Superannuation is too costly, so bill me

Superannuation: you give, they take. Paul Kelly/Flickr, CC BY-NC

The main reason superannuation costs are too high in Australia is both simple and horrendously complex: it’s the only service we buy where we give the service provider our money to look after.

It’s true that we also give our money to banks, but mostly, especially when we’re young, the banks give us money as loans.

The fact that super funds, and the investment managers and wealth advisers who run them, hold our money for us allows them to simply take some of it every month as their fee.

Everyone else has to send us a bill.

This might sound too obvious to even bother mentioning, but that system has two very powerful hidden effects:

  1. The providers of investment services get to charge a percentage of the money, and almost nobody understands percentages and even fewer understand the power of compounding;

  2. Since the fee is usually a fixed percentage of the client’s account balance, it increases at the same rate as the balance, which is in turn being fed by the sum of investment returns and all contributions – mandatory and voluntary.

Compounding fees

As a result, super and investment fees compound at several times the rate of inflation but the customers barely see what’s happening, and those that do, don’t understand it.

Say you’re 25, earning $50,000 and you start with $1000 balance in super. And say the fee is 1% (actually by the time you add in advice and investment management it’s probably more like 2%, but let’s stick with 1% for simplicity).

That 1% produces a $10 fee. In the following 12 months you contribute 9% of your salary, or $375 per month. On top of that the fund manages a return of 10% on the average balance.

At the end of the year your balance will be $5950 – marvellous. New fee: $59.50 – a six-fold increase.

Next year you got a pay rise of 5%, which means your contributions increase to $393.75 per month, or $4725. Once again the fund earns you 10%, so at the end of the year your new balance is $11,506. New fee: $115.06 – nearly twice last year’s fee.

Obviously that escalation in fees is dramatic because the balance started from a low base. That means, by the way, that people with low balances who are just starting out are subsidised by those with more money in their accounts, and that’s the best thing about the percentage fee system.

So let’s look at the same metrics for someone more established in the workforce, with $100,000 in super and a salary of $100,000 a year.

First year fee is $1,000 (1% of $100,000). Next year, assuming 9% of salary in contributions and a 10% return on the average balance, the fee is $1,194.50 – an increase of 19.45%.

Next year’s fee, assuming a 5% salary increase and another 10% investment return, is $1336.25, 12% more than last year. And the year after you get a promotion! Salary goes to $120,000 and contributions to $10,800 for the year. Your new super balance is a very healthy $158,270. New fee: $1582.70 – an 18% increase over last year.

And yet we comply…

Do you ring and complain about being gouged? Well, no, because the fee is still 1% – it hasn’t changed. And you’re feeling good about the rising balance, so why complain? And anyway, you probably don’t even know. The fee statement is there somewhere, but you never pay much attention to it.

There are two things to think about here. First, your salary is increasing by 5% so it’s a fair bet that the super fund’s staff are also getting the same sort of pay rises, possibly less.

Yet the fees are increasing at 2-3 times that rate because the law requires us to contribute 9% of salary and because investment returns usually average about three times the inflation rate as well, simply as a result of the rising stockmarket (not the super fund’s brilliance). That’s the whole point of investing in shares – they return 2-3 times inflation over time.

Second, with $150,000 in super you’re probably paying 2% in management and adviser fees (not 1%), which is $3000 a year, or $250 a month. Some people have account balances of $500,000, especially when they retire, and pay fees of $10,000 a year, or $833 a month.

Think about how many services you pay $800 a month for, month after month, year after year, or even $250 a month for that matter.

What can be done?

Super funds hate this description, but superannuation is a utility, like gas, electricity or the phone; in fact it’s more so - a government-mandated utility.

What’s more you don’t get much for the money – basically super funds put the money into large companies and ride the market up and down. This year’s winner is next year’s loser, and vice versa, and there’s no way of telling the difference between them.

Yet not only is it almost certainly the most expensive service you buy, the cost of it compounds at several times the inflation rate every year and the providers don’t have to send you a bill like the other utilities – they just quietly take some of your money each month.

And remember that the prices charged by gas, electricity and communications companies are regulated by the ACCC, which actually determines what return on capital they’re allowed to make. Super fees are not regulated at all.

So to control the ballooning cost of super, three things should happen:

  • super funds and their advisers must be told to stop skimming the accounts for their fees, and to send a bill instead that we have to actually pay

  • the costs of compliance and regulation need to be brought down, which the government is trying to do

  • the fees that super funds charge, and the profits they make, should be regulated, just as other utilities are regulated.

On second thoughts, perhaps only the first of those would be needed.

If we started getting a bill for $500 a month from our super fund, the price would quickly come down because customers wouldn’t pay it … especially when the share market was falling and along with it all the account balances.

Yes, stop making the super funds disclose the fees they skim, make them send us a bill instead.