Are we being ripped off by super?
I admire a good deal about super but there is room for improvement.
Over the past few months the giant industry super funds that dominate the industry have been in the news frequently. Very little of the coverage has been positive. Issues with client service have been highlighted, the composition of boards have been questioned and valuation policies have been scrutinised by both journalists and regulators.
This got me thinking about the differences between the retirement system in the US where I began my career and Australia where I plan on finishing it. Moving between countries provides perspective on the positives and negatives of different systems. No approach is perfect. And exploring other systems is a way to elevate the debate beyond what can become a never-ending series of often revisited partisan arguments.
The US retirement system
A quick primer on the US retirement system. I’m going to ignore Social Security which can loosely be thought of as an age pension which provides payments in retirement for anyone who has met certain work requirements.
I am going to concentrate on the tax advantaged retirement accounts which share some similarities to super. There are several important distinctions between the US retirement accounts and super. The first distinction is that the US system is not compulsory. In some cases there are incentives beyond favourable tax treatments to save in these accounts. Yet it remains a choice to save for retirement.
These incentives are generally only available to Americans who work for larger corporations. The incentive takes the form of a company match. An example is an employer who offers 50 cents for every dollar saved up to 6% of a salary as a match. An employee who contributes 6% of their own pay would effectively be saving 9% of their salary when the company match is included.
You may have heard the terms 401k and IRA in the financial news media. I’m going to skip the distinction because it isn’t relevant for my comparison to super. The point is that they are both voluntary which obviously differs from the compulsory underpinnings of super.
What is more pertinent is the two different tax treatments of retirement accounts. Both 401ks and IRA come in two flavours – regular and Roth. The regular version has no taxes on the way in. Any contribution you make – within the prescribed annual limits – is made tax free. This differs from the 15% contribution tax into super. Tax is paid on the way out. When you are retired you can remove money from these accounts to pay for your life. That is taxable income and you pay full income taxes on it in whatever tax bracket you happen to be in. Like super there are requirements for minimum disbursements that are based on the amount of money in the accounts.
The Roth version is different. You pay taxes on the way in which resembles non-concessional contributions into super, where you have paid your marginal tax rate on the funds. There are limits on how much you can contribute each year. When you remove money from these accounts there is no tax due but there are also no requirements to take money out of the accounts even when you are retired.
Perhaps the biggest difference between super and regular and Roth retirement accounts is that in the US there is no tax while the money is in the accounts. You pay no capital gains tax and you pay no tax on interest and dividends. For Roth accounts this means you never pay taxes again on any money that is contributed. Since you also have no restrictions on taking money out this gives a Roth holder complete freedom.
The other big difference is that – mostly – these retirement accounts are just opened with whatever broker you want to use. You can invest in anything you choose – funds, ETFs, cash vehicles or individual shares. If you open one of these accounts there is no administration fee. In most cases there are also no brokerage fees as the largest brokers in the US don’t charge for trading.
Where I believe super falls short
With the US primer out of the way we can turn to super. I am a fan of the compulsory aspect of super. I know there are many that don’t share my view. I certainly understand the argument that we should each be free to do whatever we want with our money. But coming from the US I see the results of that policy. Only around 35% of Americans have retirement accounts. Too many Americans are not able to retire with dignity.
That doesn’t mean super couldn’t improve. The compulsory component and the tax treatment once money is in super invites significant government overreach. We see this with the various schemes to use super assets for non-retirement purposes – COVID withdrawals and the various housing schemes to name two recent examples. It also means we all pay higher fees than we should.
The sheer size of the growing pile of money in super also invites constant scrutiny, tax proposals and policy changes. As Willie Sutton said in response to a question about why he robbed banks – that is where the money is.
Transparency
The government and regulatory agencies have recently weighed in on multiple aspects of super from client service to board composition. We’ve also had round after round of super reform. One item that hasn’t been included in any of these regulatory and reform efforts is increased transparency.
The transparency that is provided on investments held within super funds leaves a lot to be desired. Holdings disclosures occur at best twice a year and often occur at a delay of 90 days. That means for large parts of the year I have no idea what is in my retirement portfolio. When I do find out the information is outdated.
There are no disclosure requirements for Australian funds. Apparently, this is to prevent front running. Front running is purchasing an asset in the hopes of profiting because you know somebody else is purchasing the asset. Every other developed country in the world has full disclosure of assets. In the US disclosure is required monthly. But I’m supposed to accept that a $300 billion fund cannot tell me – even after the assets have been purchased – what is in the portfolio at a more frequent interval than semi-annually.
