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Pensions
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AFC3440 Pension and
Financial Planning
Topic One: Introduction (2)
Today’s lecture / Tute 1
1. Nature of financial planning
2. Issues and Problems in the Financial Planning
industry in Australia
3. Pension plans in other countries (separate
reading)
• Tutorial questions for next week (Tute 1):
1, 2, 3, 7, 8, 9,11,13,14,15, 24 and 33
The Nature of Financial Planning
• The main areas of financial planning (FP) are:
– Wealth creation
– Asset protection
– Retirement planning (including transition to
retirement)
– Estate Planning
• Main reference: AMFPG Ch.8
Basis of FP Compliance
• The basis of compliance to FP standards is that clients
of financial advisers are considered vulnerable.
• ASIC cites numerous cases of consumers who have
been given bad advice but think that it was good advice;
i.e. they don’t know the difference.
– in an ASIC survey undertaken in cases where ASIC judged
that the advice by AFSL* representatives clearly lacked a
reasonable basis, 86% of consumers were still satisfied
with the advice …
* Australian Financial Services Licence
• What do you conclude from this?
Financial advisors duties
• No, it’s not that most people are stupid!
• Rather, due to the specialised and complex nature of
FP, it means the financial adviser must be compelled
to act in the interests of the client → fiduciary duty
• i.e. there is a legal, as well as an ethical, duty to act in
the best interests of the client
• This legal duty was introduced into the Corporations
Law under the Future Of Financial Advice (FOFA)
reform program introduced in 2011 (legislative
changes effective from 1 July 2012)
• (the ethical duty is mandated by the AFSL regime)
Fiduciary duty
• Applies to advice to retail clients only
• A retail client is someone who is not classified as a
wholesale client; that is, they have not met the income
or wealth tests in the Corporations Act and have not
been assessed as being an ‘experienced investor’
• The rule of fiduciary duty is also referred to the ‘best
interest’ duty, in that it requires the adviser to act
objectively and solely in their client’s best interest
• It embodies two principles:
– “Know your client”; and
– “Know your product”
“Know Your Client”
• To ensure that advisers have a reasonable
basis for their advice, it is necessary to:
1. Perform a detailed investigation of the client and
research the client’s needs
2. Carefully record all relevant aspects of the client
3. Formulate clear advice for the client
4. Obtain the client’s decision and implement it
• Further guidance is given by ASIC RG175
• “know your product” is based on similar principles
The ‘best interest’ duty
• The following four standards apply in assessing the
behaviour of the financial adviser:
1. The planner must have acted with a reasonable level of
expertise in the subject matter advised on
2. The planner must have exercised reasonable care
3. The planner must have objectively assessed the client’s
relevant circumstances
4. The planner must have regarded any action implemented
as being in the client’s best interest in the circumstances
• In addition, advice must be in writing, often referred to
as a Statement of Advice (SoA)
SoA documentation should contain
(i) Information elicited from client
– Assets, family circumstances, cash flows, projected
cash flows, expectations, objectives, special needs,
investment preferences (and aversions), risk-profile
and any other relevant information.
– This information should be recorded, agreed upon
and signed by the client(s). It will form the basis of
the resulting financial plan. The advise should notify
the client of this at the outset.
SoA documentation should contain
(ii) Information on fees
– The fee for the service should be disclosed in the first
meeting with the client, as part of the Financial Services
Guide. The fee may for instance be divided into
progressive parts.
– Any products in which the adviser has a financial interest
(e.g. he/she receives a commission from the fund
manager, is employed by CBA to market its investment
products, etc.) must by law be disclosed to the client
(iii) Recommendations made by the adviser that address
client needs in the four main areas (refer slide 3)
Asset protection
• Protection of assets will include checking that
the client has:
1. adequate general/life insurance cover
2. secure custody of assets
3. mechanisms in place for asset protection in the
event of family breakdown
4. business breakdown/succession contingencies
in place (if applicable)
5. risk-mitigation measures in place against their
investment exposures (especially in retirement
phase).
