Superannuation, time + money
Super is your time, your money and your future lifestyle. It is time to give it the respect it deserves.
There truly is something almost magical out there in the world of investing. It’s called compounding interest, and it’s very simple. It’s the combination of time and money, and how they work so well together, when used in the right sequence.
I’m sure you’ve all heard this before, but if you just keep setting aside a portion of your money and keep investing and adding to it, your wealth will grow exponentially over time, without too much thought, hard work, or sacrifice on your behalf.
When it comes to investing time is your friend, and money can be too.
The Australian superannuation system is one of the best retirement savings plans in the world, and it is without a doubt, the most tax effective way to save for your retirement.
Superannuation isn’t a product or a fund, it’s a tax effective environment specifically designed to help you pay for your own retirement.
However, if you’re anything like the majority of people, you may be completely confused or disengaged with your super, it might even be all over the place, accruing fees and getting lost.
Superannuation is likely to be the largest liquid asset you accrue, what other investment strategy starts the day you start work and continues all throughout your working life?
We work on average 40 to 45 years of our life, and the majority of us will look at retiring around 65 to 70- years of age. Then hopefully our retirement will last another 25 years, depending on our health and wellbeing. Our superannuation is set up to pay us throughout our retirement years. Think of it as your very own payroll, where you are in charge of how much you get paid.
What state is your superannuation in?
- Do you know where all your super is?
- Do you know your risk profile and how your super is invested?
- Do you have insurance inside super?
- Do you know whether that is enough insurance and how much you are paying?
- Do you salary sacrifice?
- Will you have enough super to make your retirement a fabulous one?
I’m not expecting you to know the answers, very few people do. I am just trying to get you to think about the importance of superannuation, because that is how you are going to fund your lifestyle in retirement.
You need to take control and get engaged with your super.
The sooner you understand your super, better the outcome. Leaving it on the too hard pile for another year or two is the absolute worst thing you could do.
How much is really enough?
Well that all depends on where you want to live, how you want to live, how much you spend, when you want to retire, whether you are single or in a relationship, and whether you own your home, or continue to rent.
Thankfully there are some helpful guidelines around what constitutes a comfortable retirement in Australia, and the amount you need to have saved in order to pay for it.
According to The Association of Superannuation Funds of Australian Retirement Standard (ASFA) September 2018 suggests that in order to have a comfortable retirement at age 65:
- a single person will need approximately $545,000 in superannuation savings, which will provide a tax free income of $43,200 per annum
- a couple would need $640,000 in superannuation savings to produce a tax free yearly income of $60,843 per annum
The above figures assume an investment rate of 6% in retirement and receipt of the part age pension. It also assumes you own your own home and are relatively healthy.
If you are single and do not own your own home, it’s estimated you would need approximately $940,000 in superannuation savings to cover the cost of continuing to rent throughout retirement, and a couple renting would need about $1,100,000 in superannuation savings.
How am I excepted to know what I am going to need in retirement?
The best place to start is to look at what your current lifestyle is costing you and work back from there. Most people want to maintain their standard of living in retirement, and some like the idea of taking more overseas trips than they could when they were working.
What do you want to do when you retire?
Retiring early – is that even a thing any more?
If you want to retire at 60, a commonly used rule of thumb suggests you will need about 15 times the amount you live on before retirement. e.g. if your current lifestyle is costing you $60,000 per year then you will need approximately $900,000.
If you work until 65, you may only need 13 times expenses, which is approximately $780,000.
How am I supposed to know how much I’m going to need in retirement?
It is estimated that you may need between 75% to 85% of your pre-retirement income to maintain your standard of living in retirement. eg. if your income is $100,000, you may want to live on $75,000 to $85,000 per year when you retire.
And there are others in the industry who believe your savings should be about 10 to 12 times your current income to maintain your lifestyle in retirement.
Will 9.5% of your income get me there?
It depends on your age and income. If you are young on a high income, probably. If you are middle aged and on a low or average income, probably not.
When superannuation was first introduced by Paul Keating in 1992, he suggested a super guarantee contribution percentage of 12%, and expected that people might contribute to their super on top of that amount.
Okay, so how much can I contribute?
The concessional (before tax) contributions cap for superannuation is $25,000 per year for all age groups.
The non-concessional (after-tax) contributions cap for superannuation is $100,000 per year for all age groups.
How much can I salary sacrifice?
From 1 July 2017 you can make concessional contributions up to $25,000 via a salary sacrifice arrangement or via a lump sum payment. If you make a lump sum payment you will need to notify your super fund in writing of the amount you intend to claim as a deduction.
The $25,000 must include your 9.5% super guarantee. Some employers pay more than the 9.5%, so check with your payroll what there are contributing to your super each year.
