I recently had an interesting (and somewhat frustrating) discussion with a financial planner about making extra superannuation contributions. In general, she thought it was a good idea. In general, I was against it. We both agreed that specific situations warranted different approaches, but in my specific case – a mid 30’s woman – she thought extra contributions were wise. I disagreed.
I believe most financial advisors would recommend extra superannuation contributions to minimise tax and boost retirement income. So, what else should you be aware of when making this decision?
Why making extra super contributions can be good
Here are some of the salient points made by the financial planner during our conversation. Her reasons are summarised, of course, and I’ve added my extrapolations.
1. Reduce your tax, increase your total wealth
This was well illustrated by the use of an example of $1,000 of before-tax income:
- If you put it into super, you’ll pay 15% tax (so long as you meet the other conditions). You’re left with $850 in your super fund to be invested.
- If you take it as after-tax income, you’ll be left with whatever your highest tax bracket leaves. For example, if you earn $60,000 a year, your highest bracket is 32.5% plus the 2% Medicare levy. You’ll be left with $655 in your pocket.
Assuming you invest those totals identically, for example, you purchase the same shares, it’s very plain to see that the former – $850 of investment – is better than $655 of investment.
Given the effect of compounding, any additional superannuation you invest at the beginning of a given time period will have an exponential increase at the finish line. In other words, the 26% more in your super versus your hand today can be worth 100%+ more when you’re done (depending on how long you’re investing for).
Earnings on your superannuation are taxed at 15% until you near retirement. This may be less than the tax you pay on earnings on a positively geared investment at your marginal rate, and this also would increase the compounding value.
So, from a purely ‘numbers at retirement’ point of view, extra superannuation contributions are a winner.
2. The rules are getting tougher, so get in soon
The 2016 Budget proposed a drop in the annual contribution limit for most people to $25,000, among other changes. They’re reducing the benefits slowly but surely, and you can be confident that these changes will never go in the opposite direction. So, you best get in quick before the screws tighten.
3. You will need super in your retirement
Around 80% of retirees in Australia need the pension to survive. Even with rent assistance, it’s less than $500 a week – around the Australian poverty line according to ACOSS. That’s not much and it’s probably not going to change dramatically. If anything, the pension is likely to reduce relative to living expenses. You need some form of income outside of the pension to support you. For most people, that will come from superannuation.
4. Take advantage of super management fixed costs
This is particularly true for those with Self-Managed Superannuation Funds (SMSF) – if you’re paying the costs of running your own SMSF, you’ve got some fixed overheads to do so. By putting more cash into super, you’re making the most of those fixed costs.
Why making extra super contributions may not be helpful
There is no question in my mind that the above points are valid and solid reasons to make extra superannuation contributions. But after running some modelling on my own situation, I’ll still avoid making extra super contributions for the following reasons:
1. Freedom to retire early
If you focus your wealth and growth on superannuation, you’ll have a great reservoir of assets to access when you retire… at 67 years of age. If you want to access that money for retirement early, you may pay a penalty in the form of additional tax.
As I write this, I am 33 years old and I can support myself on the passive income from investments I made with after-tax income. If I’d prioritized super over those investments, I’d have to work now. There would be no choice – I’d need the income. So, what’s better for you: having a financial imperative to work now, or being free to choose?
I’ll always take the latter, but I just couldn’t get my points across to the planner. On reflection, it was like I was talking German and she was talking French and we were both puzzled as to why we couldn’t understand each other – at least that’s how I felt.
I now realise that my superannuation strategy is a foreign concept to most people, particularly planners. Their models are based on people working for income in their ‘prime earning years’ – 40’s and 50s – and those models don’t work if your target retirement age is earlier.
The extra tax doesn’t bother me. I think of it as paying a premium for having the freedom to choose.
2. Changing rules
If you are younger than 50, no one can tell you with 100% certainty:
- what the government definition of retirement age will be when you retire, or
- whether any additional taxes will be imposed on your super retrospectively.
Once the after-tax income is in your hand, it’s yours. It can’t be taxed again. Sure, there may be changes to capital gains tax and negative gearing rules – but if you hold on to your assets, you’re only taxed on the yield. If you have a positively geared property, you’re getting an income that replaces your need to work. A sound investment strategy with your after-tax dollars will ensure that any changes to super rules – which are in the hands of our government – do not change your retirement plans and income.
Superannuation fees are a killer. They are literally eating away your growth. For example, if your fund charges 2.5% fees and you only make 5% a year return (which is conceivable for the next ten years), you lose half of your growth. Remember the exponential impact effect? That 2.5% will do much more than halve your final balance over 30 years. It’s a higher rate than income tax in that scenario.
Of course, if you hand over your after-tax money to someone else to invest for you, you’ll be paying a fee there too. Fee reduction is only an advantage if you manage your investments yourself. Also, there are now some great direct-investment superannuation options offered by major funds that have fees as low as 0.1%. That’s hard to beat.
Bringing it all together
The decision whether to make additional super contributions illustrates this perfectly:
There are only two rules: Save and Buy Assets. Everything else is about what you want to do.
You need to decide what you want, and act accordingly. Having all the money in the world in your superannuation account is useless if it doesn’t fit with your plans.
You may be in a completely different circumstance – maybe you’re close to retirement so taking advantage of the reduced tax is a no-brainer. Maybe you just know that you’ll spend any extra money you have rather than save and invest it, regardless of your good intentions. Maybe you don’t feel confident investing yourself and so you’d rather rely on a super fund manager (in which case, have I got the course for you!)
When it comes to planning for retirement and deciding on extra super contributions – it’s 100% about priorities and what you want. So, make an informed choice! Do you make extra superannuation payments? If so, what helped you make the decision. Let us know in the comments below.
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