The sole purpose test and its interaction with super
By Pam Roberts, Senior Technical Services Manager
During the last year, financial advisers and super trustees have been grappling with a greater focus on the role of financial advice in super and how advice fees are charged. A key area of concern has been the role the sole purpose test for superannuation in determining what fees can be charged out of super.
Under section 62(1) of the Superannuation Industry Supervision Act 1993 super funds must be maintained ‘solely’ for the purpose of providing ‘core’ benefits on retirement and death and/or an ancillary purpose, such as disability benefits. This ‘sole purpose test’ is part of ancient super lore which goes back to the earliest days of super regulation. Its design was to refocus super on its retirement purpose, stop funds being used for tax avoidance and clean up the industry so it could accept compulsory super contributions. The sole purpose test hasn’t changed much in over 30 years and, although there have been strong arguments for a review1, at this stage the Government has no plans to change it.
How does the sole purpose test interact with financial advice fees?
The basic principle is that any payments from a super fund must meet the sole purpose test, including fees for financial advice. The sole purpose test does not mean that fees for financial advice cannot be charged, instead, for fees deducted from a super account or fund, the purpose of those fees must meet the sole purpose test.
There are some significant problems for advisers trying to navigate the sole purpose test:
- For such old legislation, there is very little case law that clarifies how the sole purpose test should work – particularly for retail super. The case law which does exist relates to self-managed super funds (SMSFs) and mainly deals with what investments an SMSF can make.
- The latest Australian Prudential Regulation Authority (APRA) guidance on the sole purpose test – Super Circular III.A.4 – dates back nearly 20 years to February 2001. The super industry looked very different back in 2001, when company funds dominated the landscape and the right to choose your own super fund did not exist.
The Treasurer has notified Parliament that APRA intends to release updated guidance for consultation by 31 March 2020.2 In the meantime advisers are stuck in the difficult position of having to set advice fees in super based on the old APRA Super Circular III.A.4.
- In his Final Report3, Commissioner Hayne took an emphatic black-letter position on the sole purpose test that restricted the range of advice for which fees could be charged and deducted from super accounts:
(It) is limited to advice about particular, actual or intended superannuation investments. This may include such matters as consolidation of superannuation accounts, selection of superannuation funds or products, or asset allocations within a fund. It would not include broad advice on how the member might best provide for their retirement or maximise their wealth generally. Any practice by trustees of allowing fees for these latter kinds of financial advice to be deducted from superannuation accounts must end.
What can advisers do at present?
At this stage the Government is not intending to change the law to remove or amend the sole purpose test. This may change depending on the findings of the Retirement Income Review due in June 2020.
APRA has said it will release updated guidance on how the sole purpose test applies to financial advice fees by the end of March 2020, but we’re still waiting. Until we receive this guidance, it’s important to work within the law as it currently stands:
1. The only advice fees that can be deducted from super accounts relate to advice about super and the benefits, insurance and investments choices provided through the super fund.
- Charging for advice on non-super investments or advice that relates to another super fund cannot be deducted from the super account.
- For example:
- A client invests through a platform and has both a personal super account and an IDPS account for their SMSF. The advice that relates to the SMSF investments cannot be charged to the personal super account (even though all the investments are on one platform).
- A client has an account with both an industry super fund and a personal super account through a super wrap. Advice that relates to investment choices in the industry fund cannot be paid for through the super wrap account.
- Advisers should pro-rata advice fees across super investments and the non-super investments, to ensure they are meeting the sole purpose test.
2. There must be a ‘reasonable, direct and transparent connection’ between the advice provided and the benefits provide by the super fund. For example:
- Advice fees charged from a super pension account can cover advice about the Centrelink age pension because this is directly connected to determining the level of income required to be drawn down from the client’s account-based pension. The advice provided should make this connection clear.
- A client’s other super benefits – in an industry super fund or a defined benefit fund – can be directly relevant to many of the choices made available to the member in a personal super or pension account (contributions, insurance, investment strategy, draw down rates, death benefits). So long as a clear connection is made with the benefits provided by the personal super fund, advice fees can be charged through the personal super or pension account.
- Estate planning advice. If it is directly connected to the death benefits provided by the super fund, advice fees charged through the super account can include estate planning advice.
- The IOOF super fund (IPSSF) provides for beneficiary nominations (both binding and non-binding) but will hardcode death benefits to the deceased’s estate if no nomination has been made. Because of this feature, advice about the distribution of the member’s estate on death is directly connected to the benefits provided by the super fund.
- Other super funds that have trustee discretion for death benefits do not necessarily have a direct connection to estate planning.
The threshold test is, if there is NO connection between the advice service provided and the benefits provided by the super fund, the fees relating to that service cannot be charged through the super fund.
3. Advice fees cannot be deducted from the adviser’s own super account
- Payments to a member either directly or indirectly before retirement are likely to be construed as illegal early release payments and a breach of the sole purpose test. This would include situations where an adviser has inadvertently charged advice fees to their own super account.
4. A ‘reasonable connection’ to the benefits provided
- Advice fees should be reasonable in relation to the client’s super benefits. If, on an objective basis, the advice fees charged are out of sync with the benefits provided, super fund trustees can intervene and restrict the amount of fees. Trustees are also obliged to investigate situations where it appears fees have been deducted but services not provided. This is both a sole purpose test issue (trustees can only pay out fees for a proper purpose) and part of a super fund trustee’s obligation to act in the best interests of members under super law. Commissioner Haynes made it clear that advice fees for no service was an issue for super fund trustees as well as advice licensees.
Waiting for APRA
This time last year APRA indicated it would release updated guidance on the sole purpose test before the end of 2019. It didn’t materialise. However, the Treasurer will have forced APRA into action by telling Parliament that APRA intends to release draft guidance for comment by the end of the first quarter of 2020.–– We would hope that APRA will take a modern view of the application of the sole purpose test to financial services in super and recognise the role financial advice has in benefiting consumers.
Finally - should the sole purpose test have a role in the future?
It would be a rare thing that laws designed to defeat tax avoidance and employee exploitation in a previous century would still hold their own in a radically changed industry many times its 1980’s size. The sole purpose test in super definitely has the feel that it should have gone out with shoulder pads and mullets. It imposes an unnecessary restriction on trustees providing services and benefits that are outside the narrow parameters of retirement and death benefits. For advisers it forces unnecessary char ging complexity and restrictions on advice. Why shouldn’t services assisting clients with the financial aspects of aged care and Centrelink be funded through superannuation? If a super fund provides financial protection in case of death, why shouldn’t the fund be able to facilitate the full range of advice on estate planning?
If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.