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.