Illegal early access: Finding a practical solution

The problem of illegal early access to retirement savings via SMSFs has the potential to paint a target on the sector that will attract undeserved attention. Currently, few are willing to blame it for the actions of those on the fringes and selfmanagedsuper senior journalist Jason Spits writes now is the time to get on the front foot to tackle the problem.

At this year’s SMSF Association National Conference, ATO superannuation and employer obligations deputy commissioner Emma Rosenzweig released the latest set of figures gathered by the regulator in relation to the problem of illegal early access of super involving the sector.

The numbers are not inconsequential, with the regulator estimating $251.1 million left the super system via illegal early access in the 2022 financial year and a further $231.7 million was accessed through loans to members from an SMSF.

During the same event last year, Rosenzweig revealed for the 2021 financial year, $256 million had been accessed illegally, while prohibited loans for the same period totalled $200 million, although 75 per cent of those were repaid. Further, she noted $381 million had been exited illegitimately in the 2020 income year.

These figures would have been higher had it not been for the ATO’s proactive new registrant program, which started in 2019 and prevented a further $295 million illegally exiting the super system during the 2020 and 2021 financial years.

The regulator indicated in late 2023 it would be releasing these estimates as part of a new emphasis on the problem of illegal early access, stating at the time this form of release was the leading area of concern in its oversight of the SMSF sector and the number of funds at risk of breaching access rules was growing.

ATO SMSF risk and safety assistant commissioner Justin Micale said at that time: “When someone does something wrong with their SMSF, it invariably involves them accessing some or all their retirement savings before meeting a condition of release.

“Far too regularly, we identify new trustees who enter the system with the sole intent of taking all their retirement savings before they’re entitled to.”

Yet it is not a recent phenomenon. Past selfmanagedsuper coverage of this issue shows it has been an ongoing problem for many years.

For example, in 2019, the ATO prevented $125 million from exiting super via SMSFs, as well as halting the movement of $126 million in 2020 and $170 million in 2021.

From this ATO data it is clear an alarming trend has emerged and is being perpetuated. As such, the regulator’s concerns are shared by the SMSF sector, which does not want to see it painted with a broad brush for the failings of a few.

Defining the issue

Heffron managing director Meg Heffron says there needs to be a clear definition of what is illegal early access as there are other events and triggers that also result in money leaving the super system early via an SMSF.

“There is a tendency to lump illegal early access into one basket when there are actually four issues taking place. The first is scams where dodgy people use SMSFs to steal super. They can’t steal someone’s house, but they can get them to access their retirement savings,” Heffron notes.

“The second is ill-advised products with conflicts of interest that should not exist but use SMSFs as a vehicle. The third is dishonest people who know they can use their fund for illegal access and the last is people who engage in it accidentally.

“The ATO’s estimates exclude scams because they are theft and not illegal early access, as well as product failure because the underlying assets are still in the system but may have just been reduced to zero. Its focus is on dishonest and accidental access and the solutions for these problems differ.”

SMSF Association head of policy and advocacy Tracey Scotchbrook suggests further context should be overlaid on illegal early access breaches given the ATO has routinely stated around 97 per cent of funds are compliant each year.

“We don’t have much visibility of how much of illegal early access is dishonest, but we suspect most of it is inadvertent and stems from not understanding the rules or the individuals involved have been given some misinformation they have acted on,” Scotchbrook points out.

“The biggest problem is the lack of access individuals have to advice. We are hearing of people with concerns around the lack of service or want more transparency around how their retirement savings are being invested than they are getting from their APRA (Australian Prudential Regulation Authority)regulated fund. Some establish an SMSF with a false confidence.

“It’s a classic case of people not knowing what they don’t know and so they set up an SMSF not thinking they need advice.

“Alongside this there seems to be a cottage industry emerging that is specifically targeting SMSFs in order to sell their financial products and they are separate issues, but causing a similar problem.”

Low barriers to exit

Despite the sophistication and complexity of SMSFs, the barriers to entry are at the same level as those with regard to retirement savings withdrawals, notes Super Sphere director Belinda Aisbett.

“SMSFs present an easier target compared to APRA-regulated funds and with an SMSF the only obstacle for a trustee or a promoter is their ethics or conscience because the trustees control the purse strings,” Aisbett explains, adding this is why loans are part of the wider illegal early access picture.

“We saw loans to members used to prop up a business when interest rates went up. Was there mischief? Yes, because it was a prohibited loan even though it was paid back and there were no dishonest intentions.

“There are deliberate loans as well we have seen in the past where the money is used for personal needs and promoters are successful because the trustees see the SMSF balance as ‘my money’.”

Heffron observes this mindset may have been lurking in the background, but the release of superannuation money for hardship purposes during the COVID-19 pandemic brought it to the fore, where it still remains for some people.

“Perhaps the release of super during COVID-19 created a germ of an idea that people can access their super early. Did it shift their mindset enough that they now see SMSFs as a way to access their savings in this manner?” she asks.

