Australian Government, The Treasury -

Review of Pensions in Small Superannuation Funds


1 Background to the review

This part summarises the contextual background for the review. The 2004-05 Budget announced measures to address the use of defined benefit pensions by small superannuation funds for tax avoidance and non-retirement income purposes. The measures also sought to address prudential issues with small funds, namely the ability to manage the risks of providing a defined benefit pension. The objectives of these measures were broadly supported. However, the superannuation industry raised concerns with the means chosen. On 5August 2004 the Government announced a review of pensions provided by small superannuation funds.

2 Review processes

This part identifies the key tasks required by the terms of reference, sets out the scope of the review, and explains the purpose of this discussion paper as part of the broader review process. This part also specifies how to make a submission.

The key tasks are to review the provision of pensions by small superannuation funds, to address certain concerns with small superannuation funds providing defined benefit pensions, to examine options for the provision of pensions by small superannuation funds, to prepare this discussion paper, to consult with stakeholders, and to report to Government by April 2005.

The review is directed at defined benefit pensions and other pensions that are provided in small superannuation funds. A small superannuation fund is defined as having fewer than fifty members. The review will take into account the defined benefit pension integrity measures announced in the 2004-05 Budget.

The discussion paper outlines key issues with pensions in small funds and canvasses strategies to address the issues. The paper is intended to help individuals and organisations prepare further submissions to the review. Interested parties can make submissions up until 11 March 2005.

3 Retirement income policy objectives

This part provides a policy background for the review by presenting a statement of the Government’s retirement income policy objectives.

Broadly, the objectives of the retirement income system are to encourage people to achieve a higher standard of living than would be possible from the age pension alone, while ensuring they have security and dignity in retirement. To achieve this the system should encourage people to save for their retirement, be predictable, facilitate choice, and be equitable. Australia’s ageing population also highlights the need for retirement income policy to be fiscally sustainable in the longer term.

Substantial tax concessions for superannuation encourage people to save for their retirement. These are made on the basis that the savings provide genuine retirement income. They are not intended to provide estate planning or wealth accumulation benefits beyond those necessary for retirement income purposes. Assets built up in superannuation should be drawn down in retirement.

Similar objectives underpin the generous social security concessions provided to income streams when ownership of the asset backing the income stream is signed away in return for a regular, dependable income based on life or life expectancy.

4 Key issues with pensions provided by small superannuation funds

Key issues are examined from the perspectives of choice, complexity, taxation, social security and risk.

The restrictions on small funds providing lifetime and guaranteed term pensions effectively reduce the range of income stream choices available from small funds. Small superannuation funds still can provide allocated pensions and market linked pensions. However, initial submissions argue there will still be demand for defined benefit pensions from members wanting a given level of income for their lifetime or other term.

The system for retirement income stream products in Australia is complex, reflecting a mixture of legislative frameworks that are designed to meet different retirement income policy objectives.

The non-arm’s length nature of small funds allows a member to design a pension to gain unintended tax and social security benefits. Two such arrangements, Reasonable Benefit Limit (RBL) compression and estate planning, are examined.

There are three key issues about the ability of small funds to guarantee a defined benefit pension: the lack of an employer guarantor, the absence of risk pooling, and the management of investment risks.

5 Strategies for addressing issues

The initial round of submissions suggested a number of proposals to overcome issues with small funds providing defined benefit pensions. To facilitate further comments, the discussion paper presents three main strategies that may allow greater retirement income choice for members of small funds and address, directly or indirectly, taxation, social security, risk and complexity issues.

The strategies are to develop new rules for the provision of defined benefit pensions, to modify existing pension products, and/or to introduce new pension products. The strategies could be implemented separately or in combination.

New rules to address RBL compression could include a purchase price valuation or updating pension valuation factor tables. Pension design standards and changed taxation arrangements to recover excessive benefits could address estate planning issues. Risk management options include transferring risk to the pensioner, introducing portfolio rules and attaching longevity insurance (in the form of a deferred annuity) to a pension.

Four modified product options are presented. Two options manage the longevity risks of the market linked pension by extending the term and attaching longevity insurance respectively. The third smooths payments from the market linked pension and the fourth manages the longevity risks of the allocated pension through updating the minimum payment factors.

To address tax avoidance and risk management issues the new product options are limited to account based products. Each option aims to provide a CPI-indexed pension to an advanced age, but with payment adjustments to eliminate the build up of excessive reserves. The new product options also use pension valuation factors to minimise complexity so they can be administered by fund members.

The budgetary cost of each option is still to be estimated. A possible outcome from the review could be that the restrictions on small funds providing defined benefit pensions would remain in place. Whether or not new products or product modifications or new rules for defined benefit pensions were introduced would be a matter for Government.


Next: Background to the review

Previous: Terms of reference


Commonwealth of Australia 2005
ISBN 0 642 74275 8