The Sexiest Money Topic: Part Two (Must Read for 25-60 year olds)
The investment that is Superannuation is probably the biggest investment you will have your whole life, other than your house. Therefore, it is really important to get it right, especially from a young age!
Within this article, it will be explained why investing in Super can be tax efficient for you, how contributions to superannuation works and I will run through a few hypotheticals that will hopefully make it easier for you to understand.
First and foremost, let’s run through how and why Superannuation is so tax efficient if you were wanting to invest in Super.
Have you ever thought about investing money in the Sharemarket? Well, what if I told you that you were already investing in the markets, you are already investing in real estate, you are already investing in term deposits and bonds. All these instruments that can help you gain wealth, but you probably have no idea what that all means. Which is ok, there is nothing really wrong with that, all you need to know is that your Superannuation fund manager is taking 10.5% of your income every year and investing it based on the investment mix you have chosen or they have. (Check out my part one blog here to learn more.)
Now you know that you are already investing, why invest in super, rather than in the Sharemarket? Put simply, investing in superannuation is more tax efficient.
The government has made it more tax efficient, so that people truly save for their retirement, as the social welfare system is the biggest government expenditure there is, therefore super was created to take the pressure off of the government budget. Hence, you will find that what you invest in super is only taxed at 15% (As long as your fund is compliant), rather than your marginal tax rate.
What does this mean?
If you earn $100,000, you get $10,500 in superannuation guarantee from your employer, which goes straight to your super fund. The tax rate on a $100,000 per annum income is 32.5% of every dollar over $45,000, which is 17.5% more than the 15% of income earned in superannuation.
If you were to invest $10,500 every year in the sharemarket, instead of super, any income earned from your shares in your portfolio (basket of companies) would be taxed at a higher rate. Let’s say your income from your portfolio is $500 per year, $162.5 of that would be taxed, whereas in your super fund, only $75 would be taxed.
That means investing in your superannuation fund means that you will actually save $87.5. Now as your investments increase, of course that figure would increase significantly as well.
There are many other ways in which your super fund can help you to minimise tax, one way is using concessional contributions.
Understanding how contributions to super works can be tricky, as there are so many laws and regulations, however you need to know the basics so you can utilise the system to your advantage, to set you up completely for when you retire.
So, what are the different types of contributions?
We have two main ways you can contribute to your super, outside of your employer transferring your super guarantee to your fund. You can do concessional contributions and non-concessional contributions to your superfund at any time.
Essentially, concessional contributions are when you can contribute up to $27,500 per year, which can be claimed as a tax deduction from your income. Now, your super guarantee is already included within this $27,500 figure, therefore, as long as you do not claim over this cap, you can reduce your income and therefore reduce your tax.
Using the $100,000 example again, of which $10,500 is already contributed through your employer. Therefore, you can contribute up to $17,000 more into your super, and when you submit an intention to claim from your super fund, you can reduce your income and therefore reduce your tax. (Do not forget that what you contribute to super, you will most likely not see until you retire.)
Your income has gone from $100,000 to 83,000, by claiming the contribution and therefore, you would be saving $5,865.
(after tax savings outside super: $24,967-$19,102 = $5865) [1]
Not to mention, the $17,000 is only taxed at 15%, which means your superannuation would be taxed $2,550 from the $17,000 contributed over the year, but that still means that you would be making an overall saving of $3,315 for the entire year (inclusive of super tax).
Now, there are also non-concessional contributions, whereby you are not claiming the contributions for tax purposes, however you are just looking to invest within super. The contributions are after tax, therefore, they have already been taxed and will not be taxed again within your superfund, other than on the income your contributions make.
All income from your investments, again, is only taxed at 15%, which I explained above, so we won’t go there again. But just to solidify why investing in super is better than outside of it, let’s run through some scenario’s together, a few hypotheticals so you can truly understand it.
We will run some scenarios for a 25 year old, a 45 year old and a 60 year old, to hopefully give everyone some great context on the tax efficiencies and how the contributions work for you!
25 year old, a comparison of investing outside of Super v.s investing in Super?
Let’s look at a new scenario and a new person, we will name her Sally, and Sally earns $65,000 per annum as an employee. Which means her Super Guarantee, of which her employer pays to her superfund is $6,825 per year.
Now Sally lives at home and doesn’t actually have many expenses, she socialises with friends, has a boyfriend and they are saving for a house currently. (Potentially could look at the First Home Super Saver Scheme, I would talk to an advisor about this before doing so though.)
