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Macquarie Adviser Services Magazine

perfect mixthe new elements fuelling the boom in financial advice

global equity shifts gearhow China and Germany

are driving growth

2/2007

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Macquarie Professional SeriesFinancial advisers call 1800 005 056, Institutional enquiries call 02 8232 7017 www.macquarie.com.au/eii

She is not the only European shining brightly in New York.

The Statue of Liberty was gifted to the Americans by the people of France in 1886. She pays homage to the millions of Europeans who made the US their home and helped it become the economic powerhouse it is today. Christian Lange, founder of EII’s global property team, is one of them: born in Germany, he was a successful investment manager for wealthy Europeans before he decided to set up in New York 20 years ago.

EII is now a highly regarded global property boutique manager – some of the largest institutions in the US put their faith and money in EII. It’s easy to see why. Global property provides a low correlation with other asset classes. It’s further diversified across different countries around the world, where property market peaks and troughs come about at different times;

EII is perfectly positioned to exploit these fluctuations through deep local knowledge and the courage to act swiftly.

Christian and his team have established an enviable track record over the years, consistently outperforming relevant indices. Their recipe for success is deceptively simple: don’t look at benchmarks, find value where others aren’t looking and follow your convictions.

Macquarie provides access to EII via the EII Global Property Fund, which is now available to the Australian market as part of the Macquarie Professional Series, an exclusive collection of highly individual managed funds. If you are after long-term growth and greater diversification in your clients’ portfolios, we believe you’ll like EII as much as we do.

EII Global Property Fund ARSN 117 792 113 (“the Fund”) is offered by Macquarie Investment Management Limited ABN 66 002 867 003 (MIML). The Fund is managed by European Investors Inc (EII). Investments in the Fund are not deposits with or other liabilities of Macquarie Bank Limited ABN 46 008 583 542 or any Macquarie Bank Group company and are subject to investment risk, including possible delays in repayment and loss of income or principal invested. None of Macquarie Bank Limited, MIML or any other member company of the Macquarie Bank Group guarantees the performance of the Fund or the repayment of capital from the Fund or any particular rate of return. This information is for advisers only. It is general advice only and has been prepared without taking into account the objectives, financial situation or needs of any particular investor. Before making a decision to invest in the Fund, the investors should read the Fund’s Product Disclosure Statement (PDS) which is available from us, and consider, with or without their financial adviser, whether the investment fits their objectives, financial situation and needs. Applications for units in the Fund can only be made on an application form contained in the current PDS. Past performance is no indication of future performance.

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One simple rule of investing is that starting without a plan can be like driving without a map – a hazardous pastime, particularly for the adventurous. Financial planners have built a strong case for professional success based on the fundamental premise that failing to plan is planning to fail.

But the questions Forward Thinking has posed in this edition go to the heart of the planning profession itself: what is the future destination for financial planning and what are the key shifts today shaping the advice industry of tomorrow?

The news is good. Our report finds a unique set of forces – some say the perfect mix – that in 2007 deliver a healthy prognosis for financial advice in this country. Our Cover Story is a starting point for discussion, and we welcome your feedback as always.

Elsewhere in this edition of Forward Thinking we take a closer look at the role of the emerging global powerhouse economies in China and Germany; we assess the technical impact of Australia’s new superannuation laws and we introduce a new section called ‘Investment Fundamentals’ – debunking a few myths while explaining how common investment laws or language came to be.

I trust you enjoy this edition of Forward Thinking.

Inside information

Contents

Neil Roderick Executive Director Head of Macquarie Adviser Services

Regular features28 Smart investing More than one engine driving

global growth

30 Investment fundamentals Beyond the efficient frontier – how

the risk/return world was discovered

33 The collection The evolution of the

Macquarie Professional Series

34 Wrap up What’s administration

got to do with it?

36 The hub Go with the flow

38 Technical essentials

40 Concord stock story Game on

Cover story02 Perfect mix

Bruce Madden uncovers the seven trends that are shaping the future of the financial advice industry: aging population, bulging super accounts, increasing sophistication, the regulators, technology, and product evolution.

Main feature�4 Tech talk Super becomes a dead certainty

Transitions, transitions... TTR pensions more attractive

in the new world?

Macquarie Adviser Services Magazine

2Read this story to receive CPD points.Simply log on to http://www.macquarie.com.au/ftmagazine

Financial advice is booming. New superannuation rules, an aging population and strong investment markets are fuelling high-spirited growth and unbounded optimism. Bruce Madden* uncovers a combination of elements – some say the perfect mix – that is stimulating growth and delivering a bright future to financial advice in Australia.

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perfect mi

Pundits say the financial advice industry may never have it so good.

A robust economy, a tranche of new superannuation and retirement income rules to work through and a large proportion of the adult population – the so-called Boomer generation – reaching retirement age, meaning a potential endless stream of new clients.

Such is the optimism for the future growth of the advice industry in Australia, the views of the naysayers have struggled to make a dent on the forward progress of an industry intent on cementing its future.

Forward Thinking has taken a look at the trends, identifying seven clear shifts to shape the future of financial advice in Australia. Through conversations with industry insiders, the Forward Thinking list should provide food for thought for an industry currently too busy to think about tomorrow.

Our interview with Macquarie’s technical guru David Shirlow on page 12 underpins the changing nature of superannuation and how

product manufacturers are expected to shift their focus to harness the shifting demographic and retirement income patterns.

One brake on future growth may be the supply of fresh blood. Like the rest of the population, the financial advice industry is aging. Some go so far as to say the industry is stagnating, with no net new inflow of fresh talent to replace the retiring generals of yesteryear. A near term challenge confronting the industry is: where will the new planners come from? The opportunity is for the industry to understand these demographic shifts and work to create a new and compelling push to attract and retain fresh talent.

If the industry can get that right, then its future – based on the sheer weight of demographic numbers – looks assured.

cover story

«The opportunity is for the industry to understand these demographic shifts and work to create a new and compelling push to attract and retain fresh talent.»

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This is old news: Australia is aging.

Demographers have been forecasting an increasingly aged population for some time but the transition to a nation of pensioners has been barely noticeable.

That is about to change.

According to the second government Intergenerational Report released this April, the proportion of Australians aged 6� and over is expected to double in the next 40 years to nearly a quarter of the total population. At the same time the number of those aged 8� and up will triple to �.6 per cent of the total population.

From a taxpayer’s perspective the numbers are even more sobering: today there are five people of working age for each one aged 6� and over but by 2047 that proportion will have slumped to 2.4 of working age for everyone 6� and above.

And if 40 years seems far enough away to be irrelevant the Intergenerational Report will cure anyone of that illusion.

“The pace of aging of the population is projected to quicken after 20�0, as the baby boomer generation starts to reach the age of 6�,” the Report says.

Of course, this is exactly the demographic hole the designers of Australia’s retirement savings system hoped to fill with the establishment of the Superannuation Guarantee (SG) scheme in �992.

But the SG alone won’t prevent what is likely to be a painful societal adjustment to old age.

Despite the massive pool of accumulated savings and the probable extension of working life beyond 6� for many Australians, the Intergenerational Report predicts the economy will inevitably slow over the next 40 years. The study says the average rate of growth in GDP per person will slow from 2.� per cent in the last 40 years to �.6 per cent in the next 40 years.

As well, the country will face fiscal challenges that could threaten some of the basic assumptions Australians have about what their government should provide for them: the Age Pension, healthcare, education and other support services will increasingly come under pressure as governments inexorably head into deficit.

The Intergenerational Report notes that the responsibility for retirement planning will fall more onto individuals.

“As people live longer, the way they plan work and retirement, may change. Policy frameworks need to provide opportunities for people to plan for their own future,” the report says.

But as the advisory profession is part of the same aging trend the question is will there be enough financial planners around to help the rest of the population make the right decisions?

The issue of an aging adviser workforce has already begun to shape the thinking of large dealer groups and small practices alike. The expression ‘succession planning’ has taken on a whole new meaning for financial advice businesses both large and small, with the emphasis on recruiting new talent beyond the traditional sources – like life insurance sales for example – that have served the industry to date.

Should we solve the ‘war for talent’ conundrum, tomorrow’s financial advisers will find themselves playing a central role in the lives of clients who are living better for longer, and will thus require smart advice and product solutions to help overcome the very real prospect that clients may one day outlive their retirement savings.

There are further lifestyle needs which pose significant challenges by the aging Boomers, who think differently about the traditional meaning of ‘retirement’. For example, the shift towards planned retirement communities offering five star facilities and on-call personal services is a sign of things to come. And the rise of the part-time employee among older Australians is another visible trend, as people scale back or return to the workforce to remain active and help fill the growing shortage gap of skilled labour.

Aging population – the great demographic drivershift

perfect mix

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Bulging super accounts and intergenerational wealth transfershift

cover story

Australia is putting on weight at an alarming rate. But don’t worry, the trend is healthy. In fact, the weight of money flowing into the Australian superannuation system has not only built up impressively in the �� years since compulsion came into force, but latest figures from the Australian Prudential and Regulatory Authority (APRA) show that in the year to June 30, 2006, superannuation assets grew by almost 20 per cent to $9�2 billion.

This massive pool of money has swollen by an even greater amount this year as the twin faucets of buoyant markets and the one-off tax-free contribution window pour in their contents. It has been predicted that the government’s decision to allow individuals to contribute up to $� million tax-free to their super before July this year (part of Peter Costello’s ‘Simpler Super’ reforms) will result in $�00 billion extra flows into superannuation funds.

If you add the estimated $600 billion intergenerational wealth transfer that is expected to pass into the hands of baby boomers over the next 20 years it seems as though the market for financial advice can only get better.

But there are some very important caveats to add to these heady numbers.

Firstly, recent research by the National Centre for Social and Economic Modelling (NATSEM) has cast doubt on the extent and distribution of any intergenerational wealth transfer.

In a report, NATSEM researcher, Simon Kelly, found that most baby boomers hoping for a large inheritance will be disappointed as “the richest one-fifth of those aged 6� and over in 2002 owned 63 per cent of all the wealth held by this age cohort”.

In other words, only those who don’t need a large inheritance (i.e. the already wealthy) are likely to get one.

Kelly also listed several social trends that could limit the intergenerational wealth transfer:

medical advances mean the elderly are living longer and thus consuming more of any inheritance;

many parents are choosing to spend their assets rather than live frugally so their children can inherit – the so-called ‘ski’ trend (spend your kids’ inheritance);

baby boomers’ parents may choose to hand whatever inheritance there is to their grand-children rather than their own children who will themselves be close to retirement.

So if the $600 billion doesn’t end up in the Boomers’ pockets they will be rich on their super anyway, right? Well, not according to an analysis of super balances published by the Association of Superannuation Funds Australia (ASFA) this June.

ASFA found that the average super payout this year is likely to be around $�30,000 for men and $4�,000 for women. Over the next ��-2� years the average super payout will only increase to an average $�83,000 for men and $93,000 for women, according to ASFA.

At best, ASFA says, over the next two decades super will be a “useful but modest supplement to the Age Pension”.

As well ASFA also found that the latest government-encouraged splurge into super will only marginally increase the number of people with over $� million balances in superannuation funds or retirement income products from the current estimate of 7,000.

However the clear opportunity for financial advisers is to harness the greater need to grow or manage wealth. The demand for appropriate financial planning services will not diminish, whichever way the pie is split.

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More sophisticated investors – the age of financial literacyshift

In terms of sophistication, they don’t come much savvier than our nation’s youth. And while whole forests of newsprint have been sacrificed to report the rise of generations X and Y, many in the financial advice industry have so far failed to grasp the impact that these two demographic groups will have.

Experts tell us we are broadly dealing with an ambitious, impatient and tech-savvy cohort more interested in immediate gratification than the long-term planning and prudent financial management undertaken by their parents and grandparents. There is also a strong do it yourself streak. Take the global success of the YouTube web portal as proxy for the Y generation; we can see the emergence of the cult of DIY instant celebrity. This can be witnessed through politicians such as John Howard and Kevin Rudd getting on YouTube.

We also know that shifting consumer patterns of younger Australians means they will demand a different way of conducting their personal affairs. The internet will figure largely in their interactions with professional service firms, and their loyalty to a particular service proposition or brand will prove perhaps fickle at best.

As employees, these younger Australians are expected to move around a lot, choosing to stay in any one job for shorter periods, but of course demanding higher remuneration and benefits. Expect increased pressure from these generations to also ‘fast track’ their exposure to more complex work – the ambitious “I want it now” mentality means they have precious little time to ‘do their time”.

