The first thing to understand about investing in super is that super is really just a structuring entity, not an asset class in itself.
In a technical sense, super is a Trust that holds investments on your behalf. Those investments are generally managed funds. This means that investing in super comes with the advantages and disadvantages of managed funds, which we have discussed more in this article.
However, what makes the superannuation system special is that your superfund has been blessed with some pretty damn good tax concessions:
The income earned in super is taxed at 15% for most Australians that are still working. This makes super one of the biggest tax concessions going around.
If you are lucky enough to earn over $250,000 per year, then your concessional contributions are taxed at 30%. Still a better deal than paying tax of 47% in your own name.
If you are over 60 when you take the money out, super withdrawals are generally tax free (though there are exceptions).
Not a bad deal, but it comes with a massive downside. And that’s that you can’t access your super whenever you want. Your money in super is tied up until you meet a condition of release. For most people, this practically means you are at least 60 years of age.
Although we have discussed the problems with regards to managed fund investing in earlier posts, I can tolerate investing in managed funds through super for two reasons.
Firstly, the tax concessions make super an attractive proposition, and secondly, there is not a lot of choice to avoid managed fund investing through super. Yes, we could all do Self-Managed Super Funds. But they come with their own challenges these days as well.
How to supercharge your wealth:
As a tax professional, somedays it feels that tax minimisation is a national sport.
Rarely does a day go by where I’m not asked about some new ‘scheme’ that someone heard about at the BBQ, wanting to know if it will work for them.
It’s funny to me that those same people rarely take advantage of one of the biggest tax concessions going around - contributing money to super.
In Australia, there is nowhere else currently available that can limit your tax on your investment earnings to 15%.
And it gets better from here - if you are retired and have commenced an account based pension, the income on your earnings are tax free.
For most people, the main objection to putting money into super falls into one of the following categories:
I won’t be able to access it until I’m too old to enjoy it, or
The government will probably change the rules to make super less beneficial in the future
Both objections have an element of truth. But let’s look at the advantages.
Advantage 1: Glorious tax savings
As mentioned initially, a superfund pays tax of 15% on its investment earnings, and tax of 0% in retirement if the member has commenced an account based pension.
These tax savings are significantly better than all but those earning less than $18,200 a year, as individuals earning less than $18,200 per year pay no tax personally.
But it gets better from here.
In Australia, franking credits received are refundable if not utilised to reduce your tax payable.
Let’s say two taxpayers hold an identical investment, but one holds the investment in their own name and the other holds the investment in their superannuation fund. They both earn $10,000 a year from their investment.
As a high earning individual, they pay tax at 47%, instead of 15% their superannuation fund does.
| Individual | Superfund |
Franked dividend received | $7,000 | $7,000 |
Franking credits received | $3,000 | $3,000 |
Income to declare | $10,000 | $10,000 |
| | |
Tax rate | 47% | 15% |
| | |
Tax Payable | $4,700 | $1,500 |
Less: Franking credits | $3,000 | $3,000 |
Tax payable / (refundable) | $1,700 | ($1,500) |
In this case here, just by changing the structure of where the investments are held, a tax saving of $3,200 per year is achievable.
And that’s just on $10,000 of income.
Imagine the savings if the fund was earning much more, and then extrapolate that for the number of years until you retire.
Advantage 2: Contributions made to your superfund may be tax deductible
For most people under the age of 67, they may be entitled to claim a tax deduction for contributions made to super (noting however that this is a complex area, and professional advice is recommended).
Depending on your tax rate, the tax savings are hard to dismiss.
Income | Individual tax rate | Superfund tax rate | Tax saving |
0 - $18,200 | 0% | 15% | -15% |
$18,201-$45,000 | 19% | 15% | 4% |
$45,001-$120,000 | 32.5% | 15% | 17.5% |
$120,001-$180,000 | 39% | 15% | 24% |
$180,001-$250,000 | 47% | 15% | 32% |
$250,000 and above | 47% | 30% | 17% |
It’s hard to think of an investment that yields a better return straight off the bat.
Just by utilising a legal tax saving strategy, you can make your savings go up to 32% further just by investing within super.
Like most things in the personal finance realm, and especially within the tax world, there is an element of complexity that I am going to broadly touch on with super. When making contributions to super, a few things to keep in mind are as follows:
Deductible (concessional) super contributions are generally limited to $27,500 per person per year, but you need to remember to reduce this amount by any compulsory super already paid by your employer. After all, if there wasn’t a limit on how much you could put into super, there would be someone out there that would salary sacrifice their whole income and pay no tax!
Further, you may be able to take advantage of the current unused catch up super rules that are in place. This is complex so be careful and seek advice.
Super contributions can’t be used to reduce your income past $0 into a tax loss. Many people wouldn’t normally use super to reduce their income into the tax free threshold territory either, as the tax payable on the super contributions of 15% exceeds the tax saved in this case (i.e. no tax saving as income is already tax free if your taxable income is below $18,200).
When you make a contribution to super that you wish to claim as a tax deduction, you need to provide your superfund with a Notice of Intent to claim a deduction for personal superannuation contributions. It sounds complex but most funds will have standard paperwork (most will allow you to do it online). Your fund will then provide you with an acknowledgement of notice to claim a deduction for personal superannuation contributions, and once received, you’re good to go. Note there a timing limits (plus other limits) regarding when the paperwork needs to be prepared by, so be careful here.
For those earnings over $250,000 a year, your super contributions will be taxed at 30%. The ATO uses an adjusted taxable income plus concessional super contributions formula to work out if your income is over $250,000 per annum.
Given the complexity, professional advice is always recommended.
Advantage 3: Returns compound in a lower tax environment
When you contribute to super, those contributions are deployed into investments in accordance with your designated risk profile.
That means for most people, a proportion of their funds will be invested in the stock market, which as we know, has historically given the best returns.
Why is this important?
Because when you invest, you receive investment returns, and those investment returns need to be declared as income. That income is then taxed, and, as your superfund earnings are generally taxed at only 15%, less of your investment returns are eaten up in tax, which means you have more assets that can be deployed to grow your investment returns.
Let’s use an example of someone that has invested $50,000 in their own name, versus someone who was able to accumulate $50,000 in super. This individual earns around $80,000 a year, so they are paying tax at 39% instead of 15% in their superannuation fund. We are assuming a 4% gross dividend yield in this example, and assuming a 30 year time horizon.
Investment return comparison | Individual | Superfund |
Dividend income | $2,000 | $2,000 |
Tax rate | 34.5% | 15% |
Tax payable | $690 | $300 |
After tax return | $1,310 | $1,700 |
The extra $390 that the superfund receives by way of paying less tax is then reinvested in your superfund, which then compounds to grow your savings even more over the next 30 years.
This ability to compound your investment returns, leads to come pretty amazing growth over the long-term.
The table below shows the extrapolation of your initial $50,000 investment, comparing the total investment size when invested through super versus in your own name.
In this example, I have assumed the initial balance plus any reinvested returns grow at an average rate of 4% per annum.
Year | Superfund | Own name |
0 | $50,000 | $50,000 |
1 | $52,300 | $51,910 |
5 | $62,608 | $60,308 |
10 | $78,395 | $72,741 |
15 | $98,162 | $87,738 |
20 | $122,915 | $105,826 |
25 | $153,908 | $127,643 |
30 | $192,717 | $153,957 |
By making one decision, to invest in an optimised investment structure, and doing nothing else for the next 30 years, you can potentially save $38,760.
Now imagine the impact if you kept investing in super for the rest of your life.
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