Other than the simple fairness of understanding where my money is invested this lack of transparency presents investing challenges. I can’t get a holistic picture of my overall portfolio which includes investments inside and outside of super. A broad asset class level bucket like ‘global equities’ does me no good.
It also invites questions about valuation policies, systemic risk and liquidity. More transparency would limit these questions. It would help with my own questions as I’ve become increasingly worried about each of these aspects of my retirement portfolio.
I understand that most people will shrug at my complaints about transparency. But this is money that I work hard for and is mandatorily removed from my paycheck. I support the compulsory aspect of super because I think it leads to the greater good. I don’t think it is too much to ask to understand how it is being invested.
What returns do we get for the fees we are paying?
I've chosen AustralianSuper as my super fund. Compared to other super funds AustralianSuper fees are low. That is why I selected AustralianSuper. But on an absolute basis the fee is high. It is worth thinking about what I get for that fee. AustralianSuper has decent returns. The High Growth pre-mixed option which I’ve invested in has delivered 10 year returns of 9.04% per annum. It has a 10.25% allocation to defensive assets with the rest allocated to growth assets.
However, the return didn’t keep up with what I could have gotten if I invested 40% in Global shares, 50% in Aussie shares and 10% in Australian bonds as represented by the low-cost ETFs IVV which tracks the S&P 500, VAS which tracks the ASX 300 and VGB which tracks an Australian Government Bond index. My return would have been 11.25% over the last decade if I did that. The totals fees I would have paid were .066% of my investment. The AustralianSuper non-admin fees are 8.63 times higher. More on fees later.
The three ETFs I picked above do not represent a pure benchmark for the high growth AustralianSuper pre-mixed option. However, they do represent a plausible alternative for an investor who wanted to invest passively in low-cost ETFs. But benchmarks are still important and are used by the industry to judge performance.
On a quarterly basis Morningstar puts out a super benchmarking report. You can access the Q2 report here. The following chart shows how pre-mixed options faired against our benchmarks in the Q2 report. In every category the returns were lower than the benchmark.
There is a lot of nuance involved in benchmarking pre-mixed options from super providers. There can be meaningful differences in the asset allocation from one balanced offering and another. And reasonable people can argue about the details. But on an aggregate level I don’t think we can draw the conclusion that the approach super funds are taking is outperforming indexes.
What are we paying for super?
It is also worth exploring the fees we pay for super. As I alluded to earlier, in my Roth IRA and IRA accounts in the US I pay a grand total of zero – yes, zero – fees for these accounts. They are with my broker Charles Schwab which has free trades. There are no administration fees. I can invest in whatever I want. There are management fees for any ETFs or funds I choose to invest in. But that is my choice.
I compare that with what I pay my provider AustralianSuper. The annual fees on a $250,000 balance in their pre-mixed options are $1,727. That is 0.69%. If I remove the annual $302 admin fee the remaining investment management fees represent 0.57% of the total account balance.
The AustralianSuper fees include admin fees, transaction costs and investment fees. This fee is low for a super fund. Yet 0.57% for transaction and investment fees is still high in an absolute sense. If I saved $10,000 for 40 years and earn a return of 9.04% I would end up with $3.415m. If I add back the fees and earn a return of 9.61% I would have $3.981m. That is a huge difference.
To invest $10,000 a year for 40 years and grow those contributions by $3.015m over a lifetime I am paying fees of $566,000 to AustralianSuper. That is staggering. If I had invested the same money in those three ETFs and earned the same pre-fee returns as the high growth option over the last 10 years, I would have grown my contributions by $3.511m and paid a total of $71k in fees.
Is this worth it? That is up to each person to decide. My answer is no. This might be my perspective given my parallel retirement experience in the US but I’m shocked by the fees we have been conditioned to expect for super. And many Australians are paying higher fees than I am.
According to a 2023 Rainmaker Superannuation Benchmarking Report the average industry fund My Super option charges 1% in annual fees with 0.71% of that for investment management fees. It is hard to reconcile fee levels with an industry that has scaled to such a degree. For example, AustralianSuper was managing $32 billion in 2010. Today funds under management are $341 billion. This is happening all over the industry as demonstrated by the following chart:
Managing money is a business model that benefits from scale. Many of the costs are fixed. Fees have come down. But in my opinion, they remain too high when compared with passive alternatives.