Indeed, whether or not this cohort will even want advice remains to be seen. The challenge for the industry is to create appealing points of access

for these generations, whether it be shopping mall kiosks or web-based services.

One thing is for certain, the Xs and Ys will have lived, and retired, with the benefit of compulsory superannuation all of their working lives, which is more than you can say for the older population segment.

A recent ASFA study highlighted the fact that for most Australians, at least in the medium-term, superannuation will not completely cure their long-term retirement woes.

However, as super balances continue to grow, the subject of investment and finance is increasingly entering the vernacular of everyday Australians. For most of them superannuation is now their biggest asset outside the family home. Anecdotal evidence suggests that when super balances hit $�0,000 many people start taking a serious interest in how their money is invested.

ASFA estimates the average super balance today for all those aged between 2� and 64 is $48,000.

And today Australians have been handed the power to make many important decisions about their super. Almost half of all super funds offer investment choice to members, according to the June 2006 report from APRA, up from only 38 per cent the year before. More tellingly only 48.8 per cent of super money now sits in default strategies compared to 60.4 per cent at June 200�.

Clearly, Australians are enjoying the ability to make sophisticated investment decisions and with choice of super fund now a reality they have been given even more flexibility.

The fact self-managed super funds have grown at such an extraordinary rate (almost 23 per cent in the year to June 2006) shows many individuals are confident of taking responsibility for their own savings.

Coupled with this, super-driven individual investment education is an intensive effort at the macro-level by government and the industry to lift the financial knowledge of all Australians.

Last year the assistant Treasurer, Peter Dutton, said the government “is committed to working in partnership with industry to improve the ability of all Australians, from school children to retirees, to make better decisions in managing their money”.

The Financial Literacy Foundation launched in 200� is the most high-profile of the government’s initiatives in this area and it can already claim some success. As a result of its lobbying, financial literacy will be embedded in the schools curriculum across Australia in 2008.

Financial advisers are likely to find tomorrow’s clients a more questioning and knowledgeable bunch than ever, and the challenge is that education standards for advisers must keep pace with the sophisticated needs of the emerging savvy investor. Watch for a rise in minimum entry standards, and increased pressure to promote degree level standards as the benchmark price of admission to the industry’s ranks.

perfect mix

8

Consumerism and the rise of the regulatorsshift

cover story

Even as recently as five years ago the financial advisory business in Australia (with the exception of a few high-profile scandals) had escaped much serious attention from regulators and mainstream press.

The Financial Services Reform Act (FSRA) of 2002 marked the end of that era.

As formerly free-wheeling financial planners struggled with the unaccustomed burdens of disclosure and compliance the Australian Securities and Investments Commission (ASIC) moved in for a closer look.

A few secret-shopping expeditions later and ASIC was ready to expose the conflicts of interest in an industry the consumer lobby (Choice) had notoriously labelled “structurally corrupt”.

And the mainstream press happily followed the regulator’s lead – a process that was accelerated even further by the Westpoint collapse.

Today the inner workings of the financial planning industry have been laid bare by a deeply suspicious media. Well-known economics journalist Alan Kohler, for example, has turned his railings against the evils of commissions and platforms into a new business (see The Eureka Report).

Consumer bodies, too, have become more sophisticated in their accusations against financial advisers. Post the 2003 shadow shopper exercise an outraged Australian Consumers’ Association (now called Choice) could only ask for ASIC to show up “on the doorsteps of many more financial

planners saying ‘Open the books – we want to check what you’re doing.’”

Choice’s latest demands for change in the advice industry include that:

the price for advice be agreed before any product selection;

ASIC should ban some conflicts of interest;

investors who buy funds direct should not have to pay administrative expenses that include an advice component;

hidden trail commissions must be disclosed separately with consumers able to turn off trails if they are not receiving ongoing advice and get rebates for trails paid when there was no advice.

FSRA might have switched on a torch for consumers and government to peer into the far corners of the financial planning industry but in 2007 advisers are operating in the full floodlit glare of public scrutiny. Those lights will not be dimmed. What does this mean? With an increased compliance burden, the industry will find new and innovative ways to meet their regulatory obligations to allow time to pursue the core function of their role: delivering advice.

Just as the Statement of Advice requirements have forced a re-think on front end software to help streamline what can be a cumbersome and time consuming chore, future regulatory standards will see the evolution of new front end software solutions.

The most successful advice businesses will be those who can multi-task most efficiently, using clever software and time management tools to juggle the combined demands of compliance, administration and client service. It would follow that consumer confidence in the industry would rise in line with the higher compliance standards. This is further good news for the future of advice in Australia.

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technology augmenting many adviser functionsshift

It is difficult to contemplate how any business today could function without computer technology but it is impossible to imagine an IT-less financial planning industry.

The growth of the investment platform and advisory software systems in Australia over the last decade is testament to the seemingly endless appetite of advisers for ‘IT solutions’. From simple fund reporting tools a decade ago, platforms have evolved into complex beasts capable of multi-tasking at the push of a button. Front-end software, meanwhile, has extended its ambit beyond basic portfolio modelling into CRM and is now pushing ever deeper into adviser back-office processes.

After a relatively slow start financial planners are now realising the benefits of an online world, according to a 2006 report from researcher Investment Trends.

“As an industry, planners now estimate conducting 34 per cent of their activities via the internet, up from 30 per cent in 200� and they are on track to reach 42 per cent within three years,” the Investment Trends report says. “There was a �0 per cent shift in most activities over the last year...”

However, despite all the great leaps forward, financial advisers, when surveyed, have always wanted more from their technology providers.

Last December, Forrester Research published a report that suggested advisers will soon get just what they have wanted.

In ‘The next generation of Australian wraps’, Forrester says: “The next few years will be marked by consolidation and platform development. The bank-owned platforms are already building the next-generation platforms, which will secure their domination over the next five years and have far-reaching effects.

“Development will focus on opportunities arising from industry inefficiencies. As a result, insurers, financial planning software vendors, practice management consultants, and non-bank platform providers will all be forced to change their business models.”

In the past, technology providers might have over-promised and under-delivered (or not delivered at all) to advisers but this time the revolution could go further than many might like.

The opportunity is to create even greater efficiency in the way advice is done. As firms become ever more streamlined, the business of delivering financial advice will surely benefit.

perfect mix

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product/market evolutionshift

cover story

Hedge funds; contracts for difference; private equity; infrastructure; commodity derivatives; China funds; reverse mortgages...

Five years ago any of the above products would have been treated with bewilderment or downright hostility by most investors and advisers; now they are almost commonplace.

It is a long time since a diversified portfolio consisted of �/3 cash, �/3 bonds, �/3 equities and financial engineers have responded to the desire for new product with ingenuity.

While the trend is global, from an Australian point of view the push into ‘alternative’ products has also taken on an international edge as our superannuation assets outgrow local markets.

Will we, like the good people of Holland, become net exporters of capital? That trend is already emerging as the weight of domestic capital requires new markets and new market sub-sets to, in effect, absorb the excess flood of money.

This has already seen the rise of new and interesting product lines like capital protected structured investments; hybrids; new investments based on renewable energy, environmental concerns and clean energy technology.

Structurally, the new product sets also feature innovations like performance-based fees.

But as investment markets hit such creative highs the world around them often seems close to a nervous breakdown. War and catastrophe, as always, hog the evening news but the ogre of climate change is giving them a run for their money.

Even if you remain skeptical about the claims of peak-oil research and global warming believers their impact on the political, and therefore investment, agenda is undeniable.

An article published this February in USA Today quoted Citigroup strategist, Edward Kerschner, as saying from an investor’s point of view it doesn’t matter if greenhouse gases are causing global warming or not.

“What does matter is if consumers, regulators, governments and corporations react to the perceived threat,” Kerschner said in the article.

Analysts are already trying to pick the winners and losers from the global warming trend and have earmarked companies to look out for in industries such as agriculture, alternative energy, financial services, automotive and technology.

As long as capitalism greets each challenge as if it is an opportunity the range of ‘alternative’ investment products will be inexhaustible.

Anybody up for a North Korea fund?

In 2004, the BBC found one English ‘entrepreneur’ ready to talk up the investment benefits of the Stalinist throwback state.

“It’s like China in the eighties... The market reforms are very evident,” Barrett said.

“It’s an exciting time to join the market.” It always is.

In an increasingly complex investment environment, the need for clear and dispassionate counsel will remain a constant.

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the new advice paradigmshift

As Australians get richer and older (and perhaps wiser) the demand for financial advice is reaching a new peak. In the long term, increased financial literacy and technological advances could reduce the need for advice but not in time for the current generations.

In the meantime the supply of advisers is not rising in step with demand.

Using the membership figures of the Financial Planning Association (FPA) as a proxy for the industry it is clear adviser numbers are static.

According to the 2006 FPA annual report, “the number of practitioner members of the FPA remained almost unchanged at 7,320 on 30 June 2006, compared with 7,289 a year earlier”.

So who’s going to provide the advice?

One obvious answer is the industry funds that are rapidly developing advice models. REST, for example, has recently instigated a telephone advice system for its members and other funds have adopted similar strategies.

As industry funds and other technology-based providers step in to the breach for ‘lower value’ clients, traditional financial planning businesses are staking out their claims in the mass-affluent and high net worth markets.

Financial planning is becoming an increasingly stratified business, evolving rapidly along the strong currents of mandated growth and the emerging wealth accumulators in the pre-retiree market.

The current political debate about whether to separate out advice from ‘sales recommendations’ is just another reminder that the days of an undifferentiated financial planning industry are numbered.

perfect mix

cover story

�Bruce�Madden�has�commented�on�and�advised�the�financial�advice�industry�for�over�15�years.��He�is�the�former�editor�of�Money�Management�and�launch�editor�of�Asset�magazine.�Today�his�specialist�consulting�firm�BlueChip�Communication�provides�media�and�PR�services�to�the�financial�services�industry�and�government,�including�the�federal�Treasury’s�Financial�Literacy�Foundation.Appendix 1�Source:�APRA�Annual�Superannuation�Bulletin�2005Investment�choice�and�asset�allocation�of�entities�with�more�than�four�members,�38.2�per�cent�offered�investment�choice�to�their�members.�Retail�funds�offered�the�greatest�number�of�investment�choices�to�members,�with�an�average�of�71�options�per�entity.�Industry�funds�had�an�average�of�nine�investment�options�per�fund,�public�sector�funds�had�an�average�of�seven�investment�choices�and�corporate�funds�had�an�average�of�five�choices�per�fund.�Of�the�total�assets�held�by�the�entities�with�more�than�four�members,�60.4�per�cent�of�assets�($329.5�billion)�were�held�in�the�default�investment�strategy.�At�30�June�2005,�the�majority�of�default�strategy�assets�were�held�in�equities:�32.0�per�cent�in�Australian�shares�and�22.9�per�cent�in�international�shares.�A�further�14.1�per�cent�were�held�in�Australian�fixed�interest,�10.3�per�cent�in�other�assets,�7.7�per�cent�in�property,�7.2�per�cent�in�cash�and�5.7�per�cent�in�international�fixed�interest.2006�investment�choice�and�asset�allocation�of�entities�with�more�than�four�members,�49.1�per�cent�offered�investment�choice�to�their�members.�Retail�funds�offered�the�greatest�number�of�investment�choices�to�members,�with�an�average�of�88�options�per�entity.�Industry�funds�had�an�average�of�10�investment�options�per�fund�and�public�sector�funds�and�corporate�funds�had�an�average�of�seven�and�six�investment�choices�per�fund�respectively.�Of�the�total�assets�held�by�the�entities�with�more�than�four�members,�48.8�per�cent�of�assets�($318.7�billion)�were�held�in�the�default�investment�strategy.�At�30�June�2006,�the�majority�of�default�strategy�assets�were�held�in�equities:�31.7�per�cent�in�Australian�shares�and�24.2�per�cent�in�international�shares.�A�further�11.3�per�cent�were�held�in�Australian�fixed�interest,�11.0�per�cent�in�other�assets,�8.7�per�cent�in�property,�7.9�per�cent�in�cash�and�5.3�per�cent�in�international�fixed�interest.

Federal treasurer Peter Costello might have pitched his ‘Simpler Super’ regime as the last word on superannuation, but for the investment and financial advice sector the conversations continue unabated.

According to Macquarie Adviser Services’ technical chief, David Shirlow, there is a sense of inevitability that Australia’s superannuation rules will require further ‘tinkering’ along the way.

“For example, the super guarantee system is still maturing. The way that dovetails into the aged pension will require some ongoing maintenance. We’re getting an increasing portion of people who are up for aged care and how that sits in relation to retirement incomes policy will require some thought,” Shirlow says.

