Tax-ignorant super funds ‘losing billions of dollars’

Super funds are missing out on billions by ignoring the tax consequences of their investments.

Superannuation funds are missing out on billions of dollars a year in returns by ignoring the tax consequences of their investment decisions, according to experts — leading to larger system-wide losses even than excessive fees.

New analysis has concluded retail and industry funds, with a combined $1.9 trillion in assets, could increase their annual returns by $7.54bn, or almost 0.6 per cent a year, if they maximised refundable franking credits and available capital gains tax discounts, and avoided redundant trades.

“Very few if any super funds in the country measure tax appropriately,” said Kyle Ringrose, principal at Athena IOC, an investment consulting firm.

Pension funds in the US, Britain and other countries are exempt from tax, meaning after-tax returns aren’t relevant.

Superannuation funds pay 15 per cent tax on earnings, and 10 per cent tax on capital gains for assets held longer than 12 months. As for individual taxpayers, they are eligible for refundable franking credits on dividends.

In 2013 superannuation legislation was amended to compel funds to consider tax factors when they invest, such as the 45-day rule, which is the minimum length of time Australian shares need to be held to be eligible for franking credits.

Average member account balance over time

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Mr Ringrose, former head of investments at QSuper, one of the nation’s largest super funds, said super funds might say they took tax into consideration but few did so properly.

“It’s absolutely a significant issue, if you look at any super fund’s financial statements you’ll find tax is perhaps the biggest single expense they have,” he said.

Super funds’ returns would increase by “around 59 basis points each year, on average” according to research conducted by investment adviser Parametric.

Widespread focus on pre-tax returns, it found, meant a typical saver would end up with a retirement savings balance almost $200,000, or 27 per cent, lower than if they were in a super funds that targeted after-tax returns. In its report on the superannuation sector last year, the Productivity Commission said savers in “high fee” funds — incurring an extra 0.5 percentage points a year in fees — would retire with $100,000 less.

“It’s an industry issue at the custodian level; investment managers, by and large, looks at gross returns,” said Kate Farrar, chief executive of LGIA Super, one of the handful of funds, along with Qantas Super, that focus on after-tax returns.

Gordon Mackenzie, a senior lecturer in tax at UNSW, who canvassed big super funds in 2014, said he was “blown away” by how little tax factored in chief investment officers’ decisions. “They were not interested in it; and they weren’t rewarded on the basis of post-tax returns,” he told The Australian.

“Some of the big funds have multiple investment managers which can be buying and selling the same shares at the same time, incurring tax and transaction costs,” he added.

Qantas Super, with around $8.5bn, said it gained an extra 0.25 percentage points in return each year from factoring-in tax.

“Tax and transaction costs are quite significant in terms of net return that members get. And just like every other important cost they should be proactively managed,” said its chief executive, Michael Clancy. Ms Farrer said it was “incredibly important to target after-tax returns because that is what members receive”.

“Since we started looking at post-tax returns we have made around $150m in tax savings, which is significant,” she added.

When members’ savings are in the ‘‘retirement’’ phase, they are exempt from tax, which means capital gains liquidated after retirement aren’t taxed.

“Every single SMSF in the country knows all about this, but the big super funds don’t pay any attention to it,” Mr Ringrose said.

In 2010 Jeremy Cooper, who reviewed the superannuation system for the Labor government, said funds’ ignorance of tax was a “breathtaking misalignment”.

The government has established a review of the retirement system, including compulsory superannuation, to assess its efficiency and effectiveness.