Hidden fees are a super problem

I’m calling BS Tony on your claim vanguard is the only fund that doesn’t have performance fees.

Correct. I don’t know if any index fund that charges a performance fee.

Not my problem as I run a SMSF but this was an official "response", word for word, from a few years ago to the exact question - no cynicism involved. Names deleted to protect the provider!

"........ however the tax legislation provides superannuation funds with the option of applying an alternate process being the benchmark approach. Rather than the fund having to manually track each investment buy and sell, it is able to apply a set rate (determined by the ATO each year) to the tax credits received and this effectively reduces the amount of the credits that can be claimed by that fund in the given year. The benchmark approach is required as superannuation funds generally are not able to allocate specific investment transactions to an individual member and even if they were, the fund would then have members transactions adversely impacting other members entitlements (eg. investor A buys on the 1st of January - a dividend is paid on the 5th January - investor B sells on 10th January ... In this case even though Investor A nor B have individually triggered the 45 day rule being applied, the fund would be denied the credits under the 45 day rule as the tax office only look at the superannuation fund transactions in total - not at the member level). In this situation it would not be correct to deny the full credits to either investor, so the benchmark rule is utilised across the fund so that all members are treated equally. As XXXXXX is buying and selling investments on a daily basis on behalf of over XXX,000 investors, you would appreciate that the 45 day rule would kick in for the vast majority of our holdings if the benchmark approach was not adopted.

XXXXXXXXX has utilised this approach for many years and has consistently reduced the amount of credits applied to members in the super fund by the rate stipulated by the tax office. In the past year, the rate applied by the ATO has increased significantly given broader economic and investment market activity and hence the impact on members is greater than in prior years.

You are correct in that the application of the benchmark rule does result in a situation where members may be worse off with respect to franking credits within a superannuation fund rather than holding the investments directly (or in a SMSF where fewer members mean less risk of the 45 day rule having adverse impacts on each member through other member activity). ...."

This is purely about treating unit holders fairly, not diddling anyone. If you hold an investment throughout the tax year you get full income and all franking credits attached. If you switch investments and only hold the full exposure for part of the year then you aren't entitled to 100% of dividends or franking credits. To be paid them is unfair on others.
Its perfectly reasonable for funds to take this approach and perfectly unreasonable for you to malign an industry that seeks first and foremost to do what's in members best interests.

It is quite feasible to " trade " in companies paying good franking credits. You do not have to hold all of your investment in a particular stock. As long as you hold a significant number of a good dividend paying stock you can play the buying of stock pre or post dividend as long as the trading is less than say half of your total holding.
All you have done is sold the stock that you have held for over a year and bought some different stock back. It works as I checked it out legally as an SMSF auditor.

Graham W, there are 45 day rules and the like to take into account. Fund managers do that.
But your comment isn't really relevant to the accusation made by Rob that funds cheat investors out of franking credits. They don't.

One can contribute to the accumulation phase of super but not when it's in pension phase. Is this a rort by the funds so that fees can be charged on a new separate pension account?

Super funds aren't in control of, and can't change, the legislative structures under which they operate.

Hi Mark - no its not a rort. Regulations don't allow a super fund to pay an income stream from an accumulation account nor except new monies into an established account based pension. Earnings in an account based pension are also tax free so the assets have to be segregated.
Super funds are Trust structures so are obligated by regulations to be operating in the best interests of the member (despite what many seem to think)

A separate account (pension plus accumulation) is mandatory once the super balance exceeds the transfer balance cap (currently $1.9m).

An accumulation account and an account-based pension are quite separate because they have different tax treatments. In accumulation phase, concessional contributions (such as SG and salary sacrifice) as well as investment earnings are taxed at 15%. In pension phase, there can be no more contributions and all investment earnings are tax exempt.

The super fund must also keep track of the taxable and non-taxable components of a member’s super balance because the proportion of taxable to non-taxable components is crucial for calculating the tax on death benefits. This tax is 15% plus the Medicare levy calculated on the proportion (not the amount) of the taxable component of the member’s super balance. Note this tax applies to the whole remaining super balance - the capital, not just the income.

In accumulation phase, concessional contributions and all the investment earnings are added into the taxable component. The longer the accumulation account continues with more investment earnings, the larger the taxable component. Non-concessional (after-tax) contributions are counted in the non-taxable component. Larger non-concessional contributions will decrease the proportion of the taxable component and therefore reduce the tax on death benefits.

In pension phase the proportions of taxable and non-taxable components are set in stone when the pension is started because there are no more contributions. A super fund with 100% non-concessional contributions will have zero tax on death benefits.

The easiest way to avoid this death tax is to remove all your money from super (tax-free after age 60) before death but unless you know the date of death, timing that withdrawal can be tricky. But if the member has a super balance at death, the tax payable by the beneficiaries of that benefit depends on these proportions.