Sally has $10,000 she would like to invest, but she is unsure of where to put the money. (The $10,000 is not apart of her house deposit that she is saving with her boyfriend currently, she wants to invest it for longer term savings.)
Sally is tossing up on whether to invest the $10,000 into an index fund or to contribute to her super. Let’s say for an example, the index fund has a 30 year average return of 7% per annum and her super fund has returns of 7.8% per annum, but fees of 0.8%, making the real returns exactly the same as the index fund.
Sally wants to invest the $10,000 for 30 years.
Option 1) Sally Invests into the index fund
Over 30 years, thanks to the beauty of compound interest, her return will be $66,123, minus any costs for buying the units in the fund. Giving her a total of $76,123 at the end of 30 years.
However, all the income she receives year after year is taxed at her marginal tax rate. Let’s just say she receives $300 per year from her investment, to make it super simple. $97.5 of the $300 is taxed every year, meaning that she gets taxed $2,925.
Now, I have tried to make this super simple to understand, as it can get really complicated when adding in income every year to add on top of returns. So lets just see what the total return would be if we add the $202.5 of income after tax to her returns outside of super.
Sally is sitting at a total return of $95,204.
Option 2) Sally invests in her superannuation
Now, we have already done the math, the only difference is Sally gets taxed at 15% within her super on any income, rather than the 32.5% through the marginal tax rate.
So only $45 of the $300 is taxed, now lets see how big of a difference that makes over 30 years…
Sally would have a total of $100,210 within her super fund, meaning she would have saved on tax and made returns because of it. Of course, the figures are well and truly off when it comes to the earnings, you would see the increase in income each year make a much bigger difference over 30 years. But I wanted to show you using nice simple numbers.
45 year old, coming up to retirement and unsure of how much you may need for retirement? Let’s dig in to what you should be aiming for…
First and foremost, how much do you need to retire, the numbers are all over the shop, but according to two main associations, you would need roughly $70,000 by age 67 years for couples and singles to live a modest lifestyle. Based on couples having living expenses of $39,788 per year or singles having living expenses of $27,754 per year. [2]
Of course, if you would like to live a very comfortable lifestyle, you would need $640,000 for couples and $545,000 for singles, according to the Association of Super Funds Australia. Which is a major difference from the $70,000 you need for a modest life.
The Super Consumers Australia have a bit of a different amount, whereby to live comfortably, you only need $62,000 per year in expenses for a couple. Which means you only need to save $409,000 for a couple to live fairly well, if aged 57 or below. [3]
Of course, these numbers do change yearly, therefore it pays to seek out advice where you can to make certain that you have a solid plan for retirement and everything will be fine.
60 year old, retiring in the next year to five years, what are the ways in which you can contribute to top up your super?
There are few ways in which you can truly top up your super before you retire, to make sure that you have more than enough to get you through the next 20-30, maybe even 40 years!
One of those ways is using the bring forward rules, whereby you can bring forward up to five years of concessional contributions or up to three years worth of non-concessional contributions.
The bring forward rules are complex in nature and I would truly suggest that you talk to a professional financial adviser about these rules and how you can top up your super before retirement.
Another way is the down-sizer contribution, whereby you can use the sale proceeds of a house to top up your superannuation as well. [4]
Again, before deciding to go down this track, I would highly suggest talking to an advisor before doing anything.
And finally, you can also complete co-contributions to a spouse, whereby you can contribute to your partner, who may have less super and this could make you eligible for some tax offsets.
I did not want to go into too much detail, as the closer you get to retirement, the more important it is to see a Financial Advisor and truly get a good grasp on your financial future as you move into the unknown that is retirement.
Due to regulations and laws are always changing, I would highly advise anyone to make sure they speak to a professional first before making any decisions or actions. Hence, I always suggest that you should always look out for a trusted Financial Advisor who can create a sound financial plan for your future, and for the future of your family. Someone who can be in your corner when deciding on the big decisions in life, such as marriage, kids, first home, second home, retiring etc.
I truly hope this has helped you to understand super a little bit more and why it is so much advantageous to invest in super that outside of it, when looking at tax.
For the third and final part to our superannuation blog, the next article is going to be on Self-Managed Super funds and a few more scenarios to help you truly wrap it all and understand Superannuation.
Until next time,
Take Back Control
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[1] - https://www.ato.gov.au/rates/individual-income-tax-rates/
[2] - https://www.superannuation.asn.au/resources/retirement-standard
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