There is an ongoing and contentious debate over super fees. There have been studies that compare super to pension systems from around the world and declare that Australians are in fact paying too much for super. The government has used these studies to point out that fees are too high.
The industry has responded that a traditional defined benefit pension system is not a one for one comparison. The industry has cast the blame on the government for high fees through constant mandates and over regulation.
The fact remains that on an absolute basis super is expensive when compared to the investment options outside of super. And all this finger pointing isn’t helping the people that are impacted by the high fees. That is all of us.
What do all the fees go?
The same Rainmaker report I referenced earlier also highlighted that the average retail fund fees and industry fund fees have reached parity. Retail fund fees have come down meaningfully over the years to get to this point. This is undoubtedly a good thing. But it also raises a question.
Retail funds and industry funds are different. And I will quote Canstar’s description of that difference: “the main difference between an industry super fund and a retail super fund is what they do with their profits. Industry super funds are not-for-profit and return any profits to their members, whereas retail super funds return their profits to shareholders.”
It is worth asking why the fees are the same. What is happening to the portion of the fees that retail funds are generating for shareholders at industry funds? It is something that industry super fund members should know.
The non-profit status of an industry super fund is not unique in the investment industry. Vanguard is owned by the people who invest in Vanguard funds and instead of generating profits for shareholders fees are reduced over time. The following chart shows how the increasing scale of Vanguard has benefited investors in Vanguard products. It also shows how all investors have benefited from other fund managers that are trying to compete with Vanguard.
The opposite seems to be happening in superannuation. The Rainmaker Superannuation Benchmarking Report highlighted that while the expense ratio on funds is dropping the overall fees paid to super funds is increasing at a rate that exceeds the growth in assets invested in super.
Funds under management for super funds in the 2023 financial year increased by 1.5%. Yet total super fee revenue increased by 3% to $32 billion. This is the opposite of investors benefiting from scale.
Final thoughts
I’ve been writing this article for two weeks. It has taken so long because I’m trying to decide what to do with my own super. I’ve decided to make a change. The final straw was an article in the AFR about the debate over the proposed reforms to financial advice in Australia. According to the AFR there is a disagreement between different industry participants on who should pay for the proposed ‘simple’ advice that the reform proposes to enact.
I will quote from the AFR article:
“The biggest industry funds, led by AustralianSuper and the Australian Retirement Trust, are adamant that charges for this proposed version of basic advice and advisers should be “collectively” shared across all members and covered by general administrative fees.
But retail funds and financial adviser groups argue this puts them at a competitive disadvantage given their business models require charging individuals a separate fee for any advice. They also argue it would be a regressive move given the shift to a more transparent “fee for service” model over the past decade.”
I support financial advice reform. I think financial advice can make a big difference in people’s lives. I just don’t want it myself and I don’t think my super fees should pay for something I don’t want and won't use. Taxes are the price we pay for a civilised society. And I support schools and good education even though I don’t have kids. I support welfare expenditures even though I have been fortunate enough never to need it. The list goes on.
In my opinion there is a fundamental difference between taxes and fees paid to manage my retirement savings. Some people may disagree. I respect their opinion. But to me this is endemic of the issue with super. Is super supposed to provide dignified retirements for Australians? Or is super a pool of money that can be used to pay for other things. Financial advice reform, vote grabbing housing ‘affordability’ measures and to subsidise a competitive advantage for one type of super fund over another. Sadly I think too often it is the latter.
I just can’t reconcile how I pay a fee of 0.69% a year for super when I pay no fees in the US. Without admin fees I have access to call centres and free trades. As the Vanguard chart indicates the average expense ratio of US managed products is 0.44%. As the Rainmaker benchmarking report indicated the average My Super fund charges a fee of 1% with 0.71% going to investment management. I understand the systems are different and that the tax and compulsory aspect of super mean fees are higher. Should there be that much a difference? I don’t think so.
My plan was always to switch to a self-managed super at some point and perhaps now is the time. But I have a couple other options in mind for my super which I will further research. This is not a decision I am taking lightly as there will be tax consequences for switching super. I am going to take the time to get this right. For now, I’m going to wait and see what happens with the financial advice reforms as that will inform which option I will choose. I want to hear your perspective on super. Email me at [email protected]