“If you look at some of the reasons for people accessing their super on compassionate grounds, some are absolutely genuine, but in others you could argue it is illegal early access by another name. You can also access super to buy a first residence, but it is very hard to do if you are at risk of losing your home.

“Are our policy settings on this part of super wrong and you have to question whether they dangle a carrot in front of people.”

Raising the bar

If the low barrier to exit is an issue, should there be more hurdles for trustees to jump over or should some form of mandatory advice be inserted into any process where money is leaving a fund?

ASF Audits head of education Shelley Banton says changing the dynamics of the control trustees have over their SMSFs may be a “throwing the baby out with the bathwater” solution that could create more problems.

“SMSFs are a tool and any regulated environment will always attract elements of nefarious behaviour. We know there are two types of intentional behaviour with illegal early access: people who are strapped for cash and wanting money to improve their lifestyle and dishonest people are helping individuals go through the wrong door,” Banton suggests.

“In trying to stop this with more regulation there is the danger for people who are doing the right thing under the superannuation laws being prevented from acting in a particular way.”

According to Banton, the ATO already emphasises the obligation of trustees to obey the law, but she questions whether adding education courses or requirements to seek advice when setting up an SMSF would prevent illegal early access.

“These things are doable, but would the ATO be risk-rating those who provide the advice? What about SMSF trustees who don’t want or need advice and what additional time would these measures add to the establishment process?” she says.

“Advisers are already complaining that it can take up to 56 days to have an SMSF registered on Super Fund Lookup and as auditors we know illegal early access happens after the set-up is complete.”

Pushing the responsibility to prevent illegal early access onto advisers may go some way to dealing with it, Scotchbrook notes, but they already operate under a strict code of ethics.

“Financial advisers have already got a code of ethics enshrined in law where they have obligations to a client to make sure they meet a legislative best interest duty, but also an ethical best interest duty. There are obligations to make sure any strategy or advice they are giving is appropriate to clients and they understand it,” she says.

“Tax agents are also in the front line and have a great level of responsibility with clients. They can state while they can’t provide advice, they could perhaps refuse to establish a fund where it’s not appropriate and make the clients aware of their obligations.”

Heffron says if the problem occurs under the trustee’s watch, then instead of more education about what their obligations are, they should be made very aware of what happens to those who succumb to non-compliant behaviour.

“Communicating all the negative consequences to trustees when they set up a fund would have an impact. One of the things we do is slow down trustees during the application process so we have an opportunity to give the information that if they take money out illegally, they will be found, and severely punished,” she reveals.

“Slowing the process down and making sure clients get that message, if done well and consistently, will have an impact in weeding out the people who are inclined to be dishonest.

“It won’t stop the people who are really committed to taking their money out illegally, but it might also educate the people who may do it accidentally.”

A talking point at the industry body’s conference was the fact illegal early access is not just an SMSF issue, but a wider financial services problem and APRA-regulated funds, with their scale and reach, should also be working to prevent the early exit of money from superannuation.

“APRA-regulated funds can educate members about promoters working to get people to roll out to an SMSF to engage in early access,” Aisbett acknowledges.

“People targeted by promoters are usually not on the ATO website checking for alerts and education by large funds may give them a reason to pause and question why they have been approached by these people.”

The structure is not the problem

While it might sound strange asking APRA-regulated funds to join in an awareness program for an issue predominantly affecting SMSFs, a good reason for their involvement is the prevention of high member balance leakage.

Scotchbrook believes the superannuation sector is aware of the dangers of illegal early access and the ATO is conducting in-depth reviews of every new fund and its trustees before approving its establishment. Work is also being undertaken by the Australian Banking Association to identify and prevent fraudulent transactions involving superannuation.

Banton points out these collective actions push back against the view SMSFs are inherently risky and recognise illegal early access is a whole-of-industry issue.

“If you flip the argument over, we have recently seen some APRA-regulated funds in trouble for not paying death benefits, but no one is saying they are all doing that and there is a widespread problem. The same can be said about SMSFs because the ATO has told us most do the right thing,” she highlights.

“Everyone wants to see this behaviour stamped out, but it is not reflective of the SMSF landscape.”

This fact was confirmed by Australian Financial Complaints Authority investment and advice senior ombudsman Alexandra Sidoti during a recent member forum.

“The problem we’re really seeing is the intersection between the use of SMSFs to get people in superannuation funds invested in a conflicted product of the financial firm,” Sidoti said.

“What we’re seeing here is advice models where they recommend people establish an SMSF so that those superannuation monies become available for investment in their conflicted in-house products.”

Heffron agrees while illegal early access may not be the fault of the SMSFs, it is still a sector problem and there is a need to acknowledge the risk that comes when trustees and members control their own superannuation fund.

“While we are not responsible for it, we need to care about it and do everything we can to work with other parts of the industry now to solve the problem,” she recommends.

“As such, we should be the cheerleaders for better control of dodgy products which exploit SMSFs and we should be supportive of the ATO slowing down the process of setting up a new fund because it is using that time to weed out people who are establishing it for the wrong reasons.

“While we may hate it personally in our businesses, we should be the cheerleaders for that type of preventative action.”