The superannuation of most Australians sits within an industry fund. There are numerous benefits to this; low fees, generally great returns and access to multiple investment options.
However, they have a problem. It’s a problem that is relatively unknown but could have a large impact on the future income you may be able to draw from your account.
The problem is tax, specifically capital gains tax.
In order to understand why the average super fund can be quite tax inefficient, you must first understand how they are structured.
Master Trust Structure
Every industry super fund is set up in a master trust structure.
A master trust is where each of the members money is pooled together and then invested. The trustee of this trust holds the legal ownership of these assets and you, the member, are the beneficial owner of your portion of the pooled assets.
This stands in opposition to individually owning assets. Let’s say if you personally bought a share in a company on the stock market. You own the share, any dividends paid flow straight to you and if you sell the company in the future, you might need to pay capital gains tax.
A master trust owns the assets, the trust collects the dividends, and the trust pays the tax. Once all is said and done, the earnings of this investment are passed on to you (the member) via a change in the unit price of your specific investment option. You will notice in your super fund you don’t see any dividends. In actuality, any dividends and capital growth are captured through this change in unit price.
This in effect creates the eventual tax inefficiency. But why?
Tax Rate in Retirement Phase
The standard tax rate for a super fund in accumulation phase (before retirement) is 15% (10% if the asset is held for more than a year). However, in retirement phase (accessible at age 60), the tax rate for super funds drops to 0%. That’s right, nothing.
You might assume that, once you move your super into retirement phase and continue to hold the same assets, you won’t need to pay capital gains tax (CGT) if you sell. If your super account owned the assets directly, this would be true. In Self-Managed Super Funds (SMSFs), for example, where the assets are held in the name of the SMSF, there wouldn’t be any CGT at the time of selling in retirement phase.
However, in an industry super fund, your account doesn’t own the assets—it’s the master trust that holds them. The issue here isn’t just about the CGT triggered when members move into retirement phase; it’s about the ongoing effect on returns while you remain in the pooled option.
When other members of your fund transition into retirement or leave the fund itself, assets within the pooled option need to be sold to transfer their money elsewhere. This sale of assets triggers CGT, and the burden of this tax is borne by the remaining members in accumulation phase—members like you.
The result? Year after year, even if you’re not selling your assets, the fund’s returns are reduced because part of the pool is constantly sold off to meet the tax obligations caused by others moving their money. This continual drain on returns would not occur if the assets were owned individually, as with an SMSF, where you control when and if assets are sold.
In essence, while you stay in the pooled option, you’re taking a hit on returns every time someone else in the fund moves into retirement and triggers tax events that you have no control over.
If these assets were held directly, they could be moved to retirement phase without needing to be sold, thereby retaining their unrealised capital gains.
The Solution
The solution to this problem, as we have already identified, is individual ownership. This can be accessed through the opening of an SMSF or using a Wrap account usually accessed via a financial adviser.
These options are not suitable for everyone, and will often come with higher costs, especially for lower balances.
There is another option though, one that is offered by a few industry super funds.
Direct Investment Products
It goes by many names depending on the fund offering it. Hostplus offers ChoicePlus, Australian Super with Member Direct, and CBUS Self-Managed. There are also a few smaller funds with this offering like CareSuper, Telstra Super and Legal Super.
These options provide greater flexibility in selecting investments, such as shares, ETFs, term deposits, and cash. They offer a more direct ownership of these assets and allow for greater management of tax outcomes, including better timing of capital gains and other tax-related decisions.
This direct ownership structure allows you to carry your chosen investment options between the taxable accumulation phase, into the tax-free retirement phase through what is called an in-specie transfer. This means any unrealised capital gains you built up whilst working will move with you into retirement, where they will attract a 0% tax rate. Most importantly, your returns will not be affected by other members of the super fund moving into retirement.
These products aren’t perfect though. Principally they will cost more than the standard offering by that particular fund. They also do not have the same flexibility as SMSFs or Wrap accounts as they have limited access to investments, along with a maximum percentage that can be invested in a single asset.
Each of these direct investment products differ considerably when it comes to costs and restrictions.
Comparison
The above table compares important features of each super fund’s direct investment offering (based off most recent PDS as of the date of this article).
Minimum Total Super Balance
This is the minimum amount each super fund says you must have in order to qualify to use their direct investment product.
Minimum Transfer to Direct Product
This is the minimum amount that must be transferred into the direct investment product.
Minimum Kept in Pooled Options
Each super fund nominates a minimum amount of money that must be kept in one of their standard investment options (balanced, high growth etc).
Maximum amount in ETFs/Shares
This is the maximum amount of your total balance that can be invested in listed investments at any time. More than this can be in the direct investment product itself but will need to be invested in term deposits or cash.
Annual Direct Investment Fee
This is the fee that applies directly to the funds that you move into the direct investment product itself. Other fees may apply to the funds mandated to be kept outside in standard options.
Brokerage Cost
When your purchase shares or ETFs through these products, you will need to pay a brokerage cost every single time. These costs can add up very quickly especially when you consider most pooled options are free to transact between.
Please note that there are many other intricacies of these products that must be understood before choosing to invest inside them. Refer to the PDS’ for further details.
Are They Worth It?
If the whole thing seems complex, that’s because it is. This complexity makes it difficult to broadly assess whether these direct investment products are beneficial for everyone.
However, one thing is clear: the costs, especially brokerage fees, are much higher. For balances below $250,000, these costs can considerably reduce potential benefits.
For long-term investors, the compounding effect of annual return losses due to capital gains tax could significantly reduce the value of their super. Over 20 or 30 years, this may create a sizable gap in potential returns compared to a structure with individual ownership. However, the additional fees paid for these direct products may negate the extra returns depending on your own personal situation.
Some super funds do recognise this issue through the offering of a retirement bonus that goes some way toward equalising the capital gains tax inefficiency of pooled investments.
Still, for those interested in taking an active role in managing their superannuation, these products offer a way to do so without the commitment of an SMSF. However, the flexibility afforded through these options still do not compare to a SMSF.
Direct investment options are clearly not a perfect solution, but it is encouraging to see super funds allowing their members more control over their retirement savings.
Referenced PDS’
https://www.legalsuper.com.au/siteassets/shared-media/brochures/dio-brochure-jul24-002-1.pdf
