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Free Advice on Australian Superannuation

November 23, 2014

Being a new paralegal at the office and having a part time job means that money rolls in. Which is nice.

Its also a big incentive to make sure that you’ve got all your financial gears in order. I’ll be making posts about financial matters for the coming week. The basic core rules you should know (remember the value of common advice) , compounding returns, and some more complex topics like arbitrage I’ll be covering. And no, I’m not talking about the movie. I’ll be focusing on Australian financial rules, but other readers should benefit as well.

But all that can theoretically wait when you start out. Superannuation can’t. You make $450 before tax a month or more, and you’ve got to have super. Now, thanks to recent reforms, you can get a fairly decent default super account – MySuper. Recent changes to superannuation in bringing about this is very good for the uneducated layman. But even within this, there are 2 investment (I) options (you probably want lifecycle options) , and that can make a massive difference.

The superannuation industry in Australia was worth $1.85 trillion at the end of the June quarter this year. That’s bigger than Australia’s GDP.

For you, superannuation is 9.5% of your income (Y). Its projected to rise as a % of Y over time as well. And this is assuming you don’t make any personal contributions to super, which you might want to do for retirement.

But do you need to know about super?

YES!

“A 1% difference in fees now could make up to a 20% difference to your retirement investment in 30 years, so it’s worth thinking about.” – Supersavvy

If you’re an 18 year old, we’re talking 50 years here – an even bigger difference! 0.99**50 (ie. 0.99 to the power of 50) = 0.605 .

That means a 1% difference in fees for 50 could reduce YOUR savings by nearly 40% for retirement. Thats the power of compound interest.

A 2% difference in fees is even greater. 0.98**30 = 0.545 . 0.98**50 = 0.364. What does that mean? You get 2% difference in fees over 30 years and you lose 44.5% of your retirement savings. Over 50 years you lose 63.6% of your savings.

Wait… did you just lose the MAJORITY of your retirement savings because some adviser took a large commission?

Yes, you did. Sadly, many Australians are uneducated about superannuation. And I don’t blame them. Even a former treasurer Peter Costello says he finds it difficult to understand. But you must understand. Superannuation is the most important investment you will ever make in your life, perhaps aside from your home. And, because of the power of compound interest, you need to understand now.  If I could find some of the articles I’ve read…

Superannuation is a bloody big topic. Getting through this in one post will be tough. I’m going to mostly restrict advice to young, or low Y earners so we can get through this quickly. If you’re one of those people, listen up, and do your homework. The stuff I’m talking about is worth hundreds if not thousands of dollars to your hip pocket.

Government Co-Contribution

Did you know that if you put an after tax of $1000 into your super by the end of the financial year that you could get $500 put into your super by the government if you are a low Y earner? Don’t believe me, here’s the Australian Taxation Office! Okay, its a once time thing (you can only put 1 lot of $1000 in each financial year) , but if you do it 6 years running… thats $3000 in your superannuation. Right there. Okay, this maximum benefit requires you to earn about $34000 or less. But if you’re a university student, chances are you aren’t working full time. Also, you can still get a smaller co-contribution up to about $45000 (see the ATO).

Considering that superannuation is 9.5% of Y, putting in $1000 after tax is a big contribution. For instance, I’m (very, very provisionally) projecting that such a contribution could eat up over 10% of my Y for the 2014-15 financial year. When you factor in other costs like board at home, it’d rise to abut 20% disposable Y for the 2014-15 financial year. But, you get a 50% rate of return, guaranteed! Where else can you get a guaranteed 50% return!? And its good to save early, too. That $1500 (your 1000, their 500), assuming a conservative 7% p.a rate of return over 50 years against a 3% p.a inflation rate gives a real return – in today’s dollars – of $37609 . That’s the $1500’s returns over just one year.

In short, apart from the value of compound interest, make sure to take advantage of the government co-contribution.

Low Income Super Contribution

Not surprisingly, this is for low Y earners… Simply put:

  • As a low Y earner, the Low Income Super Contribution applies. ($37000 taxable Y cap)
  • You get 15% of your employer’s contributions to super added to your super automatically by the government (15% on 10%, or, 15% on 9.5% of Y; that is, super becomes 10.45% of Y)
  • In place till 2016-17 (the LISC is under debate currently)

What About Salary Sacrificing?

If you read a bit about super or just about finance in general in the papers, you’ve probably heard of ‘salary sacrificing’ and wondered what it meant. Basically, it just means your employer agrees to reduce your salary, yet pays the amount of the reduction into super. The ATO recognises this, and, critically, this reduces your taxable income.

Now, super contributions are taxed at a maximum rate or 15%, so its actually not a good idea for very low Y earners to salary sacrifice because they are either in the tax free threshold or in the $18201-$37000 tax bracket wherein salary sacrificing has a major impact on cash flow (the 4c on the dollar you ‘save’ gets locked away, and you’re going to make ends meet; its not worth it really) . So, this is a trick for high Y earners.

Let me be clear. Salary sacrificing and superannuation ‘concessions’ are one of the biggest jokes that exist in the Australian taxation system. You in the highest tax bracket paying 45c on the dollar? Don’t worry – you can pay 15c instead if you put it into super! You can pay a lower marginal tax rate than a person earning $19000 while earning over $180000 because you won’t get hurt by the impacts on cash flow! Oh, and by the way, in case you hadn’t guessed, these ‘concessions’ greatly increase income inequality! Did I mention that superannuation concessions cost the government $35 billion a year in lost tax revenue? Did I mention that within just 5 years these concessions will cost the government more than the pension? (Wait… isn’t the aging population meant to be ‘unsustainable’?)