But while those are medium to long-term issues he says even Costello’s recent ‘simplification’ will require some more immediate adjustments, particularly around death and disability pensions.

feedback.What do you think? These are just some of the big picture trends to shape the future face of financial advice. Share your views with other Forward Thinking readers by emailing us at FTmagazine@macquarie.com

Macquarie technical guru David Shirlow explains why superannuation – no matter how simple – will always attract new debate and require further tinkering at the margins.

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“Just to take one example, the idea that if you die and your benefit goes to your adult kids, you’ll pay tax. But if you manage to pay it out of the fund (and you’re already 60) to those kids, the day before you die, you’re okay,” Shirlow says.

“In other words slow death versus fast death produces a different result! We’ll get plenty of tinkering just because we’ve had such a big change, and things like that will need to be worked through.”

For product providers too, ‘Simpler Super’ throws up a few conundrums.

Shirlow says as a result of the latest changes it is likely people will have more money in super for a longer period, including during the retirement income phase.

“It becomes more important that retirees invest for the long-term which means that typically they’ll be better placed in long-term assets and not just wanting to limit themselves to fixed-return arrangements,” he says.

“Having said that, over time I’m sure we’ll see a return to higher interest rates. So there will be an appetite no doubt for various ways of guaranteeing a certain level of income. I think we’ll see some creativity around providing a floor, if you like, for people limiting the downside on peoples’ pension accounts.”

Capital protection expected

According to Shirlow, many product providers are already grappling with how to provide retirees with some form of income or capital protection.

“Now that could be because their portfolio is insured in some way, or protected from an investment risk. Or it could be some kind of mortality risk,” he says. “That’s not an ‘across the industry’ thing, that’s more each competitor coming up with its own kind of product features to address the specific issue.”

But while the focus of the latest super shake-up has quite naturally been on how it affects current and imminent retirees, Shirlow says younger savers were also handed incentives in Costello’s package.

But were those incentives enough to encourage younger workers to stash more away in super?

“Arguably not,” Shirlow says. “We might see more incentives in that area in terms of co-contribution incentives or something along those lines. We might see more compulsion ultimately... depending on which government we have in future years.”

“In fact there have been ideas like a voluntary opt-out type system where employers will also contribute an extra 3 per cent of your salary unless you choose not to have that included. So the default is your own money goes in.”

Whatever happens, one of the few future guarantees Australians have about their superannuation system is that it will be talked about, if not tinkered with, forever.

super: a never-ending story

perfect mix

estate planning:

super becomes a dead certainty

MAstech

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Recent developments have made the case for standard death insurance and disability cover via superannuation compelling from a tax perspective in most typical cases. For wealthier clients, or those requiring high levels of insurance, the removal of reasonable benefit limits will have an obvious impact in this regard.

Quite aside from insurance, many clients have been re-weighting their wealth from non-superannuation entities to superannuation – for this reason alone it will generally be necessary to review the manner in which their wealth is dealt with on death or disability.

And there are numerous recent rule changes which can have a direct influence on the treatment of a client’s death or disability benefits.

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The time has come to revisit insurance and estate planning in relation to superannuation. David Shirlow explores features of the new super regime which give it certain estate planning appeal as well as identifying a number of key tax aspects which remain uncertain.

tech talkDavid Shirlow Head of MAstech

estate planning:

super becomes a dead certainty

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MAstech

RIP RBLs: insurance via super generally

As a general proposition, the appeal of insuring via superannuation for various types of cover has been reinforced in a number of respects. The table below outlines some key changes, most of which are positive for superannuation.

In this article we will examine each of the changes identified for life cover but not the incapacity changes. The key point to note is that the combined effect of all these changes is likely to be significant enough for many clients who currently hold these insurances outside of superannuation to rethink these arrangements.

Death benefits: how they’re taxed now

Lump sum benefits

The tax treatment of lump sum death benefits paid from taxed superannuation funds is as follows:

There are no limits to this concessional treatment: if, for example, a lump sum death benefit is paid to a dependant for tax purposes then it will be tax free regardless of its size. And, as we will show, so far as insured benefits are concerned,

arrangements funded by tax deductible superannuation contributions will typically be significantly more tax efficient than non-superannuation arrangements, whether they are payable to dependants or non-dependants.

Cover type Change

Life removal of RBLs

benefits tax reduction, especially from age 60

restrictions on to whom (and for how long) pensions may be paid

permanent incapacity removal of RBLs

benefits tax reduction, especially for non-employed clients and from age 60

broader definition of permanent incapacity, to cater for non-employees

temporary incapacity – income protection

full deductibility of premiums, including cover beyond first two years

Recipient’s status (under tax law) Tax component Rate of tax (plus Medicare)

Dependant tax free and taxable component

0%

Non-dependant tax free component

taxable component – element taxed – element untaxed

16.5% 31.5%

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To illustrate, Frank is age 4� and on the top marginal tax rate. He has an accumulated superannuation benefit of $�00k in Fund A. It has been funded entirely from salary sacrifice contributions and the service period is 20 years. He has a normal retirement age of 6�. The table below compares insuring for a net $�.�m via salary sacrifice contributions to his existing Fund A with insuring for that amount outside of superannuation (based on Macquarie Futurewise premium rates for a male non-smoking professional).

Column A shows that if the death benefit is to be paid to a tax dependant then there will be no tax

and the net insurance required is only $�.�m. In this case the pre-tax cost is 87% better than insuring outside of superannuation.

Column C shows that if the death benefit is to be paid to a tax non-dependant then, if the superannuation option is chosen, the amount of insurance will need to be grossed up to cover the tax payable on the insured amount and the additional tax payable on the accumulation amount. (The latter arises because we are introducing some ‘element untaxed’ into the tax benefit calculations – see breakout box on following page).

Clients with non-dependent and dependent beneficiaries

The fund arrangement issues, discussed on the following page, are worth contemplating in the context of nominating which beneficiaries are to receive particular benefits. Unlike non-dependants, dependent beneficiaries are unaffected by the ratio of ‘element taxed’ to ‘element untaxed’, since they won’t pay tax on any of the taxable component of a lump sum benefit. So, if different benefits have different levels of ‘elements taxed’ and ‘elements untaxed’, different results can arise via different nominations.

Further, since dependent beneficiaries don’t pay tax on any of a lump sum benefit, they are also unaffected by the level of tax-free component they receive. Non-dependants are generally in a very different position.

Benefits paid on the death of an accumulation-phase member to different beneficiaries from the one fund will typically all carry the same percentage break-up as between the overall taxable and tax-free component where death occurs in the accumulation phase. However, such benefits paid from different funds (and, in some cases, from different accounts within a large fund) may each have different tax component percentage break-ups as well as different

splits between the sub-components of the taxable component (i.e. ‘elements taxed’ and ‘untaxed’).

Revisiting Frank’s case, if a tax non-dependant is to be paid a benefit of a particular amount, it may make sense for Frank to nominate a benefit which does not attract any ‘element untaxed’ (i.e. a non-insured benefit) to be paid to the non-dependant if possible. And if Frank had built up his accumulated benefit with some non-concessional contributions the location of the resulting tax-free component would ideally be such that it could be directed first and foremost to the tax non-dependant.

So, if significant benefits are to be paid to non-dependants on death, then it is worth examining a client’s fund and insurance arrangements.

Thought also needs to be given to the after-tax value of superannuation benefits to be allocated to various dependants and non-dependants, and (as discussed later) how that sits alongside the allocation of non-superannuation assets amongst these beneficiaries. Naturally, the client needs to be comfortable that the allocations are appropriate overall.

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A. super to dependant

B. Non-super insurance

C. super to non-dependant

Accumulated super $�00k $�00k $�00k

Life insurance $�.�m $�.�m $2.023m

Effective tax on insurance proceeds

Nil Nil $�23k

Net insurance benefit $�.�m $�.�m $�.�m

premium rate per $1k $�.�3 $�.�3 $�.�3

pre-tax cost (46.5% MtR)

$�689.60 $3��8.�3 $2278.72

MAstech

For non-dependent recipients of lump sum death benefits, the ‘element untaxed’ is more highly taxed on the basis that it represents the insured part of the benefit. That is, it represents that part of the benefit upon which no contributions tax was paid in effect, because a deduction has been claimed in relation to the insured benefit.

As with pre-reform law, current law continues to identify the ‘element untaxed’ by working out the ‘future service’ component of the benefit in the manner outlined below, rather than simply identifying the insurance proceeds. ‘Future service’ is generally the period from death through until the time the client would have turned 6�.

This means there is often a mismatch between the amount taxed at a higher rate and the amount of insurance proceeds. This can work for or against a client’s beneficiaries in the event of death, depending on the amount of insurance, accumulated benefits, age and fund service period.

Typically, the greater the actual service period then (assuming other factors are constant) the greater the ‘element taxed’ portion of the taxable component, so that less tax is payable. This is because the taxable component is split into elements taxed and untaxed in proportion to the client’s actual and future service.

The ‘element taxed’ is in effect the part of the taxable component on which contributions tax is deemed to have been paid (i.e. the part of the benefit accumulated from taxable contributions during the

actual fund service period). Clearly the client’s age also affects this equation.

Let’s return to Frank’s case to explore the way his superannuation arrangements can have an effect on the amount of tax paid by non-dependent beneficiaries in the event of his death. We will now assume that the benefits are definitely going to be paid to a non-dependant and that Frank has decided to have exactly $2m of cover inside superannuation.

Frank’s actual service period for his existing superannuation in Fund A is 20 years. This is the same as his future service period, so if he insures via Fund A then the taxable component of a death benefit paid from that fund currently would be split �0:�0 between ‘element taxed’ and ‘element untaxed’. The first row in the table below summarises the tax position if he takes this approach.

If instead Frank was to arrange for the $2m cover to be effected via a second fund (Fund B), in which he had no accumulated benefit and no service period to speak of, then the tax result on death would be $7�2.�k. The reason for the deterioration in the result is that the insured benefit is bigger than the accumulated benefit, and the insured benefit is virtually all taxed at 3�.�% due to the lack of past service. (If, on the other hand, the accumulated benefit had been bigger, this fund arrangement would have produced a better result. This is because no ‘element untaxed’ exists for the benefit accumulated in Fund A since none of it is funded from deductible insurance.)

Non-dependent beneficiaries – impact of deceased’s service period

Now let’s assume that, due to a change of employment, Frank had insured in Fund A (as per scenario �) but just prior to death had rolled his accumulated benefit to Fund B but left

his insurance arrangements in Fund A intact. This scenario produces the best result for his non-dependent beneficiaries, as follows:

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Accumulated benefit

insured benefit

Actual service period

tax payable (rounded: nearest $100)

scenario 1 Fund A: insurance and accumulation

$�00k $2m 20 years $600k

scenario 2 Fund A: accumulation only Fund B: insurance only

$�00k $nil

$nil $2m

20 years Virtually nil

$82.�k $630k

$7�2.�k Total

Accumulated benefit

insured benefit

Actual service period

tax payable (rounded: nearest $100)

scenario 3 Fund A: insurance only Fund B: accumulation only

$nil $�00k

$2m $nil

20 years 20 years

$480k $82.�k

$�62.�k Total

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As with scenario 2, this provides the advantage that the accumulated benefit contains no ‘element untaxed’ since none of it is funded from deductible insurance. However, there is a dramatic improvement in the result over scenario 2 because the ‘element untaxed’ of the insured benefit is reduced as there is a significant actual service period.

Two principles emerge from this in relation to life cover effected via superannuation. Essentially, there may be an advantage in:

providing the accumulated benefit and the insured benefit from different funds; but

having as long a service period as possible applying to the fund which provides the insured benefit.

(Parallel principles do not appear to apply where the accumulated and insured benefits come from different accounts or interests within the same fund, because the concept of ‘service period’ applies to the whole fund.)

While these principles are worth being aware of, their strategic value may be limited from a practical perspective. It may also be limited by the fact that, in the case of clients insuring for permanent incapacity as well as death, the best fund arrangement for each type of benefit can often be different.

A key principle for permanent incapacity cover is to have as little actual service period applying to a benefit, because that will typically optimise the tax-free component. For example, if Frank were also to have $2m permanent incapacity cover under the same arrangement as his death cover then if, instead of dying, he became permanently incapacitated, scenario 2 would produce the best result of the three scenarios put forward.

The tax paid on the permanent incapacity benefit would be $268.8k, $�3.8k, $268.8k under scenarios �, 2 and 3 respectively. So it can be as well to be aware of the outcomes in the event of permanent incapacity. We will explore permanent incapacity benefits via superannuation in a future article.