Wealth creation
• The principal wealth creation (investment)
strategies are (not in order):
1. Superannuation
2. Gearing
3. Equities and bonds
4. Investment in the family home
5. Investment in your own business
6. Salary packaging
• See Modigliani’s ‘Life Cycle Hypothesis’ in the topic
reading, to understand the Personal Wealth Cycle
Investor Life Cycle
Figure 3 Typical growth of investor wealth over investor’s life. The MVE strategy
(which we will discuss in the course) aims to flatten out the downswing near the peak,
so that there is very little diminution of assets during retirement.
Retirement planning
• Will cover in Topic 6
• Initial focus is on financial aspects
– e.g. estimated size of lump sum, debts,
dependants, home ownership, other assets, etc.
• Financial products will be recommended
– Annuities, Allocated Pensions, age pension?
• Other information is to be gathered to “know
your client”
– Insurance, health, retirement activities and
objectives, etc.
Estate planning
• Will cover in Topic 9
• Estate planning involves orderly tax-effective
disposal of your assets. This may be during your
life or after you die.
• The main issue being addresses is how do you go
about the allocation of your estate?
– assumes there is a bequest motive
• Assets may be disposed of via wills, of course
• However, we will see that a SMSF provides the
best vehicle for estate planning (i.e. for assets
that can be held within an SMSF, so restricted).
Estate planning
• We will also consider:
– Requirements for a valid will
– Intestacy and its consequences
– The issue of dependents
> Super dependents
> Tax dependents
– Disposal of assets that are not will assets
> Joint tenancies
> Common tenancies
> Super
> Trust assets
– Business succession planning
FP industry in Australia
• The financial planning industry in Australia has
been plagued for years by the prevalence of poor,
incomplete, inappropriate or incorrect advice
• Australian advisers are not alone in this. The
problem seems endemic to the industry, because
other countries have similar problems.
• In Australia, there are two main reasons why this
has occurred:
1. Inadequate regulation by the Financial Planning
Association (FPA); and
2. The prevalence of commission-based remuneration.
Evidence from ASIC surveys
• ASIC ‘shadow shopping’ surveys of 2003, 2006
and 2012 have demonstrated unequivocally that
Financial Planners are not in general working in
the best interests of their clients.
– Yet they are required to do so by law!
• The 2012 survey assessed many examples of
advice.
– It decided that 64 examples of advice were
‘usable’ under the guidelines of the survey
– This sample comprised advice was given to real
clients over 15 months to April 2012
Evidence from the 2012 survey
• As noted earlier in the lecture, this survey found:
“Of the advice by AFSL representatives where ASIC
judged the advice to clearly lack a reasonable basis, 86%
of consumers were still satisfied with the advice”
• It further found:
– 39% of the advice was not reasonable given the client’s
needs (as required by law);
– 58% of the advice was ‘adequate’;
– only 3% of advice was considered ‘good’; and
– a switch of advisers would have resulted in higher fees
in 62% of cases.
Evidence from the 2006 survey
• A client, “Mary”, was advised to move from her (low fee,
high-performance) industry fund, into a fund that provided
the adviser a commission. The fund had higher fees and
had no better performance than the industry fund.
– (A recent report on performance of Industry Funds
Concluded: “For each $1.00 of fees, Industry funds provide
on average $17.80 per year of earnings, while the average
retail master trust delivered just $6.40”).
• Unreasonable advice was 3-6 times more likely where the
adviser had an actual conflict of interest over
remuneration (e.g. commissions) or recommending
associated products.
• In 46% of cases, advisers failed to give a written SoA
where one was required.
Regulation v over-regulation
• Up to now, a clear picture has been painted as to
why the FP industry requires regulation
• There are stringent rules in relation to entry into the
industry (e.g. AFSL, RG146)
• And there are increasingly stringent rules, many
embodied in legislation, relating to conducting of
the business of giving financial advice
– Headed to eliminating commission structures
• But has the regulation gone too far?
– i.e. is the reaction appropriate?