Enough ranting. Look, if you’re earning a decent amount of Y, salary sacrificing is a good idea. It forces you to save into super, which is good for retirement, and it can greatly reduce your tax. Even when earning, say, $45000, you’re paying 32.5c on the dollar. With salary sacrificing you more than halve your tax burden, and this reaps major benefits – see an ATO example. Also, remember that these benefits compound. Just be wary of impacts on your cash flow. The savings are real and they compound to massive savings, but you’re throwing away the key till you’re 65. Make sure you don’t need the money to live off.

Advice on Choosing a Super Fund

All the above points is rather simple, and could be found out (as I have these past few days) with research vis-a-vis the ATO. However, choosing a super fund is, for such an important area, very hard to find good advice for. Let me take that back – you can find advice, what you can’t find are brilliant comparisons between funds even on super comparison websites (at least… free ones) . In fact, just this morning I spent hours trying to assess different funds I was choosing between. Its complex, and frankly, MySuper is quite a decent option, so if you want to save yourself the hassle, go ahead. But if you want to maximise those compounding returns, listen up.

How does age change things?

Memorise this: When young, you want a ‘high growth’ investment portfolio. When older, you want a conservative I portfolio consisting of cash, fixed interest returns etc.

Why? When you’re young you shouldn’t be concerned about loss in your portfolio – you have decades to rebound. The stockmarket goes up and down, and you can afford to ride them out. Accordingly, you want high risk stocks. Many go bust, but those that succeed increase exponentially. But if you’re 60, you shouldn’t be concerned about growth so much. Okay, its nice to have a good rate of return, but you don’t want your portfolio collapsing and making retirement impossible. You want to be defended from swings.

Memorise this: When young, you want to avoid all fees and insurance. That changes as you age.

Why? Lets assume, as commonly holds, that when young you’re a low Y earner. Many fees will be fixed, say $1.30 a week for administration (eg. Legalsuper). What this means is that as a low Y earner this fixed fee is a much higher proportion of your Y than later in life when you have a larger income or larger investment portfolio. The larger your portfolio, the more you should be concerned with the % of your portfolio that is being siphoned off in ‘management’ fees or ‘investment fees’.  When young or on a low Y, however, if you’re only getting $100 super a month, you don’t want a high weekly fee! You’ll lose all your savings!

On insurance, let me tell you a tale. My friend did some work for a company for 2 weeks last year. He had his super set-up, and just accepted the default option the company gave him. The company default was set on ‘continual insurance’ or something like that for 2 policies. My friend discovered recently that he was paying something like $10/month on insurance when he hardly had $100 in his account. He basically lost all his money. In short, you don’t really need insurance when young. The only exception to this – and go consult an actual adviser / do more research as I am – would be if getting insurance early helped your ‘insurance record’ or something similar… like how you build up a solid credit rating early. You want insurance when older, however.

Types of Funds

Okay, you know what sort of growth portfolio you want, and that you really want to avoid fees and commissions. But… thats not that much help. Super companies are trying to claim they are the best, not point out how the competition is better. So, some further information.

  • Types of super
    • Retail funds
      • Mostly mid to high fees; try to make profits; financial advisers make commissions; hundreds of options; accumulation funds; big focus on selling advice etc. CBA scandal etc.
    • Industry funds
      • Generally low-mid costs; some higher. Not for profit – that is, profits put back into fund for members benefit. Accumulation funds; 5-15 options; some offer MySuper. Generally cheaper insurance cover than retail funds.
    • My Super
      • Lower fees (+ restrictions on fees that can be charged), simple features, limited investment options.

Memorise this: Go for MySuper or Industry super funds; avoid retail funds!!

Seriously, retail funds are out to make a profit. And I heard there was some problems at the Commonwealth Bank.

How Much for Retirement?

Okay… this is a massive topic, and I don’t want to address this in depth. In short, it depends on your lifestyle desires and many other factors. MoneySmart (part of ASIC) recommends (in my summarised form):

About 67% of one’s annual salary is the Y people need generally.

One other sources says that to get this, 7 times the annual salary should be in super by retirement. Note: The pension is only about 25% average weekly earnings.

You should consult a financial planner on making any of these decisions though. The point of this article is to get you on a good start to superannuation and your saving. Because of the extraordinary power of compound returns, the good work is done early. Salary sacrifice, make that co-contribution. Save more money (though, maybe not for super – that’s a locked key) for yourself. You can retire comfortably. Just start early.

Conclusions

I’ve given you a short overview on just a few ideas about superannuation. Please, do some research. Visit the ATO, MoneySmart (part of ASIC), read personal finance flogs a few times etc. I’ll be doing more articles on finance later this week. Right now, use the information here to help yourself.

Look, life isn’t about money. Nor should it be. Values, principles, experiences, friends – those are more important. Money is but a means to an end. But, it is a rather important means. If you don’t manage your money, you’ll have debt, stress, and less time for what matters, and your retirement may be dimmed in its glory. Recognise that money is a part of life. Learn the rules about growing wealth. Automate them. Then you can forget about them. Then, you can focus on what matters, without money obscuring your view.

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