Profile Blog

 

As markets continue to be wax and wane due to ongoing coronavirus fears and subdued employment and economic recovery numbers, it seems timely to remind ourselves of the types of behavioural and emotional biases that could lead to potentially risky investment behaviour, and how you can avoid them.

 

As human beings we are not well wired for the rational, dispassionate approach that economists love to think of as “normal”.

Loss aversion

Loss aversion refers to a bias in human psychology where we tend to prefer avoiding loss than acquiring equivalent gains. The principle here is that we’d rather not lose $100 than to gain $100. We tend to focus more on what we might lose, rather than on what we might get. The fear of loss can often reduce our ability to stay the course.

This was evident during the period of market volatility in late March, which saw some investors cashing out in a bid to protect a portfolio’s existing value. By realising those losses at that point in time, it meant that those same investors were less likely to have benefited when the Australian sharemarket quickly moved back and regained much of those initial losses.

A way of addressing this is to frame your portfolio gains and losses as wide as possible and over a long term horizon and not take a narrow view at one point in time. For example if you focused on just your Australian share investments you had an emotional roller coaster ride through March/April. But what would it have looked like if you total portfolio view – including international shares, bonds and even your home in your total portfolio view.

Vanguard’s Index Chart illustrates the value of a longer-term approach well with historical data showing that markets fluctuate from year to year but those who ignore the emotional swirl of short-term market conditions are inevitably rewarded for their patience and discipline in the long term.

Confirmation bias

This bias entails looking for information that supports our beliefs or choices. And during an ongoing period of market volatility, it can be particularly tempting to start thinking about changing your investment behaviour and in the process, seek out information that we think will help us make better investment decisions in the short term.

But consider this – we are told that the world is bracing for a second wave of coronavirus infections but in the same breath, we are also told that there is an 80 per cent chance of a vaccine before year’s end. Would you sell your investments now to avoid another market correction because you are convinced that a second wave of infections is on its way, or would you hold on to your investments because you know for sure that a vaccine is almost here?

The reality is, we have no way of knowing which of the two scenarios will eventuate. Actively seeking out information that confirms your thoughts on any of the scenarios, or subsequently ignoring any data that suggests otherwise and then making an investment decision based on current information, is likely to hinder rather than help achieve your investment goals.

Again, the challenge is to be disciplined and stay the course and understand what you can – and what you cannot – control. In keeping to the investment strategy that you have carefully put in place – one that will endure in both the boon of a bull market and the stress of a bear market – you’re still on track to achieve your investment goals over your investment horizon.

Herd behaviour

According to the best minds in psychology, herd behaviour is particularly relevant in the domain of finance and has on occasion, represented a major cause of speculative bubbles. During the March market volatility, it was not uncommon to hear many declare that now is the best time to invest in technology-related shares because they were booming or to invest in the health sector because a vaccine is imminent.

Are you buying bonds and moving into cash because your well-meaning uncle who’s not far off from retirement advised you to do what he did, or are you buying equities because your much younger neighbour is convinced that this is ‘the way to go’?

Rather than follow the crowd when making investment decisions that impact you alone and not the herd, you should take into account your unique circumstances and investment goals when executing on your strategy.

One strategy that you could deploy during volatile times is to spread your investments over a certain period of time. Rather than time the markets, you could instead try the dollar cost average method by putting regular contributions towards your investments until you get to your target asset allocation.

Cognitive biases are often hard to detect because they occur so naturally but learning and recognising how they can affect your decision making, especially in times of uncertainty, will be useful for every investor. And remember, this is much easier to do if you have taken the time to create an investment strategy tailored to your own risk appetite and investment objectives.

Understanding that we are all subject to biases as an investor is a powerful argument for the value of having a written financial plan that captures why you are investing and what are your personal goals. Then at times of market stress it can be retrieved from the filing cabinet (either real or digital) and used to either adjust or simply stay on course, accepting there may be well be some rough weather ahead.

 

 

Robin Bowerman
Head of Corporate Affairs at Vanguard.
16 June 2020
vanguardinvestments.com.au

 

 

The Federal Government recently announced the mandatory minimum drawdown rates for retirees with account-based pensions would be temporarily halved in both the 2019-20 and 2020-21 financial years.

 

The measure was introduced in response to the heightened volatility on financial markets triggered by the COVID-19 pandemic, essentially to provide relief to those retirees using self-funded pension income streams.