Your super fund or your SMSF administrator should be able to tell you the proportion of your existing taxable and non-taxable components.

I generally agree with everything you have written. Couple of riders there tho Jon. Death benefits is only payable by super dependents who are not tax dependents. Eg adult children. Spouse for example doesn’t pay death benefits tax. This is very important to understand for people who are concerned about this. Secondly you don’t pay Medicare if the super benefit goes to the estate. Not much I’ll grant you but 2% on $1m taxable component is still $20k tax saving. Further direct payments of a death benefit can impact government benefits that are income tested but via the estate it doesn’t tend to. Death benefits tax is on capital only. Income and cgt are different if in accumulation phase. Re avoiding death benefits tax you are better to use the taxable component recycling strategy assuming transfer balance cap space is available to cleanse your super benefit of taxable component. This means a tax dependent won’t pay any death benefits tax.

I wonder if a useful article such as this will encourage more folk to examine SMSFs?
For my part I started one 21 years ago due to argy bargy with my then planner/advisor. We (mostly it’s me) haven’t used an advisor since. We do our own investing, mainly domestic shares but lean towards companies with a significant OS presence. We have never looked back… We make our own decisions; we don’t pay others to invest poorly for us and we wear our occasional mistakes. And we get a whole lot of satisfaction from the overall process.
We’re members of an investing group called Team Invest and pay annual fees but no more than we’d pay an advisor. Given our significant ongoing success, we probably pay a lot less than we would an advisor. And it’s got to be good for the brain…

What irks me about the managed funds (my wife and I are with Unisuper) is that fees are a percentage of the balance. The admin and the investment costs should be same whether you have $160K or $1.6M in either pension or accumulation. How much harder is it to deal with larger numbers?

Exactly!…..hence the popularity of SMSFs

Agreed!

So you'd prefer that people with small balances paid the same as those with large? Because you're assuming that funds could cover costs if they charged everyone a fixed dollar amount that's the same as low balance investors.
Oh, you're concerned about large balance investors paying "too much". Well, the clever ones know how to use wholesale funds to get a lower fee in % terms than low balance investors.
And btw, if youre in a super fund they negotiate manager fees down very tight and pass that on to members. Profit-for-member funds do this moreso than for-profit funds of course.
Get off the industry's back people!

Esuperfund charges a fixed annual compliance fee for all SMSFs presumably because a similar amount of work is involved to complete annual compliance regardless of fund balance.

GeorgeB yes, but that's not actually what this discussion is about. My SMSF has fixed dollar admin fees too. But the managers I use charge a % of funds. I don't have an issue with that.

Not just fees - 100% of Franking Credits do NOT flow through

Hi Rob,

I wonder if you could elaborate on this comment.

One would think if you are receiving any form of franked income that all of the franking credits received from dividends/distributions would be taken into account when calculating your tax liability (or refund if in pension phase)?

I'm just wondering if I have missed a key point you are making here?

Rob they don't "flow through" because they're part of your tax position. So they'll give you the amount to put in your tax return so you get them.

You would want to check very carefully. The issue for most Industry and Retail funds and most Master Trusts is that they are "pooled investments" with money coming and going and a mix of investors, some in Accumulation with a 15% income tax and 10% cap gain liability and some in Retirement with no tax liability for Income or Cap Gains. Because they are "pooled", they cannot [or will not] differentiate your "exact" personal tax position. [Not dissimilar issue to the proposed >$3m new Super Tax - accounting systems can't cope or are rubbish - take your pick!]

My belief is that an ATO sanctioned "haircut" is applied. Eg CBA over the last 12 months paid out $4.65 in fully franked dividends. That is a $1.99 Franking credit [.4285*dividend], fully refunded to a Retiree and that is how it works in a SMSF. Unless it is a Segregated Super Fund and not even sure then, I do not believe that full $1.99 flows thru from Industry/Retail Funds - certainly has not, to ones I have seen in the past. Given most Aussie dividends are fully franked, other than the likes of CSL/MQG, REITS etc, check your statements and if there is any apparent "leakage", ask the question!

rob, of course it does! Trusts have to distribute income in proportion to beneficiary entitlements and they all provide unit holders with statements of the sources of their income to input to their tax returns.

Get off your cynical horse and try to understand that fund managers have legal obligations that, as a former fund manager myself, I KNOW they comply with. If the fund held CBA shares then they'll be advising unit holders of the franking credits that accrue to those unit holders.

Don't believe me? Try ringing your fund manager's call centre and asking them to confirm with the fund accountants.

I believe Rob is correct. There is no breach of fiduciary of trust by the manager it’s the structure that impacts you. The fr cr is applied to the fund not the members account as they are unitised structures. So 100% of the franking credit is applied to the fund but you personally may not benefit 100% due to the structure.