1. Reserving all the Fun – SMSF’s and reserve strategies SpeakerLachlan Semple SSA Director CompanyWillis Employee Benefits Date23 rd November 2006

2. AGENDA The How to guide - What are reserves? - Why bother with reserving? - How do you establish a reserve? Marketplace views and opinions - APRA - ATO Strategy Application(s) - Insurance - Investments - Estate planning and death benefit planning - Meet the Simpson’s Agenda

3. What are reserves?  Where the net market value of the assets of the fund exceed the total of member account balances  Used (and abused) since the inception of the life insurance and superannuation industries  “[fund] has a surplus. if.. the net market value of the assets of the fund is greater than the total value of the account balances of the members..”  You administer a surplus via special account established in the fuds’s general ledger. These accounts are called reserves.

4. What are reserves?  Before 2000, reserve accounts were generally distinguished by the categories of  Investment  Contribution  Miscellaneous  The categories above generally related to the impact of surcharge rather than describing a particular application of reserving itself.  Used (and abused) since the inception of the life insurance and superannuation industries.

5. Why bother with reserves?  The trouble with allocated pensions  Their allocated!  PVF’s -> too aggressive?  Depletion of retirement savings Before death

6. Why bother with reserves? The trouble with allocated pensions n PVF’s based on 2002 life table – minimum for male 65 is 17.30 (before 1 Jan 06 was 15.7). Life expectancy (LE) is 17.70 years. n Compare to future LE of 25yr to 39 yr depending on health.  Proposed budget changes –impact  74yr old – min is 5.0% v 7.52%  84yr old – min is 6.0% v 11.49%  90yr old – min is 10% v 18.18%

7. Why bother with reserves?  Smoothing of income  Small v Large funds and (sophisticated vs non- sophisticated members)  Value when used between investment periods  Value when used between fund members

8. Why bother with reserves?  Smoothing of income  Small v Large funds and (sophisticated vs non-sophisticated members)  Value when used between investment periods  Value when used between fund members Example - Assumptions  Homer has $625,000 and Marge has $200,000 in their SMSF  Homer has had employer contributions all his life – Marge hasn’t worked. He wants to restore some “balance”.

9. Why bother with reserves? Where investment returns are fully allocated, account balances would be  Homer has $786,364 compare to $723,516  Marge has $251,636 compare to $231,525 Homer’s Marge’s $ 314,484

10. Why bother with reserves?  Smoothing of income – arguments against  Can use spouse contribution splitting instead  Can withdraw and re-contribute with nil tax after age 60  Why bother – retirement funding from super as “joint” anyway  Post 1 July 2007, arguments for include  Situations where no spouse (same sex) or  Use reserves to shift from fund (parent) to child account  Estate planning – move from party with no dependants to party with dependants  Future legislative risk may change tax rules – while $$ in reserve, options are present

11. Why bother with reserves?  Provision of death and disability benefits (without the transfer of risk via insurance)  Benefits other than “member-financed benefits” and “mandated employer benefits” may be used by Trustee to satisfy a claim under the total but temporary disability condition of release. In practice, the only class available is non-mandated or salary sacrifice contributions  Only alternative, is to tap a reserve of the fund.  Once accessed, payments can be made up to 100% of members pre- disability income for the period that they are on unpaid leave (or not working as long as not on paid leave). No legislative maximum period of payment.

12. Why bother with reserves?  Provision of death and disability benefits (without the transfer of risk via insurance)  In the event of death, the (portion) reserve could be allocated to the members account before payment.  Provides flexibility of access to benefits. Trustees must exercise some care in undertaking the above discretions. Any disagreement from a member/trustee could invoke claims that the trustee's were discriminating against a member

13. How to establish reserve Check Trust Deed Contact supplier or solicitor for deed amendment Modify Investment Strategy Establish reserving strategy Establish crediting rate or investment return objective Identify specific accounts required 1 2 3

14. How do you establish a reserve? Check Trust Deed.  s115 of SIS permits reserves provided trust deed allows Compare the pair  “..The Trustee must allocate amounts from the income account to each accumulation or pension account in proportion to the amount standing to the credit of that account at the beginning of the relevant fund year..”  “.. The Trustee may establish a provision or Reserve within the Fund for any purpose they think fit, subject to the provisions of SIS and SIS regulations…”

15. How do you establish a reserve? Modify Investment Strategy (if needed)  Reserving for investment purposes implies that the return credited for members will be at a constant rate Compare the pair  “…achieve an investment return (net of tax and charges) in the range of CPI and CPI + 4%. The trustees are prepared to accept a negative return, on average, once in every 6 years…”  “.. Achieve an investment return (net of tax and charges) in the range of CPI and CPI + 4% measured on a rolling five/eight/ten year basis. Reserving may be used by the Trustee to deliver the investment return and to avoid posting a negative return to member accounts..”

16. How do you establish a reserve? Establish Reserving strategy  Must have reserving strategy “if there are any reserves of the entity - to formulate and to give effect to a strategy for their prudential management, consistent with the entity’s investment strategy and its capacity to discharge its liabilities (whether actual or contingent) as and when they fall due” Section 52(2)(g)  Within strategy, identify the reserve accounts to be used  For each reserve account, or, for the reserves in total, establish how reserve amounts will be invested.

17. How do you establish a reserve?  Identify which reserve accounts to be established  Investment  Contributions  Miscellaneous/General  Mortality  s279D  Forfeiture

18. Marketplace opinions  APRA Superannuation circular No II.D.1 (Managing Investments and Choice)

19. Marketplace opinions  APRA

20. Marketplace opinions  APRA

21. The Simpson’s  Homer and Marge want to do the right thing for their kids, Maggie, Lisa and Bart. However, relationships are strained after Bart blows up his school, steals from a store, beats up Millhouse and runs away.  Sadly, Bart is now in his late 20’s and has completely rebelled. His family want nothing to do with him and that’s fine by him.  Lisa has gone on to champion world causes and is happy, if poor. Homer has had a serious of promotions due to his safety record at the plant, and combined with one of his schemes (that worked), he and Marge are doing well financially.  The concern of Homer is Lisa - payback for her being the angel of the family. He also has some worries for Maggie, who has a dangerous occupation in the mining industry. Application

22. The Simpson’s  Homer and Marge are now 45. Homer has $1.3Million in super. Their own retirement needs are expected to be modest and in any- case, they have another $1 Million in other assets.  He needs to provide a mechanism to support Marge, Maggie and Lisa should he die. He cant obtain any more insurance – too many donuts! Also, he doesn’t want his estate to burden his children as a responsibility – nor does he want his children to come into substantial money on his death.  What can Homer do? Application

23. Trust deed should include provisions  on reserve establishment and management  covering the allocation policy – or when reserve can be allocated to other fund members  Have a provision for reserve to be paid as death benefit ETP to LPR upon death of last remaining member to prevent benefits reverting to the Crown  Be integrated into the investment strategy  Have a strategy for reserves  Keep your options open! Summary

24. Disclaimer This publication has been prepared to provide you with general information only. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. In preparing this information, we did not take into account the investment objectives, financial situation or particular needs of any particular person. This information is provided for persons in Australia only and is not provided for the use of any person who is in any other country.