Too good of an opportunity to miss
For many people, superannuation is the only asset they will accumulate for retirement.
For others, it is often ignored because of the view that they can’t touch it or use it until they retire, or have a fear about the complexity of superannuation.
There are two main reasons for making sure superannuation is a key component of your retirement plan:
- The long-term compounding effect of your earnings in a low and concessionally taxed environment will produce a much greater asset value at retirement incomparison to investing outside of superannuation.
- Superannuation provides protection to the assets invested in a superannuation fund, provided contributions have not been made as part of a plan for shifting assets out of the reach of creditors.
There are two types of contributions:
- Concessional contributions – where you get a tax deduction
- Non-concessional contributions – you don’t get a tax deduction
When you make concessional contributions to a superannuation fund, provided the tax rate on the income is more than 15%, you will have a greater amount of capital to invest.
For example, if you have $10,000 of income and are taxed at 38.5%, you will have $6,150 to invest after tax. If you can structure your affairs so you can claim a tax deduction for contributing the same $10,000 to superannuation, you will have no tax to pay on this $10,000, and the super fund will pay tax of 15%, leaving you with $8,500 to invest within super.
Investing $8,500 of capital provides you with a larger asset base than $6,150. If your $8,500 was invested in exactly the same assets within superannuation as the $6,150 was invested outside of super, and made an income return of 4%, the superannuation fund would earn $340 and after tax of 15% would have $289 to reinvest. If the $6,150 was invested outsideof superannuation, and the income returns were taxed at 38.5%, you would have $151 to reinvest.
Over a 10 year period of investing $10,000 of income in superannuation each year as a concessional (tax deductible) contribution versus investing in a tax environment of 38.5% outside of superannuation (assuming 4% income and 5% capital growth), the difference is:
With superannuation $133,003
Outside superannuation $86,760
That’s a 53% better after tax result. But as an average return over 10 years, comparing the benefits of making concessional contributions and not making them, the difference is:
With superannuation 11.98%
Outside superannuation 4.11%
So that means by investing the same amount of income in superannuation in a tax efficient way via concessional (tax deductible) superannuation contributions, instead of investing it outside of superannuation, you will significantly increase the after tax value of this same amount of income invested. This is a result of the compounding effect of a greater amount of capital invested due to tax savings.
You cannot claim a tax deduction on non-concessional contributions, however, if it is appropriate to make these contributions, the long term compounding effect of reinvesting a greater amount of the income earned in superannuation versus outside of superannuation still applies.
Using the same assumptions as above, but investing the same $6,150 both inside and outside superannuation, the results are as follows:
|After tax value after sale in 10 years||Average annual return over 10 years|
As part of your long-term retirement plan, some other key advantages to consider regarding superannuation are:
- When your fund starts paying a pension to you, the tax on earnings in the fund is 0%, which further increases the benefits of compounding higher after tax returns through retirement.
- When you withdraw your funds as a pension after the age of 60 (or if you are eligible, as a lump sum amount), the payments from the fund are tax free. For people born before 1 July 1960, the earliest date they can generally access their super is 55. For those born after 30 June 1964, the age is 60. For birthdays in between 1 July 1960 and 30 June 1964, the access ages will be 56 to 59, depending on the financial year in which they were born.
There is a myth that superannuation returns are poor.
There are really only three types of assets that you invest in:
A superannuation fund generally owns the same assets that you can individually. There are a few more restrictions for Self Managed Superannuation Funds (SMSF) that you should be aware of if you own or intend setting up an SMSF.
The key here is not necessarily the types of assets but the investment strategy and performance of the fund investment manager that impacts on the return. Superannuation is regarded as “set and forget” by most people – meaning money goes into super, you leave it there and hope it will grow and be there for you when you need it. You need to make sure that your superannuation investment strategy is aligned to your overall goals and objectives, and you pay the same attention to it as you do to your other assets.
What type of fund should I invest in?
Most people invest their superannuation in a public offer fund. These are funds that anyone can invest in and are often the recipient of 9% superannuation guarantee contributions. When investing in these funds, investors rarely seek advice to ensure the asset style they are investing meets their objectives. The decision of the investor is usually based on the information provided in the Product Disclosure Statement of the fund, which is rarely read by the investor. As a result, the likelihood that their superannuation asset is invested in line with their ultimate retirement strategy is low. If you use a public offer fund, make sure the assets are invested to align with your goals and objectives.
Some institutions provide more sophisticated superannuation solutions, which enable the assets of the member to be individually owned and managed within their fund. This provides a better solution for tailoring the investment strategy to align with the investors goals. However, in most instances these investments are not actively managed by the advisor. The key is to ensure your superannuation assets are actively managed as an investment, just like any other asset you would own outside of super.
Self Managed Superannuation Funds (SMSF)
A SMSF is controlled by the members. If you invest your superannuation into your SMSF, you make the investment decisions, select the assets and keep control of the decision making. In doing so you have the ability to seek professional advice to assist you with the development of the investment strategy as well as the management of the investment strategy, or you can do it all yourself.
Your SMSF can also own your insurance policies with any insurer, which means that when the policy is paid out, you, your spouse or the people you want to make those decisions under your Estate Plan can control the payment of benefits.
Some other benefits of a SMSF are:
- It can own the assets directly
- It can invest in assets such as direct real property, including your business premises
- It can borrow (there are strict legislative provisions that must be complied with when a fund implements a gearing strategy). Borrowing to purchase an asset in a SMSF, where the fund’s debt is funded via concessional (deductible) contributions and rent, can produce a significantly better after tax return, compared to if the asset was acquired outside of superannuation. The principle here is the same as the compounding effect of investing a greater amount of after tax capital. Current superannuation money can be used as equity in the property asset. Care needs to be taken when developing an investment strategy incorporating borrowings in a SMSF, as the risk of investing via a gearing strategy is greater than investing without gearing.
Superannuation Plan checklist
- By using concessional (tax-deductible) contributions to invest in to superannuation, you retain a greater amount of capital to invest.
- Concessional contributions are taxed at 15% within the fund.
- The earnings in a superannuation fund are taxed at 15%, or 0% when the fund is paying a pension.
- The long term impact of a greater amount of capital invested and the compounding effect of reinvesting returns in a low tax environment has a massive impact on the value of the assets over time.
- SMSF’s enable control over strategies by trustees.
- Your superannuation is just like any other asset. You must be actively involved in it’s performance, and not just ignore it as a “set and forget” strategy.