At the same time, the Government announced it was further reducing social security deeming rates to reflect the impact of low interest rates on retirees’ savings. The lower deeming rates will potentially help some retirees who may not have been eligible for the Age Pension to pass the existing income test limits.

Meanwhile, the 50 per cent reduction in the amount retirees are required to withdraw from their superannuation account balance annually, depending on their age, will help individuals and couples preserve more of their investment capital.

Retirees are required to pull money out of their superannuation savings at set percentage rates, essentially to reduce the amount of capital that is being held in the tax-free pension earnings environment.

The revised minimum drawdown rates

Revised minimum drawdown rates

Source: Australian Government

The latest data on retiree numbers from the Australian Bureau of Statistics shows there were 3.9 million retirees in the 2018-19 year. But that number is likely to have spiked as a result of many older working Australians having lost their jobs during the current crisis.

It’s probable that a sizeable number, already at their superannuation preservation age, will have officially moved into retirement and activated a pension drawdown account using their superannuation.

Knowing the new drawdown rules is imperative for all retirees drawing a self-funded pension.

A potential sting

For retirees running their own pension account through a self-managed structure, the changes to the mandatory withdrawal rates are very straightforward.

All that needs to happen is that the revised minimum percentage amount is withdrawn from your account before the end of the financial year, based on your account balance.

That’s a big bonus for those not needing to draw down the normal rate of funds from their account to cover their living costs.

The same could be the case for many of those using third-party account-based pension managers.

If you do use a third-party account manager, however, it’s important to be aware that the minimum drawdown changes could impact your regular pension payment amounts from the start of this new financial year (if they haven’t already).

The issue is that the wording on the Government’s fact sheet around its revised drawdowns legislation doesn’t have any specifications around how the rules are to be applied by external managers.

Some of the superannuation funds managing account-based pensions may have automatically set their members’ payments to the lower new minimum drawdown levels.

In this scenario, pension payment amounts will be reduced by 50 per cent unless you contact your fund manager and submit a request to change your pension payment amount.

Alternatively, other account managers may have left the default drawdown limits in place, with the onus on members to contact them to request the new reduced account withdrawal rates.

Those wanting to take advantage of the lower withdrawal requirements will similarly need to contact their pension fund manager and submit a request to change their pension payment amount.

Maintaining pension control

Retirees using third-party providers should already have been contacted about the drawdown changes and been advised of their options.

To avoid any potential changes to your normal pension payments, or to take advantage of the temporary lower required drawdown limits, you should contact your account administrator as soon as possible.

Pension withdrawal amounts can easily be changed to higher amounts at the request of the account holder.

Before making any financial decisions, it’s important to assess your current and future income needs.

Changes to pension withdrawal amounts can potentially impact the amount of government Age Pension a person is entitled to receive.

 

It may be useful to contact a financial adviser to discuss your plans.

 

 

Tony Kaye
Personal Finance Writer
30 June 2020
vanguardinvestments.com.au

 

 

 

In light of recent laws passed this month, many clients will need to review their estate planning to ensure their will adequately explains how superannuation and insurance payments should be dealt with.

 

DBA Lawyers director Daniel Butler said there was a recent change to the tax treatment of income from super in a testamentary trust. Subsection 102AG(2AA) was added to the Income Tax Assessment Act 1936 in Treasury Laws Amendment (2019 Measures No. 3) Act 2019, which was passed on 23 June 2020.

Mr Butler said the measure was first announced in the 2018–19 federal budget in order to clarify that minors should only be taxed at adult marginal tax rates in respect of “income a testamentary trust generates from assets of the deceased estate”.

The budget papers for 2018–19 federal budget explained that income received by minors from testamentary trusts is taxed at normal adult rates rather than the higher tax rates that generally apply to minors.

“However, some taxpayers are able to inappropriately obtain the benefit of this lower tax rate by injecting assets unrelated to the deceased estate into the testamentary trust,” the budget papers stated.

The explanatory memorandum (EM) states that the requirements under the new subsection will ensure “there is a connection between the property from which excepted trust income is derived and the deceased estate that gave rise to the testamentary trust”, Mr Butler said.

Mr Butler clarified that a superannuation death benefit relating to a deceased member’s interest in a superannuation fund is very different from the types of schemes being contemplated by the new subsection.