Older clients – non-dependent or dependent beneficiaries?

For clients aged �� or more with adult children, one topical issue is the extent to which their superannuation may be passed to their children on a tax-efficient basis.

There are a number of ways in which an adult child may receive a lump sum benefit without tax being payable, including where:

the child receives a death benefit and is a tax dependant;

before death a client aged 60 or more withdraws a benefit and then gives (or bequeaths) the amount to the child; or

the child receives a death benefit entirely comprised of tax-free component.

So far as the first point is concerned, there are various inter-generational trends emerging, such as children living at home for longer, or baby boomer retirees being more financially equipped than the following generations, which may lead to an increased advisory focus on whether a client’s adult children qualify as tax dependants on the basis of the ordinary meaning of dependency or of inter-dependency.

As for clients withdrawing benefits before death and giving them to their adult children, this may also be increasingly typical amongst wealthier families.

The gift may even be used as a superannuation contribution by the children. This might have particular appeal if the gifting occurs when your clients are at a senior age, as their children may well have attained their preservation age or be close to it, in which case access to superannuation may not be such an issue for them.

Finally, the impact of recontributions on the ultimate level of a client’s tax-free component warrants consideration. This is particularly the case given the prospect of clients being able to contribute at the same time as they receive a pension in the years from age �� until 6� (or, if they continue to meet the work test, until 7�). In this regard it is worth noting that there has been no formal change to the ATO’s position with regard to re-contribution strategies and the non-application of Part IVA ITAA36 in typical circumstances.

However, where clients do engage in recontribution, it is worth bearing in mind the discussion below about the counter-balancing impact this can have on the extent to which ‘anti-detriment’ benefits can be paid in addition to standard lump sum tax benefits.

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Pension benefits

The tax treatment of death benefit income streams paid from taxed superannuation funds is as below. Given that the fund earnings on the relevant pension

account will not be taxed, in many cases it will continue to be tax efficient to arrange for a death benefit to be paid (at least to some extent) as a pension.

Death benefits: how they will be paid now

A key development with regard to pension death benefits is the constraint imposed from � July 2007 on to whom they can be paid.

Essentially, pension benefits will only be able to be paid to:

a dependant who is not a child of the deceased (i.e. a spouse, an ‘ordinary meaning’ dependant or inter-dependant who is not a child of the deceased); or

a child who is:

– less than age �8; or

– aged �8 to 24 inclusive and is financially dependent on the deceased; or

– aged �8 or more and has a qualifying disability (broadly, this is a disability that is permanent or likely to be permanent and results in the need for ongoing support and a substantially reduced capacity for communication, learning or mobility).

Children who don’t qualify to receive a pension

While more adult children may qualify as tax dependants as a result of various inter-generational trends, adult children over age 2� will generally be prevented from receiving death benefits as pensions whether or not they are tax dependants. So estate plans which have involved payments of pensions to adult non-dependent children need to be reviewed bearing in mind the issues discussed earlier in relation to lump sums.

Children who do qualify to receive a pension

The appeal of child account-based pensions (ABPs) as part of an estate plan will be as strong, and probably stronger, than it has been in the past.

Generally, the taxable component of child pension payments will be assessable at adult marginal tax rates less a ��% rebate (although if the deceased parent was age 60 or more the payments will be tax free). This means that in 2007/8 even a child pension comprising �00% taxable component will not attract any tax unless pension payments exceeded $38,684, assuming the pension is the sole source of the child’s income.

And while the pension will need to be discontinued by age 2� (unless the child is disabled as defined), the commuted lump sum will be entirely tax free.

So, unlike pre-reform law, there is no obvious downside to choosing a pension over a lump sum death benefit if after a year or so the beneficiary or their guardian subsequently thinks better of it and decides to commute.

Under the minimum (and no maximum) payment rules for ABPs, the draw-downs can vary to suit needs, including at a level which exhausts the capital by a certain age at a consistent rate.

And if the fund rules enable restrictions to be placed on capital withdrawals and income levels (as is the case with Macquarie Super & Pension Manager and SMSFs with suitably drafted deeds), the estate plan can include appropriate protections and controls for child pension beneficiaries.

Age at client’s death Tax component Rate of tax

Either deceased or the recipient age 60 or older

tax free and taxable component

0%

Both deceased and the recipient below age 60

tax free component

taxable component

element taxed

element untaxed

tax free

Marginal tax rate less 15% tax offset

Marginal tax rate

2�

Pension death benefits – the final analysis

Super reform will clearly have different appeals for families at different stages. For clients with younger children the new rules on child pensions should generate particular interest. For clients with older

children, the primary focus will be on transferring superannuation benefits in lump sum form in a tax efficient manner, perhaps prior to death.

A common alternative way of providing protections and controls would be to pay a lump sum to the estate, and arrange for a testamentary trust to be established pursuant to the terms of the client’s will. This may be useful in circumstances where the client wants trust rules which don’t sit comfortably within superannuation.

For example, perhaps your client would like the trustee to have discretion as to the way in which income and capital can be shared between two or

more children of the deceased. In these cases the appeal of having the particular desired trust rules may be offset to some degree by the appealing tax outcome typically produced if each child has a separate superannuation pension. Assessable income paid to a minor child from a testamentary trust (or, for that matter, derived from any investment of property paid to a minor child out of a deceased estate) will attract adult marginal tax rates but (unlike the typical child pension) will not attract the ��% rebate. So there may be a trade-off.

The abolition of RBLs not only removes the constraints on the amount of tax-efficient insurance which can be effected via superannuation, it also potentially means that a greater portion of wealth will come from super rather than non-super sources on death.

The importance of integrating the terms of the will with death benefit nominations for benefits in all types of funds will not diminish. Amongst clients with SMSFs, there will be an increasing demand to co-ordinate the drafting of the death benefit provisions of the SMSF deed with the drafting of the will. The demand for sophisticated death benefit nominations is likely to escalate (for example, dealing with allocation of specific assets or providing contingency plans if certain beneficiaries don’t survive, etc).

Naturally enough, the appeal in directing superannuation benefits first and foremost towards dependants for tax purposes (and to counter-balance this by directing non-superannuation assets to non-dependants) may still be a key component of integrating the allocation of superannuation death benefits with the operation of the will. On the one hand, integration has in some respects been simplified since less attention needs to be given to particular amounts and forms of benefit payable to particular beneficiaries in line with RBL thresholds changes from year to year.

On the other hand, in many cases the abolition of RBLs means that existing will provisions (particularly those which refer expressly to RBLs) may need to be revisited to produce an effective outcome.

The terms of the will become especially important not only in how they allocate superannuation benefits which fall into the estate, if any, but also in how they ensure that, overall, the after tax allocation of the deceased’s wealth is allocated in the proportions intended. (Equalisation or adjustment clauses in wills can have a valuable role to play in evening up the amounts paid to different beneficiaries in some cases).

Finally, the art of co-ordinating the superannuation position with the will may involve taking account of the possibility that in some cases (particularly later in life, and in circumstances of ill-health) superannuation benefits may be withdrawn prior to death and will potentially fall directly into a client’s estate upon death.

As a related matter, putting in place an enduring power of attorney for appropriate family members may be particularly important to facilitate late withdrawals prior to death, to cover the situation where the client loses legal capacity.

Integrating super and non-super wealth on death

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Anti-detriment benefits and recontributions

The basic concept of additional, ‘anti-detriment’ benefits to compensate for the effect of contributions tax on lump sum benefits paid to a deceased’s spouse or child (whether the child is dependent for tax purposes or not) has survived superannuation reform. (These benefits were formerly provided under section 279D ITAA36 and are now provided under new section 29�-48� ITAA97.) We await ATO guidance as to how to calculate the size of these benefits, given that the formulae previously used have become redundant due to the introduction of new tax components.

It is worth noting that, since recontribution strategies generally increase the amount of tax-free component of a death benefit, they also generally decrease the amount of additional anti-detriment benefit that a beneficiary might otherwise qualify for. This needs to be weighed up where recontribution is pursued with estate planning in mind.

To illustrate, take the case of Jack, who will retire from full time employment just prior to his 6�th birthday in mid August 2007. He is married to Jane who is

age 62 and in good health, and they have two adult children who are in their 30s and wholly financially self-supporting.

Jack has $400,000 in super which is presently all taxable component, with an eligible service date of � January �989. He intends to commence an ABP with these funds upon retirement.

Let’s compare the outcome if, as soon as he retires, Jack simply commences an ABP with �00% taxable component with what happens if he cashes the $400k as a lump sum, immediately recontributes that and then commences an ABP with �00% tax free component. The following table provides the results if Jack were to die soon after the ABP commences and a $400k benefit were to be paid in three typical ways.

An important assumption in this analysis is that Jack’s fund will be able to pay an anti-detriment benefit, so bear in mind that it may not be relevant to some clients’ superannuation arrangements. The anti-detriment benefit numbers have been estimated using an adaption of a formula the ATO previously accepted for calculating these.

Certain death benefit uncertainties live on

You can see that if the death benefit is paid to the adult children as a lump sum then scenario 2 produces a $7,0�9 better outcome because, while an anti-detriment benefit is only available under scenario �, it does not completely offset the tax payable. However, the net advantage of recontribution may be significantly less than first imagined.

You will also notice that, by contrast, if the death benefit is paid to Jane as a lump sum then scenario � produces a $70,�88 better outcome.

So there are a range of factors to consider in assessing different options for clients’ estate plans, including:

who is likely to receive the benefit (having regard to life expectancies, whether your client has the power to decide who will receive the benefit, etc);

if the benefit is likely to be paid to the spouse, whether it is likely to be received as a lump sum then re-contributed (having regard to the spouse’s age, work status, contribution limits, etc);

if the spouse receives it as a pension, who is likely to receive the benefit in the event of the spouse’s death? If so, the column C outcomes may be more relevant to the analysis than column A.

In some cases the prospect of withdrawing the benefit just prior to death and gifting the proceeds may also be worthy of consideration.

CGt liability of fund disposing of assets after death and other issues

Under pre-reform law it was not clear in what circumstances, if any, a fund trustee would become liable to pay CGT on disposal, after the death of a pensioner, of assets which were backing the pension. The position under reform law is also unclear. This and a range of other interpretational and practical issues relating to death benefits will need to be resolved during the coming months or, maybe, years.

A. Jane takes benefit as ABp

B. Jane takes benefit as lump sum

C. Children take benefit as lump sum

scenario 1: ABp with 100% taxable component

Anti-detriment benefit? Nil $70,�88 $70,�88

Tax and Medicare @ �6.�% if applicable

Nil Nil $77,647

Total value of benefit after tax $400,000 $470,�88 $392,94�

scenario 2: Recontribution then ABp with 100% tax free component

Anti-detriment benefit? Nil Nil Nil

Tax and Medicare @ �6.�% if applicable

Nil Nil Nil

Total value of benefit after tax $400,000 $400,000 $400,000

transitions, transitions...TTR pensions more attractive in the new world?

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As advisers working in the superannuation field, we’ve all just been through the biggest transition since the Superannuation Industry (Supervision) Act �993 and Superannuation Industry (Supervision) Regulations �994 (collectively referred to here as ‘SIS’) were introduced back in �994. This transition has many implications for Transition To Retirement (TTR) pensions.

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tech talkDavid Barrett Division Director, MAstech

New payment factors

From � July 2007 all new account-based pensions (including new TTR pensions) will be subject to new minimum payment factors.

Superannuation fund trustees may elect to apply the new minimum payment factors to allocated pensions (including TTR APs) already running prior to � July 2007. Note that although Macquarie Adviser Services has taken up this option, in order to minimise disruption to clients’ cash-flow levels, we have continued to make payments under the old rules for 2007/08 unless or until the client notifies us to do otherwise.

The new factors mean those aged ��-64 will be required to draw at least 4% of their account balance per annum. With the removal of the maximum withdrawal limitation for non-TTR allocated and account-based pensions, TTR pensions commenced on or after � July 2007 (and those commenced prior to � July 2007 adopting the new minimum payment factors) will be subject to a maximum withdrawal limit of �0% p.a. Chart � below compares the old and new factors, showing the increased flexibility of the new factors.

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Taxation of TTR pension payments

Given the changes to the taxation of pension payments in general, TTR pensions will also have two distinct periods of taxation: pre age 60 and post age 60.

During the pre age 60 period pension payments are prima facie assessable income, with a ��% tax offset applying. Any tax-free component in the

purchase price will result in a fixed percentage of every payment being non-assessable, non-exempt (NANE) income, reducing the level of otherwise assessable income.

During the post age 60 period all payments will be NANE income.

