Your Superannuation Plan

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Superannuation is the vehicle by which all Australians can grow their wealth in preparation for retirement. It is generally the most tax effective vehicle in Australia. All income is taxed at 15% when you are in the accumulation phase (ie, pre-retirement) and 0% when you are in the pension phase (ie, retired). The same rules apply for capital gains if you sell an investment, except that if you have held an asset longer than 12 months inside of superannuation, then only a 10% tax bracket applies. Otherwise, it is 15% for less than 12 months if you are in the accumulation phase and 0% if you are in the pension phase.

These low tax brackets are really phenomenal when you think about it. Unless you are not working (at which point you are usually not paying tax, so therefore are in a 0% tax environment), where else can you invest or grow wealth and pay such little tax? Yes, sure, I guess there is always the Cayman Islands or the Bahamas....

The reason the tax payable on superannuation is so low or negligible, is to encourage investors to put money into superannuation. This can be done either via your employer (if you are working or self-employed) or by making extra contributions yourself within the current rules. There are two types of ways to put money into superannuation: (1) concessional (deductible) contributions and (2) non-concessional (non-deductible) contributions. More on this later...

Superannuation is usually held first via an industry or retail fund (ie, Australian Super, Hostplus, REST, Colonial First State etc) and eventually individuals either decide to keep their superannuation as is, move to a different industry or retail fund, move it to another superannuation structure (ie, an self-managed superannuation fund).

Superannuation can be the most effective way to grow your overall wealth, because of the tax savings you can achieve. However! The trick is that you are not usually allowed to access it until you are close to retirement or retired. There are other ways to access it, but let's keep things straight forward for the moment. As such, the temptation to sell down your investments and spend your superannuation is very difficult and as such, you generally have a longer time frame to accumulate wealth. Which is a good thing! How you go about it is important, and we'll spend some time talking about this shortly.

So! Why should you consider making additional contributions to superannuation?

Because if you are on a tax bracket of 32.5% (hypothetically) and 35 years of age, for ever $1 you earn, almost a third goes to the Australian government. Inside of superannuation however, only 15 cents goes to the Australian government. You can imagine that over time, the compound effect of this stacks up rather fast. And it does, make no mistake about it!

However, coming back to the access point, given the long time to access to superannuation (again, assuming we take 35 years of age as your current age), many people question the benefit of superannuation and don't turn their minds to it until they are in their fifties. Fair enough! Additionally, you have a mortgage to service, a household to run, a car to upgrade, holidays to go on, weddings, kids, education .... and on it goes.

However, be this as it may, keep in mind that when you do retire, your superannuation is meant to support you through your retirement, which could be 20 or 30 years! That is a decent amount of time you need to be supporting yourself through, not to mention the activities you may want to do during retirement (ie, think big holidays for at least the first couple of years of retirement) and increasing healthcare costs that may arise. The decisions you make earlier on have a big impact on your outcomes. So, superannuation is a very important aspect of managing your wealth and it definitely deserves our attention and the sooner you start turing your mind to it, the better.

Parking other aspects of our life that require funding for the moment, let's focus on superannuation for a moment and how to increase your superannuation balance. Coming back to the two types of contributions, you can contribute each year up to $25,000 as a concessional contribution (before-tax) and up to $100,000 as a non-concessional contribution (after-tax). Everything your employer puts into superannuation account for you is before-tax and counts towards your $25,000 annual limit. Have you ever looked at your payslips and worked out what your employer is putting into superannuation for you each year? This is handy information to know, because it then gives you an idea of what you may be able to contribute into superannuation if you want to make a concessional (pre-tax) contribution should you wish to increase your superannuation balance overtime.

Here's a great question. When you think about your current lifestyle, would you miss $68.50 per week? Would you even notice that it wasn't appearing in your bank account? Assuming you are still on the 32.5% tax bracket, that works out to be approximately $100 pre-tax income per week (it's not an exact calculation due to tax bracket tiering, but just go with it for a minute...). So if we look at $100 pre-tax per week, that's $5,200 pre-tax per year that you are reducing from your overall pre-tax income package. 

If you wouldn't notice $68.50 missing per week, by re-directing it to your superannuation account either via salary sacrifice (talk to your employer about this) or by making the contribution at the end of the financal year (ie, before 30 June) and claiming a personal tax deduction, you are effectively increasing your superannuation balance each year by roughly $4,420 (ie, $5,200 minus 15% tax of $780). If $5,200 had gone into your personal name instead, you would be paying 32.5% tax, or $1,690 to the Australian Government and have a net take-home pay of $3,510. This is before you even start investing it and paying more tax on earnings or capital gains! Note that by paying $780 in tax via your superannuation fund rather than $1,690 in tax via your personal name, you are saving $910 in tax which you get to keep instead within your superannuation fund. 

Second to this, given someone aged 35 has potentially 30 or more years until retirement, it is important to have a look at your investment option within superannuation as you can afford to take on more growth given the advantage of time. Do not feel you have to just accept the option provided to you! Have a look at where your superannuation is invested and consider what else your current superannuation provider offers. If you are currently in a balanced option (most people are), have a look at see whether they have a growth or high growth option. Take a look at what each option offers in terms of portfolio weightings (ie. 30% in Australian shares, 20% in International shares and 50% fixed income versus 50% in Australian shares, 30% in International shares and 20% in fixed income) and decide whether you are comfortable changing to a higher growth option. Even if you ultimately decide to stay with your current investment option, being proactive about making that decision is the most important part rather than passively letting someone else decide for you.

Now, the big question we hear all the time is the mortgage versus superannuation question. To be honest, ignoring tax for the moment (as the tax savings add up and are really attractive over time as the above example for superannuation highlights), it really comes down to returns. We'll talk about mortgages and buying properties for personal or investment purposes another time, however when deciding what is the best outcome for you, if your interest rate on your mortgage is higher than the investment return within superannuation or any portfolio for that matter, pay down your mortgage. If your investment returns are higher within superannuation, consider a small contribution to superannuation and pay down a smaller amount of your mortgage. You can do both!