“While this is an interest under a trust, the deceased member was entitled to that payment prior to their death and the payment can either be paid to their executors (or legal personal representative) or to a dependant,” he explained.

“Similarly, insurance proceeds paid to a person’s executors that form part of their deceased estate, from a life insurance policy on their life following their death, has a relevant connection to the contractual entitlement to insurance cover.”

Both superannuation death benefit payments and insurance proceeds paid to their executors following a person’s death that forms part of their deceased estate have a relevant connection to that person’s membership interest or contractual entitlement, he stated.

These amounts, he said, can be contrasted to the example in the EM where a related family trust makes a capital distribution of $1,000,000 to the testamentary trust.

However, clients may still need to review their estate plans and wills to make sure they are appropriate in view of this new law, he cautioned.

“Wills moving forward should be more carefully drafted as many wills do not provide sufficient guidance on how superannuation and insurance payments should be dealt with,” he warned.

“Some, for instance, seek to transfer these amounts directly to a testamentary trust rather than being paid a deceased estate which then converts to a testamentary trust following the finalisation of the administration of a deceased estate.”

Mr Butler said the deceased estate generally progresses into a testamentary trust once the “date of assent” is arrived at.

“The date of assent is, broadly, where the assets and liabilities of the estate can be established and the estate can now be dealt with certainty. Prior to this stage, a potential beneficiary generally has no interest in an unadministered estate,” he explained.

Mr Butler also noted that there is opportunity for the Commissioner of Taxation to exercise some discretion where he considers the income from superannuation death benefit payments and insurance amounts do not relate to the property in question.

“This aspect can give rise to some degree of uncertainty if there is not a sufficient connection between the proceeds and the deceased person or the appropriate documentation such as a suitably drafted will is not in place,” he said.

 

 

Miranda Brownlee
29 June 2020
smsfadviser.com.au

 

 

Overall growth of SMSF sector has continued despite a drop in the number of new funds in the December quarter 2019, the latest ATO statistical report shows.

 

The SMSF sector continued to recorded growth in the December quarter 2019 despite a dip in the number of newly established funds compared to the previous quarter, according to the latest ATO data.

The regulator’s “Self-managed super fund quarterly statistical report – December 2019” revealed the total number of funds increased to 594,163 during the December quarter from 589,737 in the September quarter.

The number of new funds reached 4632 during the December quarter, with only 197 funds wound up, resulting in a net establishment of 4426 funds across the sector.

By contrast, 6324 funds were set up in the September quarter, with 444 funds wound up in the same period, which resulted in a net establishment figure of 5880.

In addition, the report revealed the total number of members of SMSFs had increased to 1,115,822 in the December quarter from 1,108,010 in the previous quarter.

It also showed the total estimated assets of SMSFs for the December quarter dropped to $739 billion despite steady growth in previous quarters, including a jump from $730 billion in the June quarter to $740 billion in the three months to 30 September.

The top asset types held by SMSFs by value in the December quarter were listed shares ($221 billion) and cash and term deposits ($151 billion).

The asset value of limited recourse borrowing arrangements (LRBA) reported by SMSFs for the quarter remained consistent at $44 billion.

The ATO’s recent statistical overview of the SMSF sector for the 2018 financial year revealed the growth in the number of SMSFs reporting LRBAs had steadied and was now increasing at a manageable rate, with some noting this had reduced the sector’s risks around these investments.

As part of its report on the SMSF sector, the ATO also found the level of SMSF wind-ups hit a record high during the 2018 financial year, while new establishments fell away.

 

 

Tharshini Ashokan
July 1, 2020
smsfmagazine.com.au

 

In the first article of a four-part series on SMSFs and property development, I focus on related-party leases and how to keep them compliant.

         

The ATO has flagged their concern about an increase in the number of SMSFs entering into related-party property development arrangements for subsequent disposal or leasing.

These arrangements include participating in joint ventures, entering into a partnership or investing through ungeared related unit trusts or companies.

Where property development activities comply with the superannuation legislation, then legitimate property developers should not be worried.

But care needs to be taken to ensure there are no breaches of SIS.

Regulatory concerns

The slippery slope to having to deal with the ATO quickly arises from not understanding how the SIS legislation operates, especially where some arrangements may contribute to questionable dealings that fail to meet the relevant operating standards.