Chart 1: New ttR min/max payment levels vs Ap pVfs

New TTR min/max payment range for TTR pensions

� Jan 06 AP min payments

� Jan 06 AP max payments

11

10

9

8

7

6

5

4

3

% o

f ac

coun

t b

alan

ce

Age

55 56 57 58 59 60 61 62 63 64

This article seeks to clarify many of these implications, including the impact of new payment levels and changes to the taxation treatment of payments, as well as revisiting condition of release and preservation issues. We also include some

further analysis of the big picture question: ‘Should my client be in accumulation or pension phase?’

For many clients TTR pensions will be even more attractive in the new world!

2�

What happens when a TTR pension recipient retires?

One condition of a TTR pension is that access to the underlying capital is heavily restricted. However, there are a range of circumstances where commutation of a TTR pension is allowed, including:

at any time, when the funds are transferred back to the accumulation phase;

at any time, up to the amount within the TTR pension account which remains unrestricted non-preserved (see discussion below);

upon meeting a condition of release, including:

– death, permanent incapacity, financial hardship, etc;

– attaining age 6�;

– retirement.

Once a condition of release (such as retirement) is met a TTR pension may simply continue to run as an ordinary allocated or account-based pension (ABP), with the maximum payment restriction simply dropping away. Hence there is no need to commute the TTR pension and purchase a new ABP with the proceeds. However, commutation and recommencement may be preferred, for example, where the client wishes to add more capital and/or combine existing pensions to run one ABP account.

Treatment of unrestricted non-preserved monies within a TTR pension

The general purpose of a TTR pension is to allow access to preserved and restricted non-preserved benefits which a client wouldn’t otherwise have. But in some cases taxation efficiency might rank at least as highly as access to the benefits. Either way, understanding how the preservation rules work with TTR pensions may be important.

When transferring monies from accumulation phase into a TTR pension in the same fund, APRA has confirmed that the amounts transferred are taken to have come firstly from the unrestricted non-preserved (URNP) element, then the restricted non-preserved (RNP), and finally the preserved (Pres) element. Then, as each payment is made from the TTR pension, the payments reduce firstly the URNP until that is exhausted, then the RNP, and finally the

Pres elements. This treatment naturally reduces the amount a client could otherwise access without meeting another condition of release.

If maintaining maximum access to funds is a high priority, thought should be given to moving URNP benefits to another fund prior to commencement of a TTR pension. This will leave a client with access to the URNP benefits in the separate fund as well as the benefits paid from the TTR pension in the original fund. Note that although regulations were released on 29 June 2007 removing the need in some cases for fund trustees to aggregate accumulation accounts for calculation of taxation component and apportionment purposes, preservation components continue to be treated on an aggregated basis.

Example:

Mark is age 55 and has a super fund balance of $500,000. He is considering starting a TTR pension. Part of the balance relates to an employer ETP he rolled over back in 2003 – i.e. $50,000 is unrestricted non-preserved, the remaining amount preserved.

If Mark starts a TTR pension with any of the existing funds, the first $50,000 will be deemed to have been taken from the unrestricted non-preserved element. If he starts the TTR pension with the entire $500,000, and draws the maximum 10% in the first year, at the end of year 1 his entire remaining benefit will be preserved.

Alternatively Mark could roll over $50,000 to another fund and elect the whole amount rolled over is unrestricted non-preserved element. Starting a TTR pension with the balance and drawing the maximum $45,000 in the first year, plus $5,000 as a lump sum from his accumulation fund, would leave $45,000 unrestricted non-preserved benefits remaining, which Mark could access at a later date.

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Accumulation or pension phase – which is more effective?

We have seen in previous articles and workshops that the TTR pension/salary sacrifice strategy can be very rewarding for clients for a number of reasons (see, for example, Forward Thinking Q1/2006 Splitting super contributions – better late than never and sooner than we thought). But what of the client who is already fully utilising her or his concessional contribution limit ($�00,000 if age �0 or more), preventing any further salary sacrifice as part of a TTR/salary sacrifice strategy? Is it worth this client purchasing a TTR pension despite the additional income created?

Let’s consider Anne, age ��, who is interested in maximising her retirement funding. After some significant contributions in recent years she currently has approximately $600,000 accumulated in superannuation. Let’s assume that Anne is unable to salary sacrifice any more than she currently is, for any one of a few possible reasons. Looking at the $600,000 in isolation, should she commence a TTR pension, or leave the funds in the accumulation phase?

If the funds are left in accumulation phase they will accrue returns in a ��% taxation environment. Capital gains are taxable at either ��% or �0%, depending on whether the assets are held for �2 months or not. Furthermore if the assets are held until the funds are transferred into pension phase, they could be effectively CGT-free. So for a given set of return assumptions the net effective tax rate in the accumulation phase will vary depending on the asset turnover rate/strategy.

On the other hand, if the funds are transferred to a TTR pension they will accrue returns in a tax-free environment. There will, however, be some taxation implications prior to Anne’s 60th birthday on the minimum (4%) pension payments she is required to draw. Let’s assume these pension payments are reinvested (after payment of income tax) into a separate accumulation superannuation account as non-concessional contributions (NCC) within her NCC cap. We can then calculate the net effective tax rate (including the income tax paid) effectively applicable to total fund earnings, including the taxation on the returns in accumulation account where the NCCs are re-invested. We can then compare the tax paid in each strategy in terms of the net effective tax rate.

We have calculated the net effective tax rate for the periods from age ��-�9 and 60-64 inclusive for each strategy, i.e. remaining in accumulation phase or switching to a TTR pension (with �00% tax-free component, �0% tax-free or 0% tax-free components in the TTR pension purchase price). Within each TTR pension scenario we have varied Anne’s marginal tax rate. The results, along with the account balances at age 60 and 6� are displayed in the following tables – each table represents a fixed level of asset turnover per annum (i.e. 0%, 30% and �00%).

This allows comparison of the net effective tax rate for ‘Accum Only’ strategy (silver shading) against the ‘TTR + Accum’ strategy. The ‘TTR + Accum’ result is shaded blue where it produces a better result than the equivalent ‘Accum Only’ strategy. Otherwise it is shaded black.

Notes: Return assumptions – see Appendix 2

TTR + Accum strategy provides a better result than Accum Only strategy

Accum Only strategy provides a better result than TTR + Accum strategy

table 1: Net effective tax rate – 0% asset turnover (i.e. hold capital assets until pension phase)

Marginal tax rate

$600k Accum

only

$600K ttR + Accum strategy

100% tax free 50% tax free 0% tax free

All All 30% 40% 45% 30% 40% 45%

Age 55-59

Effective tax rate 8.20% 0.76% 4.�6% 6.89% 8.07% 8.42% �3.�8% ��.�9%

Acct bal at 60 8�4,4�0 878,��� 86�,7�8 8�8,026 8�4,�60 8�3,000 837,�37 829,80�

Age 60-64

Effective tax rate 8.20% 2.06% �.97% �.92% �.89% �.88% �.77% �.7�%

Acct bal at 65 �,2�6,808 �,280,��2 �,26�,944 �,2�0,934 �,24�,428 �,243,777 �,22�,7�6 �,2�0,74�

27

some key points to note from these results:

In the majority of cases a TTR pension strategy appears to be attractive, based on the assumptions used above. However, top marginal tax payers should consider carefully adopting this TTR pension strategy with �00% taxable component prior to age 60.

Turnover of assets has significant impact on the effective tax rate in the ‘Accum Only’ strategy (8.2%–��.2%). Conversely asset turnover has no impact in pension phase. (Incidentally, the effective tax rate of ��.2% for �00% asset turnover in the ‘Accum Only’ strategy is not an error – it results from return assumptions which include property-related tax-deferred income.).

‘Accum Only’ strategy is not impacted by varying the marginal tax rate or the initial level of tax-free component.

Where the TTR pension is commenced with �00% tax-free component, varying Anne’s marginal tax rate has

no impact, as all pension payments are NANE income prior to age 60, as well as afterwards. Only the rate of asset turnover varies the results.

The ‘TTR + Accum’ strategy provides preferred results after age 60.

A �00% tax-free TTR pension provides a better result than the other options illustrated.

The results for the ‘TTR + Accum’ strategy might be improved by using the re-invested after tax contributions (i.e. non-concessional contributions) to add to the existing TTR pension by commuting it and restarting with the re-contributed funds.

Note that these results assume the client cannot utilise a TTR/salary sacrifice strategy. If the client could salary sacrifice the results may be significantly improved.

The results indicate that in general a TTR pension is a valid strategy for most clients. However, careful analysis and modelling

is required to determine whether top MTR clients should use a TTR pension before age 60. Sometimes these clients may benefit from remaining in the accumulation phase until age 60 and commencing a TTR pension from that point.

summary

The 2007 reform of the superannuation system has improved the relative attractiveness of TTR pensions. Pension payment levels are more flexible and changes to the taxation of superannuation income streams have positive effects, especially after age 60. Upon meeting a subsequent condition of release like retirement, a TTR pension will automatically transform to an ordinary ABP. Care should be taken to use only preserved benefits when purchasing a TTR pension if maximum access to capital is a priority.

Broadly the TTR pension appears to be a very attractive vehicle to help maximise retirement benefits – we expect a high percentage of clients aged ��-64 will benefit from a TTR strategy.

tech talk

table 2: Net effective tax rate – 30% asset turnover (i.e. capital assets are held for 31⁄3 years)

Marginal tax rate

$600k Accum

only

$600K ttR + Accum strategy

100% tax free 50% tax free 0% tax free

All All 30% 40% 45% 30% 40% 45%

Age 55-59

Effective tax rate �2.60% �.�6% 4.93% 7.2�% 8.4�% 8.76% �3.48% ��.87%

Acct bal at 60 840,628 877,2�9 864,�68 8�6,902 8�3,068 8��,9�8 836,�94 828,9�7

Age 60-64

Effective tax rate �2.60% 3.�3% 3.00% 2.9�% 2.87% 2.86% 2.68% 2.�9%

Acct bal at 65 �,�77,7�8 �,273,�70 �,2��,446 �,244,70� �,239,334 �,237,723 �,2�6,239 �,20�,498

table 3: Net effective tax rate – 100% asset turnover (i.e. capital assets are held for less than 12 months)

Marginal tax rate

$600k Accum

only

$600K ttR + Accum strategy

100% tax free 50% tax free 0% tax free

All All 30% 40% 45% 30% 40% 45%

Age 55-59

Effective tax rate ��.20% �.39% �.��% 7.4�% 8.6�% 8.96% �3.66% �6.04%

Acct bal at 60 832,496 876,4�3 863,866 8�6,237 8�2,423 8��,279 836,022 828,393

Age 60-64

Effective tax rate ��.20% 3.76% 3.60% 3.�0% 3.44% 3.43% 3.22% 3.��%

Acct bal at 65 �,���,063 �,269,�06 �,2��,642 �,24�,0�7 �,23�,423 �,234,�77 �,2�3,008 �,202,423

Sometimes the most telling event is the one that did not happen. The lack of any global contagion from the US economy’s weak growth path over the past year has confounded analysts conditioned to consider the United States as the sole engine of the world economy. That continued single-minded obsession with the US economic trajectory has led many investors to prematurely bail on the bull run – the sharp but short-lived sell-off triggered by convulsions in the US housing market earlier this year being a case in point. For them, it was unimaginable that global growth could power ahead when the United States has been expanding at an annual rate of just 2 per cent, as has been the case for the past five quarters.

But a new world order has been in the making, defined by China’s growth surge and a European economic renaissance. At just under US$3 trillion, the Chinese economy in nominal terms is still less than a quarter the size of the US economy. But with a pace of expansion now more than four-times that of the United States, China is incrementally adding more to global growth than the US is.

The even bigger surprise is the German-led revival of Europe’s economy. Last year the Eurozone grew by 2.6 per cent, spurred by a 3 per cent rise in Germany. An intense focus on increasing productivity has helped Germany’s export sector become highly

competitive, and it is now benefiting from booming demand in emerging markets. With projected growth for 2007 in the 2.5 to 3.0 per cent corridor, Euroland will likely outperform the US economy for the first time in recent history.

If the US lapses into an outright recession, the impact may still be large enough to unravel the global economic story. But any scenario less drastic than the dreaded recession now looks manageable, with the Euro area and China together accounting for a larger share of global GDP than the United States. Almost effortlessly, it seems, the world has escaped its risky dependence on US economic power.

