bn pa. While this figure is regarded as ropey, the real number is clearly much larger than the $2-3bn involved in the Pink Batts scandal, and much of it goes to the SMSF segment. Shouldn’t we be just as concerned to see that it is not wasted?

Posted In: Trialogue