Regulation v over-regulation
• Under current regulations, an adviser must provide a
written SoA whenever advice is given.
• As you will learn from your assignment, the SoA needs
to contain not only the advice, but also the basis on
which it is given.
• This means inclusion of the client’s personal financial
circumstances, risk profile, objectives and so on, in
addition to the advice given
• But what if a client rings you up and says ‘Should I buy
ANZ shares now, what do you think?’
• see article by Robert Brown in topic notes
Comparison with other countries
• See reading on Moodle
– The aim of this reading is to provide some basis
for comparison of Australia’s Superannuation
Guarantee Scheme (SGS, ‘super’) with pension
arrangements in other countries
– Only a selection of schemes is discussed and
the depth and breadth of discussion varies quite
a bit
– Countries covered: US, UK, Canada, Ireland,
New Zealand, Singapore
Common Themes
• a number of factors apparently common to all or most
pension arrangements emerged.
• In most countries there is generally a basic Social
Security pension available for which all may apply.
This may be means-tested.
• In addition there is a nationally coordinated earnings-
related pension scheme to top-up or replace the basic
scheme.
• This in turn may be replaced by or augmented by a
statutory individual or small group account (similar to
our SMSFs).
Common Themes
• As with SGS the legislation, regulating national
schemes has been continually changed by
incumbent governments so that it is invariably
unnecessarily complicated.
– This is true of both the basic pension and the
private pension schemes.
• While there have been suggestions that a large
number of national schemes could be standardized,
this seems unrealistic. The way tax is levied, the
expectations of different populations and their
governments, the national ethos, etc. would appear
to be too different across nations, so problematic.
A look at pensions plans worldwide
• UNITED STATES. Retirement age is now 65.5 and gradually
increasing. It will become 67 for people born after 1960. The
US government's Social Security pension system faces
long-term financial problems as retirees from the population
boom after World War II use social security benefits and
fewer workers contribute the current plan.
• RUSSIA. Current retirement age is 60 for men, 55 for
women. Many retirees work beyond that to supplement their
pensions, which average the equivalent of about US$80 a
month. Some want the age raised but others say with
Russia's high mortality rates it doesn't make sense.
A look at pensions plans worldwide
• ITALY: The state pension system has helped make Italy
one of the world's most indebted nations. At 15 percent
of gross domestic product, pension spending is among
the highest in Europe. In 2008, the retirement age
changes from 57 to 60 for women, and 65 for men.
• FRANCE: The retirement age is 65 for the private sector,
but varies in the public sector, depending on the
profession. France has €900 billion (US$1.06 trillion) in
pension liabilities to fund in addition to its record levels
of public debt. As from 2010, France would not seem to
have enough workers to fund pensions for its swelling
ranks of retirees.
A look at pensions plans worldwide
• JAPAN: Japan's retirement age is low, with most
companies setting the mandatory age at 60, but the rapid
aging of society is forcing changes. From 2005 to 2015,
the number of Japanese aged 60 or older will increase by
about 7.25 million, while those between the ages of 15
and 29 will decrease by about 3.81 million. This would
mean one in three will be over 60 by 2015. Last year, the
government required companies to gradually raise the
retirement age by 2013.
• GERMANY: The government is considering raising the
retirement age to 67 from 65. Some figures have shown
that of that only two of five people between the ages of 55
and 64 are still in the work force these days.
A look at pensions plans worldwide
• GREECE: The European Union has warned Greece that
five years ago that it would face a problem due to
increased aging of its population. With one of the lowest
birthrates in the EU, its population of 10 million is rapidly
aging. Greece is in dire trouble with unmanageable
Sovereign debt deriving from its unfunded pension
scheme. Under the current system, the basic retirement
age for men is 65 and for women it is 60, but this may be
changed under ‘austerity measures’.
• CHILE: Retirement age is 60 for women, 65 for men. Chile
pioneered the private capitalization system for retirement
that has been in effect since the 1980s amid sporadic
debate, with some saying the system is bound to failure
because many employers are not making the mandatory
contributions to their employees' retirement funds.