The change in the growth equation is manifesting itself in the rising importance of Chinese equities in determining global financial market sentiment. Each decade, some asset class or other captures the imagination of investors. In the 1980s it was the Japanese market, due to that country’s rapid ascent. In the 1990s it was the NASDAQ, driven by the tech boom. These days investors are riveted by the movements of the Chinese market, with the daily ebb and flow of the Shanghai exchange often setting the trend for the rest of the region.

Of course, following the near-vertical climb in Chinese share prices of late, the impulsive reaction of many financial commentators is to label that market as

smart investing

28

more than one engine driving global growth

29

global markets

A new order has been in the making... almost effortlessly, it seems, the world has escaped its risky dependence on US economic power. Ruchir Sharma, Morgan Stanley Investment Management head of emerging markets, explains why the US is no longer the centre of the universe.

Read this story to receive CPD points.Simply log on to http://www.macquarie.com.au/ftmagazine

another ‘bubble’ waiting to burst. While there are some incipient signs of froth, recent performance is more a result of the changing global economic order. All major stock market booms are rooted in a powerful growth transformation; the current Chinese share-price appreciation too, in large part, is driven by huge profit growth churned out by a booming economy. Earnings growth for Chinese companies in the first quarter of this year was a phenomenal 80 per cent, and according to consensus estimates it could exceed 30 per cent for the rest of the year, justifying at least some of the 50 per cent gain in the Shanghai composite index this year.

Meanwhile, in the developed universe, investors seem to be consumed by ‘EU-phoria’. As a recent Merrill Lynch survey shows, investors are extraordinarily bullish about European stocks, with a record number of respondents sharing the view that the Eurozone has the most favourable corporate outlook of all major developed market regions. European stocks are up a strong 10 per cent this year, after having tripled in value in dollar terms since the 2003 trough.

It is a sign of the changed times, and also a testament to the dynamism of the US corporate sector, that the US stock market has also reached new highs even as the underlying economy downshifts to a much slower pace. American firms have adapted to the changing economic balance by becoming much more global in nature, with their overseas operations now accounting for nearly 40 per cent of sales, up from less than 30 per cent in the late 1990s. Empirical Research Partners estimates that half the US equity returns this decade have come from ‘China plays’ such as energy, materials, machinery and construction-spending companies. That is despite the fact that these sectors on average represent only 8 per cent of the US market.

A world of multiple growth engines, then, doesn’t mean financial markets are less synchronised. The interlinkages in a globalised world are far too strong for any meaningful decoupling to occur. What the new world order implies is simply this – to get a fix on global growth and financial market behaviour, it is as important to track Chinese and European economic data as the whims of the US housing market.

About the authorRuchir Sharma is head of the Global Emerging Markets Equity team and a member of the Global Tactical Asset Allocation Investment Committee at Morgan Stanley Investment Management. He joined Morgan Stanley in 1996 and has 13 years of investment experience. Prior to joining the firm, he worked with Prime Securities (Delhi), a non-banking financial services firm, where he helped run the firm’s foreign exchange business. Ruchir is a columnist with Newsweek and writes for publications such as The Wall Street Journal. He is also a contributor to The Economic Times, India’s leading financial daily, and has been writing a regular column on global financial markets since 1991. Ruchir received a B.A. with honours in commerce from the Shri Ram College of Commerce, Delhi.

30

investment fundamentals

It’s a common phrase that has passed into the parlance of modern investment thinking – but what exactly is the

‘efficient frontier’ and who invented it? Bruce Madden delves into the mysteries of Modern Portfolio Theory.

31

unravelling the mysteries of modern portfolio theory

beyond the efficient frontier – how the risk/return world was discovered

US-born Harry Markowitz never thought he’d end up writing the seminal paper on modern investment theory.

Had you asked a 10-year-old Harry in 1937: “What do you want to be when you grow up?” he would not have replied “an expert investment theorist”.

“Becoming an economist was not a childhood dream of mine,” he admitted in an autobiographical piece written in 1990 to accompany the Nobel Prize he won in that year.

There was nothing in Markowitz’s Chicago childhood to indicate a particular interest in economic matters – he was not a mathematics prodigy or mentally troubled in any way. In fact his early years sound dead ordinary.

“Growing up, I enjoyed baseball and tag football in the nearby empty lot or the park a few blocks away, and playing the violin in the high school orchestra,” he wrote in 1990. “I also enjoyed reading.”

His early choice of literature included such high-brow material as “comic books and adventure magazines, such as The Shadow”.

Something must have clicked academically, however, for Markowitz to author at the tender age of 25 an economics paper that would transform investment theory and which still informs the decision-making of the funds management industry today.

“I was particularly struck by David Hume’s argument that, though we release a ball a thousand times, and each time, it falls to the floor, we do not have a necessary proof that it will fall the thousand-and-first time,” he wrote.

It could be argued that Markowitz picked up and ran with that ball – a very long way.

Even so his decision to study economics at the post-graduate level hardly appears to be driven by a passionately-held belief in the certainty of his misunderstood genius.

“I considered the matter for a short while,” Markowitz wrote, “and decided on economics. Micro and macro were all very fine, but eventually it was the ‘Economics of Uncertainty’ which interested me – in particular, the Von Neumann and Morgenstern and the Marschak arguments concerning expected utility; the Friedman-Savage utility function; and L. J. Savage’s defence of personal probability...”

Obviously, this last sentence is where the lay-reader tunes out and only Nobel Prize-winners continue.

Markowitz, who turns 80 this August, won his Economics Nobel Prize in 1990 primarily for a doctoral thesis published in 1952 on ‘Portfolio Selection’.

Embedded in this paper was a series of calculations that laid the basis for Modern Portfolio Theory and included for the first the time a phrase that would be uttered by fund managers for decades to come: ‘the efficient frontier’.

The essence of Modern Portfolio Theory is simple: you should diversify your assets. Even before Modern Portfolio Theory, the concept of diversification was understood by investors in an intuitive sense but Markowitz’s genius was to translate this intuition into the first serious mathematical analysis of portfolio risk and return.

If he thought he was on the verge of such a ground-breaking economic theory, however, Markowitz does not betray any excitement when describing ‘the moment’ it arrived.

“The basic concepts of portfolio theory came to me one afternoon in the library while reading John Burr Williams’s Theory of Investment Value,” he wrote.

“Williams proposed that the value of a stock should equal the present value of its future dividends. Since future dividends are uncertain, I interpreted Williams’s proposal to be to value a stock by its expected future dividends. But if the investor were only interested in expected values of securities, he or she would only be interested in the expected value of

investment fundamentals

32

the portfolio; and to maximise the expected value of a portfolio one need invest only in a single security.

“This, I knew, was not the way investors did or should act. Investors diversify because they are concerned with risk as well as return.”

It was this flash of illumination that lit the way to the ‘efficient frontier’ for Markowitz.

Using historical standard deviations of investment returns for various asset classes and securities he was able to construct a set of portfolios capable of giving the highest possible return for any given level of risk – this is the efficient frontier.

Expressed graphically the efficient frontier traces a graceful curve within the two parameters of risk and return: those portfolios below the line don’t carry enough risk for the expected level of return while portfolios above the line contain too much risk compared to the expected return.

Markowitz assumed that rational investors, given the choice of two portfolios with the same expected return would select the one with the lowest amount of risk.

In fact, he was able to show that a portfolio proudly marching onto the efficient frontier offered a better risk/return ratio than the average risk/return of its component parts: Markowitz had stumbled upon the fabled ‘free lunch’ many smart investors are said to enjoy.

It was an elegant, thought-provoking and ultimately paradigm-smashing theory but in 1952 most non-academics thought Markowitz was out to lunch.

An article on the Investor Solutions website shows just how far-out the efficient frontier appeared to the investment community for many years after it first appeared in print.

“When Harry Markowitz defended his dissertation on Modern Portfolio Theory in the early 1950s, it’s doubtful that anyone present had any inkling of the tremendous impact it would have on modern finance,” the article says. “But the revolution didn’t exactly spread like wildfire; it took a long time for the impact to be felt. Academics laboured away in obscurity, steadily building a wealth of knowledge until the world was ready for it.”

According to the story, the efficient frontier didn’t really become influential until after the 1987 sharemarket crash. Today Modern Portfolio Theory is an article of faith for the investment industry and every fund manager who wants to join the throng must find a place for themselves on the efficient frontier.

Technology too has helped spread the investment gospel according to Harry. When Markowitz first dashed out his theory, computers were pushing out the borders of the technology frontier – and it wasn’t a very efficient one.

Cut to 2007 and the computing power available to portfolio managers is truly awesome. Any manager worth their salt can conjure up a ‘portfolio optimiser’ from their laptop in seconds and show clearly how their hedge fund/contract for difference/North Korean private equity fund etc would enhance your efficient frontier.

Despite its widespread acceptance today the efficient frontier concept is not without its critics.

Chiefly, Markowitz’s theory has been questioned because of its reliance on standard deviation as a measure of risk. Modern Portfolio Theory has morphed into Post-Modern Portfolio which has reworked some of Markowitz’s original assumptions. As well the rise of behavioural economics has shed more light on his most dangerous assumption of all – the existence of the ‘rational investor’.

In putting a mathematical construct around risk Markowitz revolutionised the investment industry. His efficient frontier defined new territory that investors are still exploring today.

Whatever his boyhood dream, Markowitz, the only child of Chicago shopkeepers Morris and Mildred, looked back with pride on his actual achievements in his 1990 Nobel article.

“I am sorry I cannot acknowledge all the people I have worked with over the last 38 years and describe what it was we accomplished,” he wrote. “As each of these people know, I often considered work to be play, and derived great joy from our collaboration.”

There are some things even a boy can’t imagine.

«The basic concepts of portfolio theory came to me one afternoon in the library while reading John Burr Williams’ Theory of Investment Value.»

the collection macquarie professional series review

Independent ratings1 The funds within the Macquarie Professional Series have been highly rated by researchers.

The first of the Macquarie Professional Series Funds was launched in November 2004. We have selectively grown the Series to seven managers and last quarter closed our first fund (Morgan Stanley Global Franchise Fund) over capacity. In an age of growing homogeneity, the Macquarie Professional Series aims to deliver a degree of specialisation and conviction rarely seen today.

Nov 04 – Morgan Stanley launches

Mar 05 – Walter Scott launches

Oct 05 – Concord launches

Mar 06 – CSL launches

Aug 06 – 1st billion reached

Dec 06 – Arrowstreet launches

Feb 07 – Inaugural Investment Forum

May 07 – EII launches

May 07 – Morgan Stanley closes over capacity

Jun 07 – Winton launches

Jul 07 – Walter Scott reaches $1 billion

Jul 07 – 2nd billion reached

Feb 08 – 2nd Investment Forum

Meet our managers We recognise the importance of you hearing directly from each of the managers within the Macquarie Professional Series. As a result, we have a schedule of regular teleconferences and face-to-face sessions for advisers, with each of the managers. Spaces are limited in these sessions, so please look out for the upcoming teleconferences and meet the manager sessions in Adviser e-news.

Looking for more information?For more information on the Macquarie Professional Series, speak to your Business Development Manager, call us on 1800 005 056 or visit the Macquarie Professional Series tailored section of our website at www.macquarie.com.au/professionalseries

Fund S&P Zenith van Eyk* Lonsec

Arrowstreet Global Equity Fund (hedged) – – A –

Concord Australian Equity Fund 3* R A R

CSL Active Commodities Fund 3* – A –

EII Global Property Fund 4* HR – R

Morgan Stanley Global Franchise Fund 4* HR A –

Walter Scott Global Equity Fund 5* R A HR

The evolution of the Macquarie Professional Series

33

34

wrap up

what’s administration got to do with it

Macquarie has developed a new brochure called Administration matters to help advisers explain the full benefits of using portfolio administration platforms with their clients. Order your brochure by emailing wrapsolutions@macquarie.com

35

macquarie wrap review

Making it easier to be a better investor

Diversification is one of the crucial parts of being a successful investor. However, the more clients diversify, the harder it is to keep track of their money, and the less in control they are. It’s more difficult to move the money around as they want to and the paperwork mounts up. Keeping track of transactions can become complex and confusing. This is especially difficult around tax time!

As you may have experienced, having your client’s diversified investments on an administration platform, means your client doesn’t have to worry about the paperwork and it makes it easier to be a better investor (and a better client!).

More information, less paperwork

With all information in one place, your clients receive consolidated, comprehensive reports from one central source – rather than piles of paperwork from different funds and companies.

Making transactions easier and faster

When it comes to transacting, your client won’t suffer tedious delays as paperwork moves back and forward between your office and investment institutions. The following regular or ad hoc transactions occur automatically:

regular investment plans;

withdrawals and deposits;

distribution payments;

collecting dividends;

buy/sell orders;

call payments;

switches;

pension payments; and

fee withdrawals.

