What Is An Effective Way To Save For Retirement?

Superannuation is one of the most tax effective ways to save for retirement. The generous tax concessions applied to superannuation, coupled with regular contributions, can lead to long-term financial independence and day-to-day peace of mind when you retire.

Growing your superannuation

For most people, your employer pays a regular amount into a superannuation account on your behalf. This is called the ‘superannuation guarantee’. You can also grow your superannuation by making extra contributions. Over your working life, your superannuation benefits from compounding returns. This is where investment returns are generated on the returns you’ve already earned. Making extra contributions makes the most of this snowballing effect. There are two contribution types:

• Concessional contributions – using money that is yet to be taxed such as your salary, or

• Non-concessional contributions – using money that has already been taxed such as savings in the bank. There are caps on the amount of contributions you can make each financial year. Be sure to monitor your contributions and the annual caps that change each year to avoid paying extra tax. For more information, visit www.ato.gov.au and search’ Contribution caps’. You can also refer to ‘What are the limits on superannuation contributions?’ fact sheet or speak to your financial adviser.

Why superannuation is a tax-effective way of investing

To illustrate the tax effective nature of superannuation, compare:

• Using an effective salary sacrifice arrangement with your employer to forego $10,000 of your pre-tax salary. This amount is automatically added to superannuation as a concessional contribution, or

• Investing $10,000 of your salary after it is paid by your employer.

By investing in superannuation, you are $2,400 better off as the net amount invested is $8,500 in comparison to $6,100. Additionally, future earnings inside superannuation are taxed at only 15%. If your marginal tax rate is 39% (including Medicare Levy), this means investing in superannuation leaves you 24% better off and you can take advantage of compounding returns.

Extra savings for retirees

Where a member over age 60 has rolled their superannuation to commence a pension, earnings of the product are generally not taxed, withdrawals and pension payments are tax-free. As the earnings of these products are not subject to tax, there is a cap on how much you can have in this type of product at any time. Currently, the cap (known as the general transfer balance cap) is $1.7 million (this figure can vary based on your personal circumstances).

Managing your superannuation

How your superannuation grows also depends on your choice of superannuation fund and how it is invested. There are many different types of superannuation funds. Understanding what makes up each of these categories can help you find a fund that best suits you. Some of the most common are summarised in the following table.

Most superannuation funds will allow you to select how your money is invested and will usually offer a selection of investments based on Australian and International Shares, Property and or Fixed Interest. As different asset classes offer different levels of risk, it’s important to choose wisely and get advice to help you determine what is right for you.

Accessing your superannuation

You cannot access your superannuation until you satisfy a condition of release. The most common conditions of release are where you:

• Have reached your preservation age and retired,

• Ceased an employment arrangement on or after the age of 60, and

• Attain 65 years of age (even if you are still working).

To determine your preservation age based on date of birth, see

below:

.

There are also special circumstances where at least a part of your superannuation can be released before reaching preservation age. These include permanent or temporary incapacity, severe financial hardship and compassionate grounds to name a few. For more information, visit www.ato.gov.au and search ‘Condition of release’.

Benefits and risks of investing in superannuation

Superannuation offers a range of benefits as outlined below:

• Reducing your income tax – with a salary sacrifice agreement with your employer, your contribution is taxed at 15% instead of the marginal tax rate you’d normally pay based on your salary. You may also be able to claim a tax deduction for other contributions you make.

• Reduced tax on investment earnings – when you invest outside of superannuation, any income earnt is taxed at your marginal tax rate. Within superannuation, the

investment earnings on your accumulated superannuation is generally taxed at a lower rate of 15%.

• Diversification – superannuation is usually invested in a broad range of investment assets (property, bonds, cash etc), meaning it is generally well diversified and has less risk than shares alone.

• Cheaper insurance cover – as superannuation funds can negotiate group discounts on insurance premiums, they can pass these savings onto members. While the cover offered by superannuation funds is generally basic in nature, it can be cost effective in comparison to insurance owned outside of superannuation. Another advantage to having insurance inside superannuation is that premiums are automatically deducted from your superannuation and not payable from your cashflow directly.

• Protecting your assets from bankruptcy – if your superannuation is held in a regulated fund, bankruptcy will not impact your retirement savings. Money withdrawn from your superannuation after bankruptcy could be protected also. Any funds that are withdrawn from your superannuation prior to bankruptcy are an asset of the bankrupt estate.

• Tax-free income when you retire – if you satisfy a condition of release after turning age 60, you can typically access your superannuation without paying tax.

