Australia’s $50bn legacy super problem for members

Australia is losing out on billions of dollars in retirement savings due to the proliferation of legacy super and investment products, according to EY.

The government must help consolidate $50bn in legacy super and investment products into modern ones, as complex regulatory settings are stifling innovation and better outcomes for members, the Financial Services Council has said.

Modernising the system would deliver $16bn more in ­savings to members at retirement, and more than double that in ­government revenues and ­savings, according to an EY report released on Monday.

The report, commissioned by the FSC, which represents retail super funds and life insurers, says that the proliferation of products that could benefit from “modernisation” is creating system-wide inefficiencies and negative outcomes for all stakeholders.

Legacy products, or those with existing members but closed for new members to join, have usually delivered lower returns and incur comparatively higher fees.

Some of these legacy super products have been left behind through regulatory change, such as the ban of grandfathered commissions, and the Your Future, Your Super (YFYS) reforms, which this year was extended to choice products.

The YFYS reforms have led to closures of underperforming funds and mergers. But this has also resulted in legacy products, because when funds that have similar investment options merge, there are significant barriers to combining the two options.

“The government has been very focused on how we penalise products that have been seen to underperform, and now that we’ve identified the underperformers, the next part of that needs to be how do we shift towards getting those products out of the system for the benefit of consumers?” FSC chief executive Blake Briggs said.

The EY study found the new performance test on trustee-directed products would add a further $4bn in legacy products.

The lobby group is urging the government to prioritise completing the legislative reforms needed to address the barriers identified in the Your Future, Your Super reforms.

“The YFYS regime is now putting up in lights the range of products that are underperforming by those measures. But consumers in those products can’t be transferred out of them into newer, more competitive products, because they incur individual tax consequences when they do that,” Mr Briggs said. “This is in a lot of ways a design flaw of the Your Future, Your Super regime that the government needs to be proactive in fixing.”
The FSC wants two key changes around deferring capital gains tax when transferring between equivalent products and allowing trustees to treat members at a cohort level for transfers.

It says that capital gains events should only be recorded when the member disposes of a product, not when they are transferred between equivalent products.

“The trustee should not have to worry about a capital gains event occurring when they transfer the members from one product to another,” Mr Briggs says.

Mr Briggs also argues that allowing trustees to treat members at a cohort level, rather than having to get individual approval from each member to transfer them between products, is another key change needed.

That would allow trustees to more easily consolidate members into contemporary products when it is in their best interests.

Allowing for such reforms would result in a more “modern” system that would give access to better products to members and deliver increased government revenue of $22bn by 2050, as well as $19bn in lower age pension outlays, the EY report says.

“This ticks all the boxes,” Mr Briggs said.

The EY paper says there are about $132bn invested in legacy super and investment funds, ­affecting 1.8 million accounts.

Its research and findings, however, exclude the $81bn in legacy defined benefit products that make up the bulk of outdated funds.
Also when a fund moves to a new IT or regulatory system, trustees create new product suits while having to maintain the old ones.