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Getting SMSF advice right

Aug 26, 2019, 11:48 AM

By Peter Burgess

Peter Burgess SuperConcepts SMSF expert

SMSF advice is under more scrutiny than ever, thanks in part to an unflattering ASIC report.

In 2017 ASIC reviewed 250 client files where advice had been given to setup an SMSF. The purpose of the review was to quality-check the advice including whether it met ‘best interest’ requirements.

The findings, released last year in ASIC’s Report 575, were alarming. In over 90% of cases there were advice failings. And in 10% of cases, the client risked being significantly worse off in retirement as a result of the advice.

So what went wrong?

ASIC found two main contributing factors for the substandard advice: 

  1. The adviser did not demonstrate they had conducted sufficient research into, and properly considered, the client’s existing superannuation products before recommending the establishment of an SMSF; and
  2. The adviser did not demonstrate they had adequately considered the client’s objectives, financial situation and needs before recommending the establishment of an SMSF.

In 234 (94%) of the client files reviewed, the adviser recommended that the client switch from their existing superannuation product to an SMSF. In 204 of these files (87%), the adviser failed to conduct a reasonable investigation into the available options. 

In many cases, the adviser failed to clearly demonstrate why the client’s existing superannuation product was not fit for their needs and objectives. They also failed to explain how the SMSF would leave the client in a better position.

In 210 files (92%) assessed as non-compliant, ASIC found that the adviser had not investigated all of the client’s relevant circumstances, or had not demonstrated how they had considered them in the final advice provided to the client. Importantly, the adviser failed to satisfy the safe harbour steps for the best interest duty which requires, among other things, that the adviser base all judgements on the client’s relevant circumstances.

What can we learn from this review?

The findings of the review showed the advice-giving process needs significant improvement in some areas. Clearly, before recommending the establishment of an SMSF, the adviser must ensure they have properly investigated all of the client’s relevant circumstances, and be able to show that they have done so.

ASIC report 575 provides 38 practical tips that advisers can use to improve the quality of their SMSF advice. These practical tips follow a logical sequence of client discussions and disclosures and provide a useful advice framework when the establishment of an SMSF is being contemplated.

While all 38 practical tips are important, having considered the findings of this review, coupled with the results of our own client research, the following three practical tips, for me, stood out as being critically important.

Tip 1 — Disclose the risks of an SMSF structure

In 2015, ASIC published INFO 205 to assist advisers when providing personal advice about SMSFs. It contains important information about the risks associated with SMSFs. However, despite being available, ASIC found this information is still not being routinely discussed with clients and found significant deficiencies in the disclosure of risks by advisers.

When the establishment of an SMSF is being contemplated, advisers must be familiar with the risks set out in INFO 205 and ensure these risks are properly disclosed to clients. The risks set in INFO 205 include:

  • Lack of statutory compensation in the event of theft or fraud
  • No access to certain dispute resolution mechanisms
  • The impact on insurance
  • Appropriateness of different SMSF structures
  • Trustee obligations and the time and skills necessary to operate an SMSF
  • Trustee obligations to develop an investment strategy
  • The need to consider an exit strategy

While these are the risks that should always be canvassed with clients, there may be other specific risks particular to the client’s circumstances that should also be discussed and disclosed.

Tip 2 — Assess the alternatives to an SMSF structure

Advisers should weigh up the alternatives. There are APRA-regulated funds which offer DIY investment options, and these should be considered against the client’s financial situation, needs and objectives.

It’s important to conduct a reasonable investigation into the financial products that might achieve the client’s objectives and needs – and doing so is a safe harbour step for the best interest requirement under section 961B(2) of the Corporations Act 2001.

As part of the SMSF advice process, advisers should always be able to clearly articulate answers to the following questions:

  • Why not an APRA-regulated fund?
  • Why an SMSF?

