How Super is Super?
Superannuation, affectionately referred to as “super” by many Australians, is the compulsory retirement savings plan which was formalized in the early 1990s with the “Superannuation Guarantee”. This made it mandatory for employers to pay a proportion of their employees’ wages into a savings account with specific conditions for release. It was intended to create an income stream in retirement separate to the Aged Pension.
How does it work?
In its current form, the Superannuation Guarantee requires employers to pay a minimum of 9.5% of their employees’ wages into an investment account which is chosen by the employee. Most individuals in Australia can now choose their own Super fund, which makes for fierce competition amongst funds to secure those deposits.
During the course of your life, as you move from job to job, your super moves with you and most of the time you can direct a new employer to pay your super into the same fund that you specified for your last employer. Ideally as you grow older, your super balance grows – both through the contributions made by your employer, and returns from the investment of those contributions – until you retire, and then convert your super into an income stream, which pays you an annual, monthly or fortnightly amount which is tax free.
How long does it last?
The amount of super you have at retirement is usually what determines how long it will last. There is a minimum amount you must withdraw each year, based on your age, once the balance has been converted into an income stream, so each year your balance gets smaller. However, that balance is also still invested and should earn a return based on the performance of the asset classes you’ve invested in.
As you get older the amount you must withdraw increases and it becomes unlikely that your investment returns will outpace your drawdowns. So having a healthy starting balance when you go into retirement is very helpful.
How do I make it grow?
There are two main ways to pump up your super balance. Growth through contributing additional amounts on top of what your employer pays, or growth through investment.
Voluntary contributions to superannuation are made in two ways. They can be added from your pre-tax income, in which case your taxable income is reduced accordingly. Or they can be made from your after tax income. In both cases, the amount you can contribute is capped annually, and in the case of pre-tax contributions, payments made by your employer as part of the super guarantee are included in the capped amount. For pre-tax contributions the cap amount is $25,000 annually (or $75,000 over three years) and for after tax contributions the cap is $100,000 annually (or $300,000 over three years). Your super fund can assist you with calculating how much remains of your cap if you’re ready to make additional contributions.
Unfortunately we can’t control the market and ensure we always get a spectacular investment return, but what we can do is make sure that the fees we are paying to our super fund are reasonable and competitive. Super funds are required to disclose all the fees which they pass on to their customers, and a comparison between them soon shows that these fees range widely. Our net return on investment is calculated as:
Gross Return (%) – Fees (%) = Net Return
A super fund with lower fees means that even if they average the same return as most other funds for the same range of investments, your net return on your super will be higher, and that can make a significant difference in the long term.
The MoneySmart website has a great article on how to choose a super fund, and a calculator which shows the impact of different fees over time.
It is easy to see how superannuation provides a tax effective way for planning for retirement and understanding the basics can really help us take advantage of what it has to offer.
*The information provided in this article is general information only and does not take into account your objectives, financial situation or needs. Before making a financial decision, please assess the appropriateness of the information to your individual circumstances and consider seeking professional advice.