Take a moment and picture the following scenario. You have just retired and decide that you would like to access your Super Benefit as a tax free Simple Account Based Pension. You have worked hard and are looking forward to enjoying the spoils of your labour. You have accumulated a sizeable Super Benefit of $1 million and at age 60 think that a tax free pension drawdown of $60,000 per annum should be a comfortable income to live on.
Accordingly you apply to your existing Superfund to commence your Pension. Soon afterwards the Superfund informs you that the application has been rejected. That's right rejected. Your existing Superfund informs you that their Superfund is apparently frozen and they are not allowing withdrawals at this time. This may change shortly at which time you will be informed. Outraged you apply to Rollover your benefit to another Superfund. Again failure. Rollovers apparently have been frozen as well. In fact all Fund withdrawals have been frozen until further notice.
Sounds like a horror story. It is. But it should not surprise you that it can happen. We all had a small taste of this possibility in the recent Global Financial Crisis and there is no reason to think it cannot happen again. In fact a recent study suggested that as early as the year 2025 there will be so many baby boomers retiring that contributions from working Australians will be insufficient to meet the fund withdrawal requirements of retirees.
It is true to assume that all Superfunds have liquid assets to meet retiree withdrawals, but sometimes they are insufficient. The way the current system works is that a Superfund will set aside cash reserves sufficient to meet expected Member withdrawals. If Member withdrawals begin escalating then in the early stages of this transition period Superfund's may have insufficient monies to meet Member withdrawals.
That is, as retires as a percentage of the overall Superfund increase, the Superfund will need to ensure that more of the Fund is held in liquid cash to meet the Member withdrawals. Having more in cash investments potentially lowers the Funds overall returns. Alternatively the Superfund may need to sell assets to meet increasing Member withdrawals. Selling may occur at inappropriate times when the market is weak potentially harming the overall performance of the Fund. How much can it affect the market you ask? Well imagine the problem is experienced by a significant number of Superfunds at once and they all seek to sell at once. The Australian Market is not that large in world terms and large selldowns can have a disastrous effect on share prices harming Superfund performance. What's even worse is that some Funds invest in illiquid assets. How do you raise cash for Member withdrawals when the Fund invests in a shopping centre?
The recent GFC has shown us that when a Fund experiences a period of illiquidity or weak markets it becomes more conservative in future in how it invests. For example whilst the US market has nearly doubled off its low between early 2009 and 2011 and commodities have doubled and tripled over the same time, most Superfunds have barely come close to matching these returns. One of the reasons is that Superfund's are investing more conservatively and with higher levels of cash to ensure that the GFC issues are not repeated. Hardly inspiring.
When we invest there is always risk. There is "Economic Risk" that the economy will be weak or that we enter a recession or interest rates begin going up. All negative for Super Returns. There is "Market Risk" that the market falls for all sorts of reasons leading to corrections or worse. Again negative for Super Returns. Then there is "Stock Specific Risk" where the economy and markets are fine but your Superfund simply picks the wrong stocks. These are risks we have always put up with but given that Super is for such a long timeframe we hope these risks will work themselves out.
But now there is a new risk. "Provider Risk". The risk that the Superfund you choose will not be able to pay your benefit when you need it or will need to raise cash to meet increased Member withdrawal requirements. Many will argue this is simply rumour mongering. However this is not the case. The structure of the current Superfund system lends itself to these risks. Why? Because Superfund Structures whether they are Retail or Industry Superfunds are trust structures where the decisions of the Superfund assets are dictated by the Fund Trustees.
Even worse than not being the actual person making the decisions for your Super when you invest in Retail and Industry Superfunds it is important to understand that as a Member of these Funds you actually own nothing! That's right you as an individual Member own nothing! The Retail or Industry Superfund you invest in actually owns the assets. You simple have a beneficial entitlement in these assets as a Fund Member. And it is the Superfund Trustee who can dictate how and when your Super Benefit will be paid having regard to the effects your withdrawals will have on all Members of the Fund. Whilst you could care less about the other Fund Members, your Superfund must consider all Members when making decisions.
This is the reality. Your Superfund can do whatever it likes including freezing Member withdrawals and there's nothing you can do about it. The truth is that when you invest in Retail and Industry Superfunds you expose yourself to "Provider Risk". Now it may be only 1 in 100 of Funds that suffer problems, but what if it is your Fund? Not a pleasant thought is it.
Is there an alternative? Yes! The only way to eliminate "Provider Risk" is to actually own the assets making up your Super. Not to be an indirect owner of assets via a large Retail or Industry Superfund. And the only way to be a direct owner of your Super is through a SMSF. This is the only legal structure in Australia that allows you to own and control your Super Benefit because you are the Fund Trustee! When you are the Trustee of your own SMSF you can sleep at night knowing that no one can put a freeze on your retirement benefit!