Money: Nest-egg schemes are not so super

One of the confusing things in the whole debate about saving for retirement is the role of the more than 200 retail superannuation funds in the market.

It is logical to think that if you cannot join a workplace super scheme the next logical step is to put your money into a retail superannuation fund to build up your retirement nest egg.

The reality is quite different. There is nothing special about superannuation funds. For a large chunk of the population, a superannuation fund is one of the last places they should put their money as they will end up paying more tax than necessary. What's more, they can be inflexible and in many cases have high fees.

The Government Actuary, Geoff Rashbrooke, who oversees the Superannuation Act, agrees there is nothing special about super funds, expect maybe for the people who promote them.

Super funds, because of their perceived link to retirement, become easier to sell to unsophisticated investors who have been bombarded with the "save for your retirement" message.

The success of this strategy is demonstrated in figures from managed funds research house IPAC Securities.

In the three months ending June 30, super funds achieved a net fund flow of $26.7 million while two of the other legal structures (insurance bonds and group investment funds) both recorded negative flows. However, they were some way behind the more popular investment vehicle, unit trusts, which grew by $355.2 million.

IPAC general manager David van Schaardenburg says net funds flow in the three months to June 30 was up 7 per cent for unit trusts and 2 per cent for superannuation funds. Despite seeing an increase in funds under management in the quarter, the overall trend for superannuation funds is downwards.

IPAC's figures show that flows into super funds reached an all-time high of more than $400 million in December 1993, but plummeted the following year. Since then there have been two minor rallies, the later being in the period ending June 1999.

Mr van Schaardenburg says super funds have benefited in the past from things such as the Government's surcharge on the state pension. However, there's been a "big structural shift" and these types of funds are out of favour because they have no benefits over other types of managed fund.

The heat has been on super funds for some time, and IPAC and the Government Actuary aren't the only ones questioning their viability. In the past two years, Consumer magazine has published two articles which argue that these sorts of funds are dinosaurs as much as sharks.

Colonial First State Investments chief executive Bruce Abraham has described them as "galling," an "embarrassment" to the savings industry and "dishonest."

That raises the questions: What are super funds and why aren't they so super?

Retail super funds, like all other managed funds, are a way for people to pool their money and have it invested by a professional manager.

The distinctive characteristics of super funds is that they operate under their own law (the Superannuation Schemes Act enforced by the Government Actuary) and they are taxed at a flat 33 per cent rate.

That means investors don't have to worry about dealing with imputation credits when they do their annual tax returns (which also means they can't use these credits to offset other tax costs).

If your marginal tax rate is less than that then you're paying extra tax unnecessarily, yet if you are one of the select group who pay tax at 39c on earnings over $60,000 then super funds provide a benefit.

The Government is in the process of giving the rich a tax break if they have a portion of their salary directly paid into a super fund. Under this break, the money that goes into a super fund will be taxed at 33 per cent instead of 39 per cent.

The tax issue works two ways, though. WestpacTrust Financial Services general manager Girol Karacaoglu pointed out to a superannuation conference in Wellington last week that people on rates of less than 33 per cent are disadvantaged in super funds. Yet they are convenient if you don't want to deal with imputation credits.

Another big issue with super funds is their fee structures. One of the major criticisms has been that they are too expensive and the fees aren't clear.

To understand this concern it's necessary to split super funds into two broad categories: old-fashioned and new-style funds. Old-fashioned funds are mainly the ones that life insurance companies have promoted in the past. They tend to have high up-front fees that stop the fund from performing.

The "modern" super funds have been embraced by the banks as they move into the savings market. These funds are competitive on fees and look very similar, if not identical, to unit trusts. The issue of fees is important as the higher they are the more they cut into returns.

Financial planner Murray Weatherston says that raises another issue about super funds, namely how they are invested.

He correctly contends that to increase your wealth you have to invest in growth assets such as shares and property. The trouble with many super funds is that they are labelled "capital stable," take on little risk and invest in things like cash and bonds. The result is that the saver will be comfortably poor in retirement.

"I think it is a crime to encourage people to save their money in a form which, while being capital stable, will get them nowhere in the long term," he says. "Superannuation funds should be outlawed from providing capital stable and conservative investment options for their clients."

The third big issue with super funds adds to confusion about the products.

The perception is that if you put money into a fund it is locked in there until retirement. The law even says that to gain registration a fund has to be "principally for the purpose of providing retirement benefits."

Sounds pretty straightforward, but as is often the case with savings it's complex.

Many of the firms that sell super funds will let you take money out before retirement, thus making it just like a unit trust.

Technically this is a breach of the law, but it is the equivalent of driving without a seat belt. The chances of getting caught are slim, and the punishment is minor.

The Government Actuary has the power to deregister a fund if it fails to comply with legislation, but if there is nothing special about being a super fund, losing official status is also not a major deterrent.

Mr Rashbrooke is trying to tighten up the rules in this area and issued a discussion paper which proposed strict guidelines on what "principally for retirement" means. He says many super schemes aren't meeting their legal requirements; at present he is trying to deregister two retail funds.

The irony of this is that while they might get deregistered the public won't know, because the actuary has a policy of not disclosing fund names.

One of the biggest players in the super funds area is fund manager Armstrong Jones.

Managing director Paul Fyfe accepts that these funds aren't the most popular at the moment; however, he believes they will make a comeback under the current Government. His rationale for this is twofold.

First up, it has given people earning more than $60,000 annually a small tax incentive if their employer pays some of the salary directly into a super fund.

Secondly, Finance Minister Michael Cullen is seriously considering changing the tax system so that money invested isn't taxed until it is withdrawn from the scheme.

The idea being mooted is similar to the 401(k) scheme used in the United States where people can save up to $US9000 each year and not be taxed on the earnings.

Mr Fyfe, who is also head of the Investment Savings and Insurance Association, believes the Government will make the changes and it will encourage people to use super funds for that purpose.

Super funds aren't so super at present, but maybe, like Superman himself, they are about to step into the telephone booth and be transformed.

* Philip Macalister is the editor of online money management magazine Good Returns. Good Returns provides news on managed funds, mortgages, insurance, superannuation and financial planning.