As a result, a fund breaching the in-house asset rules or not meeting their record-keeping requirements can result in costly rectification action to help bring the SMSF back into compliance.

In-house asset definition

The in-house asset rules, along with all SIS rules, are in place to stop SMSF trustees from receiving a benefit from their SMSFs before they retire. And although the definition of an in-house asset appears to be straightforward, the legislation surrounding in-house assets is anything but simple.

SMSFs involved in property development ventures need to have an understanding of the in-house asset rules as well as who is a related party of the fund.

An asset becomes an IHA (under s71 SIS) when SMSF trustees either loan, invest or lease the assets of their SMSF to a related entity. A related party is any member of the fund, a standard employer-sponsor or Part 8 associate of either of these.

In broad terms, an asset of an SMSF that is used and enjoyed by a related party of the fund is generally an in-house asset.

Regardless of whether the use of that asset also contravenes the sole purpose test or not, the trustees must still ensure that the total market value of the SMSF’s in-house assets does not exceed 5 per cent of the market value of the SMSF’s total assets.

Conditions for ungeared entities

An SMSF may invest in a related company or unit trust without it becoming an in-house asset if it meets the conditions of r13.22C SIS at the time the investment is acquired and at all times while the fund holds the investment.

The conditions relevant for property development inside these entities include:

SISR Conditions Ungeared Unit Trusts & Companies Must Meet

  • SMSF has less than 5 members

  • Only assets in the unit trust are cash and property

  • The unit trust cannot borrow or give a charge over the assets of the fund

SISR 13.22C

  • Related-party lease only allowed for business real property
     
  • Related-party lease must be legally binding
     
  • Related-party transactions must be at market value
     
  • Must meet r13.22C at all times

SISR 13.22D

  • Cannot operate a business through the trust
     
  • All transactions must be at arm’s length

Where the fund fails to meet any of the conditions in r13.22C, a catch-22 situation arises, triggering r13.22D which states the related entity is required to meet the conditions of r13.22C at all times to be exempt from the in-house asset rules.

Not meeting the conditions of r13.22C means that all investments held by the SMSF in that related company or unit trust, including all future investments, will become in-house assets.

The asset can never be returned to its former exempted status, even if the trustee fixes the issue/s that caused the assets to cease meeting the relevant conditions.

It can be difficult, therefore, for SMSFs to meet and maintain these conditions while undertaking property development investments.

Decisions that cause the exception to cease will require the fund to divest itself of the shares or units it holds over the 5 per cent limit within 12 months.

Where the fund holds 100 per cent of the shares and the only asset in the ungeared entity is property, this may result in a fire sale of the property and winding up the unit trust or company.

Property development v carrying on a business

There is nothing in SIS which prohibits an SMSF from running a business, but the business must be:

  • allowed under the trust deed and the investment strategy
  • operated for the sole purpose of providing retirement benefits for fund members

Where the trustee of an SMSF carries on a business, the activities of the business should not breach the sole purpose test, and any business operated through an SMSF must comply with the investment rules and restrictions applying to SMSFs.

One of the most critical implications for classifying property development as a business is where the fund has invested in an ungeared unit trust or company.

By definition, these types of trusts are not allowed to carry on a business and r13.22D will cease to apply, with the investment losing its exemption from being an in-house asset.

How poor record keeping can bust the trust

Overlooking a legal technicality within a lease arrangement can trigger an r13.22C event that may cause the in-house asset exemption to cease to apply. In other words, failure to have a legally binding lease agreement in place with a related party can bust the trust.

Where a previous lease contract does not provide for a continuing legal relationship after the lease expires, and the trustee has not renewed the lease, the lease arrangement ceases to be legally binding.

Can it be fixed?

Under these circumstances, the fund becomes subject to the 5 per cent in-house asset rules requiring the disposal of some units.

As it is unlikely that the fund will be able to sell units to an unrelated party to reduce their investment to below the 5 per cent in-house asset threshold, selling the property to redeem the units becomes the only option.

Conclusion

The complex SMSF path to property development is paved with legislation, resulting in more onerous obligations and responsibilities for SMSF trustees. 

While property continues to remain a sought-after investment within SMSFs, it is critical to keep on top of the rules to ensure that funds with property development investments continue to operate in a compliant manner.

 

 

Shelley Banton
Head of technical, ASF Audits
smsfadviser.com

 

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