Corporate actions

Clients often learn the hard way on managing corporate actions like share buybacks. An administration platform manages these on your client’s behalf. This further removes administration hassles and paperwork, assisting with comprehensive, audited tax reports.

So what does happen at tax time?

One of the biggest advantages of an administration platform is at tax time. An administration platform creates an orderly paper trail of all the transactions for all their investments. When your clients need the information for tax reporting all the necessary records are ready and waiting.

Custodial structure

An administration platform can handle all these matters on your clients behalf because of its custodial structure. While your client remains the beneficial owner of the investments, their administration platform – the ‘custodian’ – holds legal title. This means that your client can offload a great amount of the paperwork but remain the owner of the underlying investments and receive all the benefits of holding them – such as income payments, access to discount cards and special offers. So they retain control, without having to control the mounting paperwork.

With 30 June behind us, we now know that industry super funds spent over $8 million* from January to 30 June 2007 on advertising. That’s a lot of noise! As a result, you may have experienced some clients questioning the value of their platform. To you it’s an easy answer as it helps you be even more efficient... but this isn’t exactly a client-friendly response! To help you guide your clients through that noise, and in direct response to your feedback, we have developed a new client facing tool, Administration matters, exploring these key areas...

* Neilson expenditure report as at 30 June 2007 (excludes online, STV and trade expenditure).

36

the hub

If you heard your clients were going to be taking part in a $56 billion windfall what would you do?

Chances are you would do everything you could to make sure you knew exactly how much of ‘the pie’ would be going to your clients and then you would work with them to make sure they did something financially smart with it.

Ironically, a windfall similar to this amount is paid out to Australian share market investors in dividends every year. The estimated annual dividend payout as at May 2007 was around $56 billion1. This figure of course fluctuates over time depending on a variety of factors such as overall market capitalisation. Even with fluctuations though it’s clear there is a lot of money flowing out of Australian companies back into shareholders’ hands and some of these shareholders are likely to be your clients.

Who wants in?

According to the latest ASX Australian Share Ownership Study, 38% of Australians (6 million people) own shares directly2.

Many of these investors, however, simply focus on the shares themselves and the potential capital gains that can be made from them. The dividends paid out by the companies are often treated as a windfall gain instead of being treated as part of their overall investment income. You’d be hard-pressed to find a client who hasn’t opened their mail one day and had the nice surprise of a dividend cheque from a share holding they had forgotten about. This cheque more often than not sits uncashed on the kitchen

Are you making the most of your clients’ dividend income?

with the flow

37

macquarie cash management review

bench for a month or two and then when it is cashed the money is spent on buying themselves or their family something they previously couldn’t justify buying.

Of course, there is nothing really wrong with this type of behaviour, it’s just that it focuses on spending not on investing. If your clients don’t have a system implemented that helps them to monitor and manage their dividend income, how much of their income, and therefore their wealth creation potential, are you not seeing?

The power of one

The key to helping your clients understand the potential of their dividend income is to first ensure they understand the power behind having one account for all of their income. Many clients still manage their income through a variety of different bank accounts each with their own particular or peculiar ‘purpose’ and their own access point. Conversations such as, “... that goes into my savings

account which I can only access via the local credit union branch, but if I need money for the plumber I take that out of my cheque account which I transfer to my ATM account via phone banking...”, would not be foreign in any adviser’s office. The challenge is that these behaviours are deeply held and for many clients the idea of consolidating all of their income, including dividends, represents a change and a risk to them. However, the real risk is clients not understanding that their diversified investment strategy could be much more powerful if a consolidated income strategy sits behind it.

Consolidating income into one central account is not only efficient as it saves on fees and makes it easier to track all income sources (particularly at tax time), but it also makes it much easier for all of your client’s income, no matter where it’s sourced from, to be put to work in an active investment strategy.

Ebbs and flows

In the six months to May 2007, the Macquarie CMT experienced over $2 billion in net flows. During that time the Trust held around $14 billion so the flows represented a significant proportion of the Trust. This continual flow of money through the Trust is a pattern that continues to play itself out

If we look only at dividend flows into the Macquarie CMT, for that same six-month period, clients directed nearly $1.8 billion in dividend income through the Trust. And if we look at the 12 months to May 2007 close to $3.5 billion in dividend income alone was credited to accounts held in the Trust. Clients then reinvested a significant proportion of this money to create further investment income. That’s a lot of money in itself, but if we compare it to the $56 billion that is expected to be paid out in dividends over the year, chances are there is still a lot of dividend income that has the potential to be directed and properly managed through a cashflow management system to then invest further.

Directing the flow

But how do you ensure your clients are directing their dividends so they can be appropriately used to help fund their overall investment strategy? The answer to this question doesn’t need to be complicated but it does depend on the type of client you’re dealing with.

For those clients that are still receiving their dividends by cheque and ‘managing’ their

cashflows through a variety of different bank accounts, you need to first educate them on consolidating these accounts into one central cashflow account. They need to understand that by doing this, you as their adviser will have a clear understanding of their cashflow position at all times (assuming it’s an account where you can view their balances and see their activity) enabling you to proactively work with them to maximise their wealth. Once they understand this you can then ensure that their income consolidation occurs across all of their dividend income as well.

For those clients who are already on the cashflow management journey and understand the power of consolidating their income, it really is just as simple as completing a form for the relevant share registries. The Macquarie CMT has an online automated form that makes this process very simple – you type in the stock codes for each of your client’s shareholdings and a letter with your client’s details is automatically generated for the appropriate registry. This has the effect of increasing your client’s investible income without them having to do anything or buy anything – yes, the money was there before, but without direction it was unlikely to be flowing to a place where it could generate more income.

Helping your clients to simply capture their dividend income and make it work harder for them not only benefits their bottom line but also increases your funds under advice and your overall client value proposition.

The power of channelling dividend flows

Income

Investment assets

$$$ $$$$ $

Diagram is for illustrative purposes only. 1 Reserve Bank of Australia, Dividend Yield Statistics – www.rba.gov.au 2 ASX, 2006 Australian Share Ownership Study – www.asx.com.au

«If your clients don’t have a system implemented that helps them to monitor and manage their dividend income, how much of their income, and therefore their wealth creation potential, are you not seeing?»

38

MAStech

TaxationMarginal tax rates and thresholdsEffective 1 July 2007 to 30 June 2008

Taxable income Tax payable/marginal income tax rate1

Residents

Tax payable/marginal income tax rate1

Non-residents

Up to $6,000 Nil 29%

$6,001 to $30,000 Nil + 15% 29%

$30,001 to $75,000 $3,600 + 30% $8,700 + 30%

$75,001 to $150,000 $17,100 + 40% $22,200 + 40%

Excess over $150,000 $47,100 + 45% $52,200 + 45%

Notes: 1 Calculate income tax liability by multiplying the amount of income in excess

of the lower threshold by the stated marginal tax rate, and adding the base ‘Tax payable’ amount to the result.

SuperannuationContribution eligibility rules

Contributor

Your age You (personal) Your spouse or another person (not including your employer)

Your employer

0-64 No test applies No test applies No test applies

65-69 Work related test Work related test Mandated: no test applies

Non-mandated: work related test

70-74 Work related test1 Not eligible Mandated: no test applies

Non-mandated: work related test1

75+ Not eligible Not eligible Mandated: no test applies

Non-mandated: not eligible1

1 These contributions can be accepted if they are received within 28 days after the end of the month in which the individual reached age 75 and provided that they met the work related test in the year the contribution was made.

Notes:

Contributions (other than employer contributions) cannot be accepted if the individual’s tax file number has not been provided.

Non-deductible personal contributions (excluding contributions arising from a personal injury payment or a small business CGT exempt asset sale) cannot be accepted by the fund if they exceed the non-concessional contribution cap that applies to the individual for the year in which the contribution was made.

The work related test requires the individual to be gainfully employed for at least 40 hours in a period of not more than 30 consecutive days in the financial year in which the contribution is made.

SuperannuationContribution limits

Contribution type Annual limit (Cap)

Concessional contributions

2007/2008 is $50,0001, 2

Amounts that exceed this limit count towards the non-concessional contribution cap.

Non-concessional contributions

2007/2008 is $150,000 and will remain as three (3) times the concessional cap (CC).

Personal injury proceeds

No limit if specific conditions and timeframes are met.

Small business CGT exempt asset sale proceeds

$1 million lifetime limit3

Amounts that exceed this limit count towards the non-concessional cap.

Employment termination payments (directed termination payments)

2007/2008 $1 million

Certain employment termination payments specified in contracts as at 9 May 2006 can be rolled over to super up until 30 June 2012. The amount of such a payment that represents the post June 1983 service counts towards the individual’s concessional contributions cap to the extent that it exceeds $1 million.

1 Indexation to AWOTE each year, rounded down in multiples of $5,000.2 A higher annual transitional limit of $100,000 will apply up until 30 June 2012

if you were aged 50 or more on the last day of the relevant financial year in which the contribution was made. This cap is not indexed.

3 An individual under the age of 65 is able to ‘bring forward’ the standard annual limit over a three year period to accommodate larger one-off payments. For example, this will allow a person under age 65 to contribute up to $450,000 in any financial year in which the person is under age 65 at any time in that year in respect of a three year period.

Spouse contribution rebate

Receiving spouse’s assessable income and reportable fringe benefits

Spouse contribution rebate

<= $10,800 18% of the lower of: total contributions for the income year; or $3,000

> $10,800 but < $13,800 18% of the lower of: total contributions for the income year; or $3,000 – (receiving spouse’s assessable income + reportable fringe benefits – $10,800)

>= $13,800 Nil

Government co-contribution

Assessable income & reportable fringe benefits

Co-contribution 2007/2008

<= $28,980 Lesser of: Eligible personal contributions x 150% and $1,500

> $28,980 but < $58,980

Lesser of: Eligible personal contributions x 150% and $1,500 reduced by 5c per $1 of assessable income and reportable fringe benefits over $28,980

$58,980 or more Nil

Thresholds will be indexed annually in line with AWOTE from 1 July 2007.

The minimum Government co-contribution (where income does not exceed higher income threshold) is $20.

The contributor must:

Be less than age 71 at the end of the income year.

Have 10% or more of their total income for the income year sourced from activities which result in them being treated as an SG employee and/or from the carrying on of business.

Lodge an income tax return for the income year.

Not hold an eligible temporary resident’s visa at any time during the income year.

Redundancy payment limitsThe tax-free portion (which cannot be rolled over) of certain redundancy payments is calculated as follows:

2007/2008 2006/2007

$7,020 plus 3,511 for every year of service

$6,783 plus $3,392 for every year of service

The amount in excess of this tax-free amount is an employment termination payment. From 1 July 2007, employment termination payments can generally not be rolled over to a superannuation fund. Transitional rules apply to certain employment termination payments that were specified in a contract as at 9 May 2007 and where the payment is rolled over to super prior to 1 July 2012.

39

technical essentials

SuperannuationTax treatment of lump sum and pension payments – taxed sources

Taxpayer’s age

Tax free component

Taxable component

Under preservation age:

Lump sum 0% 21.5%1

Pension payment 0% Marginal tax rate2

Preservation age to age 59:

Lump sum 0% Amount up to $140,0003 – 0%

Amounts over $140,000 – 16.5%1

Pension payment 0% Marginal tax rate less 15% tax offset

Age 60+:

Lump sum 0% 0%

Pension payment 0% 0%1 Includes Medicare levy of 1.5%.2 A disability pension is taxed at the recipient’s tax rate less a 15% tax offset.3 This is the low rate threshold for 2007/2008. This threshold is increased at

AWOTE and will increase in $5,000 amounts.

SuperannuationPayment factorsAccount based pensionsTable of minimum percentage factors

Age of beneficiary Percentage factor

Under age 65 4%#

65-74 5%

75-79 6%

80-84 7%

85-89 9%

90-94 11%

95 or more 14%# Transition to retirement pensions also have a maximum annual payment limit

of 10% that applies until a condition of release has been satisfied, such as, retirement or reaching age 65.

The minimum payment amount is determined by multiplying the account balance by the percentage factor for the relevant age at commencement of the pension and at 1 July each subsequent year.

Social SecurityAsset test thresholdsThe pensions assets test taper rate will be halved from 20 September 2007 so that recipients lose $39 p.a. (rather than $78) for every $1,000 of assets above the relevant threshold. This would extend the cut out level of assets as follows:

Age pension assets testEstimate for period from 20 September 2007

Homeowner Non-homeowner

Full pension Pension cut out

Full pension Pension cut out

Single $166,750 $520,750 $287,750 $641,750

Couple $236,500 $825,500 $357,500 $946,500

Note: Estimate only – pension cut out figure may change due to variations in CPI adjustments.