For example is you make $100,000 and your employer pays 9.5% into your super, then they would be adding $9,500 into your super each year. That means you can add an additional
$15,500 into super to bring your concessional contributions to the maximum of $25,000.
If you exceed your contributions cap of $25,000, you may be liable to pay extra tax, and any excess concessional contributions may count towards your non-concessional contributions cap.
I’ve heard salary sacrifice reduces my tax, how does that work?
The maximum tax paid on concessional contributions paid into super is 15% up to the contribution cap limit of $25,000.
Let’s say you’re on 32% tax bracket, by directing your money into your super before you pay tax on it will save you 17% tax on the amount you contribute into super. Eg. $5,000 in your pay will be taxed at 32% which equals $1,600. If you direct that money into your super instead you will pay 15% contribution tax, or $750. Therefore, you would be saving yourself $850 in tax.
If you are on the 37% tax bracket would see a tax savings of 22%. Eg. $5,000 in your pay will be taxed at 37% which equals $1,850. If you direct that money into your super instead you will pay 15% contribution tax, or $750. Therefore, you would be saving yourself $1,100 in tax.
However, once your combined income and super contributions exceed $250,000 you will pay an additional 15% contribution tax, which means you will pay 30% contribution tax on your super contributions. And you’ll be very close or over your concessional contribution cap of $25,000. Eg. 9.5% of $250,000 is a super guarantee contribution of $23,750.
Pros of salary sacrifice
- It may reduce your income tax payable
- You are investing your money for your future self in the most tax effective investment environment available
- You may be able to retire earlier, or with more money
Cons of salary sacrifice
- It will reduce your immediate cash flow
- You will not be able to access your money until you reach preservation age, which could be anywhere between 55 and 60, depending on your year of birth.
What is happening in Australia today
The Household, Income, and Labour Dynamics in Australia Survey 2017 (HILDA) showed that women retired with an average of $230,901. Men retired with twice as much.
Reasons for the gap include the gender pay gap, taking time off work to look after children, partners and parents, or becoming a single parent. There is even a “baby super debt”, which estimates that taking five years out of the work force in your 30’s can reduce your super balance by $80,000. The same can be said for travelling or working overseas of course.
But let’s put those figures into context. Compulsory superannuation was only introduced in Australia in 1992. Retirees in 2017 have not had the full advantage of saving their entire work life, they were also adversely affected by the Global Financial Crisis.
Time is the magic ingredient when it comes to your eventual financial freedom. That why is always makes sense to put a little extra money away, the younger you start the better.
There is a really simple mathematical rule to remember around compounding interest and that is the Rule of 72. I refer to it all the time to explain compounding interest to clients.
It’s a quick calculation that will give you an idea of how long it will take your money to
double based on a constant rate of return.
For the Rule of 72 to work you need to leave your money invested so the interest earned is continually compounding. This is continually happening in the background for you within your super.
Now of course we all know that your super will never have a constant rate of return, but I’m just trying to illustrate the magic of time where money is concerned.
Here is how compounding interest works in practice. You have $100 invested at 10% per annum interest, so at the end of the first year you have $110, because your $100 has earned you $10 in interest and you’ve added the $10 to your original $100.
The next year you make 10% interest on $110, which is $11. The you add $11 to your $110 and you’ve got $121 invested for the third year, and 10% interest of $121 is $12.10. You see where I am going with this? Because you are adding interest on the base amount each year that you are earning 10% interest on, the rate of growth is exponential.
So back to the rule of 72, here is the calculation.
72 divided by the interest rate = Time it will take for your money to double.
Remember, we are only talking about a constant rate of return which is why this is just a handy guideline.
So, let’s say you are making 7% return
72 divided by 7% return = 10.71. What that means is if your money is constantly making 7% return every year and you keep compounding the interest and keep it invested, your money will double in ten years, or 10.71 years to be precise.
- 72 divided by 8% return = 9 years
- 72 divided by 10% return = 7 years
How much you can afford to put away each year is important, but that number pales in comparison to how much time you have to invest. The sooner you start, the greater the advantage you’ll have.
Have a look at your spending patterns and see where you might be able to change the way you are spending, so you can afford to start salary sacrificing today. Your future self will love you for it, and your present self won’t even notice the difference.
Important Note: Please remember that you need to understand and be comfortable with the fact that whatever money you put into your super will not be accessible until you reach preservation age, which could be anywhere between age 55 and 60, depending on your year of birth. And there is no guarantee these ages won’t increase.
General Advice warning
Information contained in this document is of a general nature only. It does not constitute financial or taxation advice. The information does not take into account your objectives, needs and circumstances. We recommend that you obtain investment and taxation advice specific to your investment objectives, financial situation and particular needs before making any investment decision or acting on any of the information contained in this document. Subject to law, Capstone Financial Planning nor their directors or employees:
- gives any representation or warranty as to the reliability, accuracy or completeness of the information; or
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