• Beneficial social security assessment – if you are in receipt of an income support payment from Centrelink or Department of Veteran’s Affairs (DVA), superannuation in accumulation phase is not counted under the income and assets test until you are Age Pension age.

Access the Government co-contribution – if you’re a low to middle income earner and you make non-concessional contributions, you can boost your superannuation with a government co-contribution.

For more details, visit www.ato.gov.au and search ‘Government co-contribution’.

• Simple ongoing management – it can be managed with minimal or no effort from you as your superannuation fund manages the investments within superannuation on your behalf, depending on your fund type.

However, these benefits need to be considered alongside the following risks:

• Fund performance– How your superannuation fund performs relies on the expertise of those employed to manage the fund. While superannuation funds endeavour to

maximise returns for members in line with stipulated investment guidelines, there is a risk that investment managers may underperform the market.

• Fees – Being with a superannuation fund that charges high fees can lead to your superannuation balance being eroded. It’s important to regularly review the fees charged by your superannuation fund to determine whether it is remains competitive in comparison to other funds in the market.

• Liquidity – your superannuation can only be accessed after a condition of release is met. If you contribute to superannuation and later change your mind, you may not be able to access these amounts.

• Contribution caps – there is a limit on the amount of contributions you can make each year. Exceeding these caps can generate extra tax.

• Cap on tax-free earnings – if you satisfy a condition of release after turning age 60, you can typically access your superannuation without paying tax. At this time, you can rollover your superannuation to commence a pension. This is known as the ‘retirement phase’ of superannuation. As the earnings of these products are not subject to tax, there is a cap on how much you can have in the ‘retirement phase’ of superannuation at any time. Currently, the cap is $1.7 million.

• Balance erosion from insurance premiums – if you purchase insurance insider superannuation, your retirement savings can erode over time. The cover will automatically lapse if the balance of your account is insufficient to cover premiums.

Other strategies to grow your superannuation Claiming a tax deduction for personal contributions to superannuation:

For similar benefits to salary sacrifice, you may be able to claim a tax deduction for contributions you make to superannuation. This reduces your taxable income and you only pay tax at 15 percent on the contribution, potentially increasing the amount that you have available to invest.

The low-income superannuation tax offset: For low income earners, the low-income superannuation tax offset (LISTO) may refund the 15 percent superannuation contribution tax. You must have an adjusted taxable income of less than $37,000 p.a. to qualify. The maximum LISTO paid is $500, equal to 15 percent of concessional contributions up to $3,333. LISTO is paid into your superannuation account. For more information, visit www.ato.gov.au and search 'lowincome

superannuation tax offset’.

The Government co-contribution If you are a low to middle income earner and you make a personal after-tax contribution to superannuation you may be eligible for a Government co-contribution. The maximum Government co-contribution is $500, payable at a rate of 50 cents for every $1 of eligible contributions that you make.

The co-contribution reduces by 3.333 cents for every dollar that your adjusted taxable income exceeds $42,016, with no co-contribution payable when your income reaches $57,016. Spouse contributions to superannuation If you make after-tax superannuation contributions on behalf of a low-income earning spouse, you may be eligible for a tax offset up to $540. This is an 18% offset on the first $3,000 of contributions. To qualify, your spouse needs to earn less than $40,000. This reduces your tax payable. For more information, visit www.ato.gov.au and search 'Spouse tax offset.'

Split contributions to a spouse

Contribution splitting to a spouse is a long-term strategy to even out the superannuation balances between spouses, which may help to maximise the combined total of superannuation savings that can be transferred to retirement phase income streams in the future. For more information you can also refer to 'What is contribution splitting' fact sheet.

Downsizer contributions

If you are age 60 or over, you are able to contribute up to $300,000 of the sale proceeds of your principal residence without meeting an age or work test. FSpeak to your financial adviser about the other conditions that apply to be able to use these strategies to maximise your superannuation.

Superannuation Pros:

• Reduce your income tax

• Reduce tax on investment earnings

• Diversification

• Can offer cheaper insurance

• Protect your assets in bankruptcy

• Generate tax-free income when you retire

• Beneficial social security assessment

• Access to Government co-contribution

• Simple ongoing management

Superannuation Cons:

• Relies on long term fund performance

• Fees apply and vary depending on the fund

• Cannot be accessed until a condition of release is met

• There are limits on contributions, the total amount of

superannuation you can have and the total amount of

‘retirement phase’ pensions

• Rules are complex and subject to change

Financial advice

Contact Matthews Steer's Private Wealth team today to get on top of your finances. Book a consultation today on 03 9325 6300.