ASIC report 575 provided two examples of where a recommendation to setup an SMSF was considered ‘compliant advice’ by ASIC. In both cases the adviser was able to demonstrate that the client was suitable to be an SMSF trustee and that an SMSF would be beneficial for them. The adviser had properly considered the client’s objectives, financial situation and needs, and had based all judgements on the client’s relevant circumstance.

In both cases, answers to the questions ‘why not an APRA-regulated fund and why an SMSF’ centred on the cost savings to the client, given their substantial super balances. These cost savings were clearly quantified in the advice documents and accepted by ASIC as a genuine reason for the establishment of an SMSF.

Other than cost, it may be that an SMSF is in the client’s best interest due to the possibility of higher investment returns. Here, the justification should not alone focus on the added investment flexibility and control of an SMSF – but should also explain how the outperformance will be achieved and will leave the client in a better financial position in retirement relative to an APRA-regulated fund. For example, it could be the case that specific investment options not available in an APRA-regulated fund will deliver the client better investment returns consistent with their risk profile.

An SMSF may also be in a client’s best interest from an estate planning perspective. Here, the justification would need to show how, compared to an APRA-regulated fund, an SMSF can better accommodate a client’s death benefit wishes, in terms of tailored outcomes and tax-effectiveness, and with regard to the client’s specific circumstances.

In any event, the adviser also needs to ensure the client is suitable to be an SMSF trustee, the client understands the risks, and all judgements to establish an SMSF have been based on the client’s relevant circumstances.

Tip 3 — Record keeping

Of the non-compliant advice uncovered in ASIC’s review, in all cases there were record keeping problems.

One of the more common problems was the omission of file notes documenting discussions relevant to the advice – such as conversations about the client’s relevant circumstances and their reasons for seeking advice.

Client file notes should be kept for every step of the advice process. This is particularly important when providing a recommendation to establish an SMSF, as the adviser needs to be able to demonstrate that they have informed the client of the risks and obligations of being an SMSF trustee, have evaluated the alternatives, and that they have assessed the client to be suitable to be an SMSF trustee.

Creating contemporaneous client file records at the time of the event (i.e. client meeting or phone call) assists with ensuring that records are accurate. Accurate and complete client files also assist in the event of a client compliant, allowing the adviser and the licensee to respond to the client in a timely and client-focused way.

Where a recommendation to establish an SMSF has been provided, advisers should have file notes which, at a minimum, document:

  • Discussions the adviser had with the client about the roles and obligations of being an SMSF trustee.
  • Whether any red flag indicators were identified and how the adviser assessed the client’s suitability to be an SMSF trustee.
  • The risks of an SMSF structure that were discussed with the client.
  • An explanation of the need for an SMSF investment strategy and the benefits of asset diversification. If the client has a preference for property, discussions about whether the property investment is appropriate and, if a limited recourse borrowing arrangement is being recommended, an explanation of the costs and risks.
  • An assessment of the alternatives including a discussion about whether an APRA-regulated fund will meet the financial situation, needs and objectives of the client.

A final word

Given the findings of ASIC’s review and its well documented concerns about the quality of SMSF advice, you could be forgiven for thinking recommending the establishment of an SMSF is a high-risk proposition. But what’s not so clear in ASIC report 575 is whether the advice, which was assessed as being ‘compliant advice’, would have been compliant if the adviser had not recommended an SMSF. In report 575, ASIC stated:

‘In a compulsory super contribution environment, it is essential that consumers can choose how to invest their super savings. A healthy and vibrant SMSF sector is a key conduit for exercising this choice. In the right hands, SMSFs can be very effective retirement savings vehicle. In the wrong hands, however, SMSFs can be a high-risk option.’ 

My interpretation of the above is that there will be circumstances when establishing an SMSF is absolutely the right option for your client. The advice needs to be given by an appropriately qualified adviser adhering to ASIC’s SMSF advice guidelines. Where an adviser does not meet this criteria, they should refer the client to an adviser who does.