Age pension assets testFrom 1 July 2007 to 19 September 2007

Homeowner Non-homeowner

Full pension Pension cut out

Full pension Pension cut out

Single $166,750 $343,750 $287,750 $464,750

Couple $236,500 $531,000 $357,500 $652,000

Pension reduced by $78 p.a. per $1,000 of assets over full pension thresholds.

Income test thresholds

Full pension Pension cut out1

Single income $3,432 $37,940.50

Couple $6,032 $63,414.00

Pension reduced by 40c for every $1.00 of income over full pension thresholds.

Full pension thresholds change each 1 July.

Cut out thresholds change 20 March and 20 September – when pensions and allowances indexed to CPI.

Deeming rates and thresholds

3.5% for first $39,400 for single ($65,400 for couple)

5.5% for balance over these amounts.

Rates and thresholds valid from 20 March 2007.

Term Allocated Pension

Remaining term (whole years) Payment factor

0 1.001 1.002 1.903 2.804 3.675 4.526 5.337 6.118 6.879 7.6110 8.3211 9.0012 9.6613 10.3014 10.9215 11.5216 12.0917 12.6518 13.1919 13.7120 14.2121 14.7022 15.1723 15.6224 16.0625 16.4826 16.8927 17.2928 17.6729 18.0430 18.3931 18.7432 19.0733 19.3934 19.7035 20.0036 20.2937 20.5738 20.8439 21.1040 21.36

Source: SIS Regulation Schedule 6

stock story

game onwhy Aristocrat is a winner Oliver Ansted from boutique investment house Concord explains where Aristocrat Leisure Ltd slots into its portfolio.

Globally, the past two decades have seen state and regional governments striving to run balanced budgets in the face of escalating health costs and social spending. This has prompted governments to seek out new sources of tax revenue. One substantial source of new revenue has been gaming taxes, as governments have deregulated gaming to enable gambling in a clean, regulated environment, and to simultaneously tax the business.

In most regulated gambling environments, slot machines account for the bulk of the revenue and profitability, as their automated nature is suited to the high volume of potential customers, offering efficiency, scale and low operating costs.

Australia has been a relatively early mover in this phenomenon, and the intensity of slot machines in NSW, Qld and Victoria, for instance, is among the highest in the world on a per capita basis (see chart below).

Aristocrat’s heritage is in the Australian market, which as a

result of its early-mover status, has been at the forefront of the development of the slot machine industry.

Having its R&D headquartered in Australia, Aristocrat has been able to achieve and maintain a leading market position in this strategically important market, and it has proven consistently that its machines deliver maximum returns to the key industry stakeholders.

The advanced state of the Australian slot machine market and Aristocrat’s leading position within it has resulted in the company’s products being highly successful in several major offshore markets. Aristocrat has had substantial success penetrating the USA – the world’s largest regular slot machine market (by units) – and Japan, the largest overall slot machine market. Aristocrat has also achieved a leading market share in one of the world’s most exciting new gaming jurisdictions, Macau, as a result of the strength of its product performance.

We expect continued growth in Aristocrat’s business from:

opening of new jurisdictions and further expansion of existing jurisdictions;

continuation and potential improvement in replacement cycles of installed machines in major markets as venue

operators seek to optimise machine performance;

product suite expansion, including multi-terminal games and server-based technology; and

continued growth in pricing.

Aristocrat has magnified its earnings growth over the past few years by streamlining its productions process and supply chain, such that its business is focused much more heavily on intellectual property rather than equipment manufacturing. This, combined with the above structural dynamics, has seen substantial cash generation and created a very strong return on investment characteristic.

After initially closing its door to new funds in February 2003,

Concord has decided to reallocate some of its total capacity to retail investors, through the Macquarie Professional Series.

Concord is also the first Australian equities manager in the Macquarie Professional Series – it joins international share managers Walter Scott & Partners and Morgan Stanley’s Global Franchise Fund, as well as global property manager EII on the exclusive list. This is the first time Concord has opened up directly to the retail market on a stand-alone basis. Investors who ultimately invest with this highly-regarded high conviction Australian equity manager will have confidence that Concord’s limit on retail funds flow means its core investment principles won’t be compromised.

40

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Slot machine intensity

Adviser Services 1800 808 508

Fax 1800 550 140

Email adviser@macquarie.com.au

Website www.macquarie.com.au/advisers

Alternative Assets 1800 808 508

Cash Management Trust (CMT) 1800 808 508

Macquarie Professional Series 1800 005 056

Macquarie Wrap 1800 025 063 Investment, Superannuation and Pension solutions.

Macquarie Life 1800 005 057 For all insurance queries.

Managed Funds 1800 814 523 Managed funds for wholesale and master fund investors including equities, fixed interest and diversified portfolios.

New South Wales Level 11, 20 Bond Street Sydney NSW 2000

Queensland Comalco Place, Level 8, 12 Creek Street Brisbane QLD 4000

Victoria Level 26, 101 Collins Street Melbourne VIC 3000

South Australia Level 2, 151 Pirie Street Adelaide SA 5000

Western Australia Level 27, Allendale Square, 77 St Georges Terrace Perth WA 6000

OTH7249 08/07

1 Zenith’s ratings are prepared exclusively for clients of Zenith Investment Partners (Zenith). The rating is of a general nature and does not have regard to the particular circumstances or needs of any specific person who may read it. Each client should assess either personally or with the assistance of a licensed financial adviser whether the Zenith rating or advice is appropriate to their situation before making an investment decision. The information contained in the rating is believed to be reliable, but its completeness and accuracy is not guaranteed. Opinions expressed may change without notice. Zenith accepts no liability, whether direct or indirect arising from the use of information contained in the rating.No part of this rating is to be construed as a solicitation to buy or sell any investment. Zenith usually receives a fee for rating the fund manager and product(s) against accepted criteria considered comprehensive and objective.Lonsec ratings current as at the following dates: Concord – May 2006, EII – May 2007, Walter Scott and Morgan Stanley – March 2007. Any Lonsec Limited (Lonsec) (ABN 56 061 751 102) rating presented in this document is limited to “General Advice” and based solely on consideration of the investment merits of the financial product(s). It is not a recommendation to purchase, sell or hold the relevant product(s), and you should seek independent financial advice before investing in this product(s). The rating is subject to change without notice and Lonsec assumes no obligation to update this document following publication. Lonsec receives a fee from the fund manager for rating the product(s) using comprehensive and objective criteria.To the extent that any ratings, opinions or other information of Standard & Poor’s Information Services (Australia) Pty Ltd (ABN 17 096 167 556, Australian Financial Services Licence Number 258896) (Standard & Poor’s) constitutes general advice, this advice has been prepared by Standard & Poor’s without taking into account any particular person’s financial or investment objectives, financial situation or needs. Before acting on any advice, any person using the advice should consider its appropriateness having regard to their own or their clients’ objectives, financial situation and needs. You should obtain a Product Disclosure Statement relating to the product and consider the statement before making any decision or recommendation about whether to acquire the product. Past performance is not a reliable indicator of future performance. Ratings can change or cease at any time and should not be relied upon without referring to the meaning of the rating. For more information regarding ratings please call S&P Customer Service on 1300 792 553 and also refer to Standard & Poor’s Financial Services Guide at www.assirt.com.au. Each analytic product or service of Standard & Poor’s is based on information received by the analytic group responsible for such product or service. “S&P” and “Standard & Poor’s” are trademarks of The McGraw-Hill Companies, Inc. ©2007 Standard & Poor’s Information Services (Australia) Pty Limited.*van Eyk Limited (ABN 99 010 664 632 AFSL 237917) (van Eyk) rates investment management capabilities rather than individual products. This rating is valid as at July 2004 Commodities Review October 2006 (Australian Equities) and June 2007 (International Equities) but can change or cease at any time and should not be relied upon without referring to the meaning of the rating, as well as the full manager report, available to subscribers at www.irate.vaneyk.com.au. van Eyk has not directed the publication of Commodity Strategies Ltd., Morgan Stanley, Arrowstreet, Walter Scott & Partners and Concord Capital Limited’s ratings. Past performance information is given for illustrative purposes only and should not be relied upon as it is not an indication of future performance. The rating is not intended to influence you and your client’s investment decision in relation to any products managed by Commodity Strategies Ltd., Morgan Stanley, Arrowstreet, Walter Scott & Partners and Concord Capital Limited and does not take into account your client’s individual financial situation, needs or objectives. We recommend that you and your client do not rely on this rating in making an investment decision and instead you seek advice from an appropriate investment adviser and read the product disclosure statement before making such a decision.The following financial products (Funds) mentioned in this publication are offered by Macquarie Investment Management Limited ABN 66 002 867 003 (MIML): Macquarie SuperOptions, Macquarie ADF Superannuation Fund, Morgan Stanley Global Franchise Fund, Walter Scott Global Equity Fund, Concord Australian Equity Fund, EII Global Property Fund, Arrowstreet Global Equity Fund and Macquarie Cash Management Trust. Before making a decision to acquire, or to continue to hold, an investment in a Fund, investors should obtain and consider a copy of the relevant Fund’s current offer document which is available from us. Applications to invest in a Fund will only be accepted if made on an application form included in, or accompanying, the current offer document for the Fund.Investments in the Funds are not deposits with or other liabilities of Macquarie Bank Limited ABN 46 008 583 542 (MBL) or any other member company of the Macquarie Bank Group (the Group) and are subject to investment risk, including possibly delays in repayment and loss of income or principal invested. Neither MBL nor any other member company of the Group guarantees the performance of the Funds or the repayment of capital from the Funds or any particular rate of return.This publication is for adviser use only and must not be distributed to retail investors. It is not intended to be personal, financial or legal advice. The information contained in the magazine is given in good faith and obtained from sources believed to be accurate. It does not take into account the investment objectives, financial situation or needs of any particular investor. These matters should be considered when deciding whether the investment is appropriate. Note also that investment portfolios are indicative only and may change frequently. Returns quoted may bear no relation to future performance. Views expressed by contributors are personal views and they are not necessarily endorsed by any Macquarie entity or the publisher.

corporate directory

How to contact Macquarie Adviser Services:

For further information on products and services:

Directory of offices:

Appendix 2: Base return assumptions

Asset Allocation Capital Growth Income Other

Australian Equities 30% 5.50% 3.50% 80% franked

Property 10% 2.00% 6.00% 20% tax deferred

Cash 5% 4.50%

Australian Fixed Interest 20% 5.50%

Overseas Equities 25% 7.00% 2.00%

Overseas Fixed Interest 10% 5.50%

Your clients’ cashflow is the fertiliser for your business.

Macquarie Investment Management Limited ABN 66 002 867 003 (MIML or “we”) is not an authorised deposit-taking institution for the purposes of the Banking Act (Cth) 1959 and MIML’s obligations do not represent deposits or other liabilities of Macquarie Bank Limited ABN 46 008 583 542. Macquarie Bank Limited does not guarantee or otherwise provide assurance in respect of the obligations of MIML. The Macquarie Cash Management Trust (CMT) is offered by MIML. In deciding whether to acquire or continue to hold an investment, investors should consider the current Product Disclosure Statement (PDS) which is available from us. Applications can only be made on the application form contained in the current PDS. This information is provided for the use of licensed financial advisers only.

Every adviser would like their business to flourish and it’s possible, simply by smarter management of your clients’ cashflow.

The Macquarie Cash Management Trust (CMT) brings to life your clients’ financial behaviour. Providing you visibility across their income, expenses and current balances – with specialist tools for self managed super funds.

By understanding your clients’ financial behaviour you will be able to strategically channel their cashflows and deliver better results. This knowledge, along with automated balance alerts and other innovations, will enable you to act on investment opportunities swiftly.

For advisers this translates into more funds under management, higher returns for your business, and happy clients.

Clients will be further pleased by how the CMT streamlines

their cashflow management through detailed reporting

and online flexibility that is second-to-none. Operating

efficiencies also accrue to your business. The Macquarie

CMT integrates with your financial planning software.

Back-office paperwork decreases. Fees can be directly

deducted from your clients’ accounts. And tax time is

simplified. In short, more nourishment – and even greater

performance for your business.

The Macquarie CMT is Australia’s first and largest CMT

(over $�3 billion in funds under management). We have over

25 years of experience, and have won ASSIRT best fund

manager every year from 2003 to 2006.

To see your business flourish call 1800 005 056 or visit www.macquarie.com.au/cashflowtoolkit