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How to build a small seed into a “super” investment
For many of us, the topic of this post will be the second biggest investment of our lives. The first, being your home. I am talking about superannuation. But what is superannuation or “super”?
Superannuation is your retirement fund. The little seed that given time and the magic of compound interest will hopefully turn into a massive oak tree that provides you with the retirement you, well …… you probably haven’t even thought of retirement, let alone dreamt of the retirement you’ll have.
It’s not something that should be in the front of your mind either. However, it should be something that you peek at once or twice a year.
The most important step is setting your superannuation (or “super”) correctly in the beginning. Then just let it go until you maybe hit 40. Then it needs some serious attention.
In this post I’ll go through some of the basics of super, why it’s important and some of the things to pay attention to.
If you are aged between 18 and 30, it really is of minor importance (but still requires attention). When you hit retirement and you wish you have more, you’ll kick yourself, but by then it will be too late.
As I said earlier, plant the seed and just let it grow.
Your retirement fund will be a part of your investment portfolio.
Your potential assets at retirement:
- Your home
- A bank account
- Your superannuation fund
- Shares you own.
- An investment property
However, for many retirees, it’s a bank account, a small superannuation fund and maybe they own a home. To get by they live off the Age Pension.
Let me tell you right now, don’t let that happen to you.
So, what is superannuation anyway?
I’ve heard that some believe it’s a bank account that is kept for you until retirement. Your boss puts money aside for you and when you retire you can access it. Or it’s just something you have when you retire.
Superannuation is a special account, with thousands of rules surrounding it, that holds money for your retirement.
Those rules determine how and when money goes into it. They also determine how you can take money out.
Unfortunately, superannuation is a complex area.
“Super” is the general term people use to describe superannuation. However, superannuation is made up of two phases.
The accumulation phase starts when you first earn enough to get super contributions from your employer and lasts until you reach at least 60 years old.
When you retire, you move into pension phase. You live off the money you have in the account.
The accumulation phase is a build up of the funds in your account. The very important part!
The Australian Government created the superannuation system because they know they can’t afford to pay an adequate income to you when you retire. They need you to supply some or all the funds you need in retirement.
Where does the money for superannuation come from?
According to the Australian Tax Office, as of 2021 (rules change all the time!), all employees over the age of 18 are eligible to receive super from their employer. You may be a full-time, part-time or casual worker.
Employees under 18 are treated differently. As an employee, you are eligible to receive super if you work more than 30 hours a week, or you are paid $450 or more (before tax) in wages or salary in a calendar month.
Make sure you know what you should be receiving.
Money going into your super account is called a contribution.
Contributions from your employer into your super account is called the Superannuation Guarantee. Basically, it’s forced savings.
The superannuation guarantee, or SG, dictates the minimum percentage of your earnings your employer needs to pay into your super fund. This percentage is controlled and legislated by the Australian Government.
The current SG is 10% of your income. The rate of SG is planned to increase over the next few years to 12%.
If your salary is $50,000 before tax (see chart below), your employer will pay an extra $5,000 into your super account. Your 10% SG. Therefore, your total income is $55,000 ($50,00 take-home, $5,000 SG).
Warning: If you are browsing job ads, the advertised income may include SG or SG is on top of the advertised figure.
For example, the job advertises a total package of $50,000. This will include the 10% SG. Therefore, your actual pay will be $45,455 and your SG will be $4,545.
Another job advertisement will say $50,000 plus SG. Total package will be $55,000.
When you are comparing jobs and salaries or wages be aware of this quirk of the system.
And this is how you superannuation seed begins to grow.
The key point is that your SG is a percentage of your income and not a set amount.
Therefore, the more you earn, the more SG you receive. The successful get wealthier. A salary or $100,000 will provide a SG of $10,000.
This is a limit on how much SG you can receive. But you need to earn well over $200,000 for that to be an issue. Congratulations if you have this problem.
Why is superannuation a good thing?
To encourage people to save for their retirement, the Australian Government places a different rate of tax on superannuation.
Important note:
Your SG contributions (from your employer) are taxed as it is treated as income.
The current tax rate is 15% on the SG contributions.
This is great for everyone except those who earn under $18,200. Under this level of income, you don’t pay any income tax. It will probably be taken out of your pay, but you’ll get it back when you do your tax return.
Tax on $50,000 is $6,887.
Tax on $55,000 is $9,287. (Assuming you took the full $55,000 and no SG)
A difference of $2,400.
However, the tax on your SG of $5,000 is only $750.
Overall, you pay $1,650 less in tax.
Your SG is taxed at a lower rate than your take-home pay.
Even better is that the investment earnings on your super account are taxed at 15% instead of your marginal tax rate as it would be if you held the investment in your name (i.e., outside super).
Even better still, as of 2021, when you retire after the age of 60, all investment earnings and capital gains are tax free.
Just think, if you invest well and your super account has made capital gains of $1,000,000, when you move into the pension phase you pay no tax on the gain or the earnings.
Talk about incentive.
However, what will happen over the next 30-40 years until your retirement is anyone’s guess. The rules change all the time, so no one knows what it will look like when you retire. Unfortunately, there is nothing you can do about the changes. All you can do is try to take advantage of the rules of the day.
But what IS your super account?
So far, we now know that
- Superannuation is a forced (not necessarily a bad thing) savings account for retirement.
- When you earn an income, your employer (in most circumstances) will pay an extra 10% of your income into your super account.
- The government then takes their cut (15%).
Once your money enters your superannuation account it is invested.
Just to make sure that this is clear.
Your money is invested. I reiterate the point because I know there are people out there that did not know this.
When you filled in forms with your employer to commence a new superannuation fund, you were most likely given an option to select what investments you wanted.
If you did not select an option, you will be put in a default fund. These days this is called MySuper (e.g., MySuper Balanced Fund). It won’t always be clearly defined in such a way but generally each super provider will have a MySuper investment option. These options are usually lower in fees and diversified across a range of asset classes.
If you think back, no one asked you to fill in a risk profile or even told you what you would be investing in. And I bet you didn’t even ask. In the early days, I didn’t either. There’s no shame in that.
Below is an example of the type of asset classes you’ll be invested in. Some we discussed last post, others are a little more specialised.
This fund is called a Balanced fund for this superannuation provider. The definition of “balanced” differs throughout the industry. Some see it as 50% growth assets and 50% defensive assets. That makes sense.
Let’s add up the growth component of this fund.
- Australian shares
- International shares
- Private equity
- Listed property
- Direct property
- Infrastructure
Total growth is 77.5%.
You can usually find this information by digging around on the providers website or you can look at a document called a Product Disclosure Statement.
Often, the name of an investment option is a marketing gimmick and is not a true indication of what you are invested in.
This is an example of a High Growth Fund. 91% Growth.
You don’t actually own the assets in your superannuation account like you would if you personally purchased the shares or direct property. The superannuation fund owns these investments for your benefit.
Therefore, the only decision you need to make is what investment option is most suitable for you and your circumstances.
This is not advice as I don’t know your particular situation, however, the longer your investment timeframe (30-40 years) the more aggressive you can afford to be with your asset allocation. This means more growth assets in your portfolio, if not 100% growth assets. You have time to ride out the ups and downs of the investment markets.
However, this all comes down to your appetite for risk.
Superannuation providers
The “everyday” name for a superannuation provider is super fund.
First of all, who is your super with? You should look that up.
In the early days of your work life, you may have worked different jobs in different industries. Maybe a hospitality job while at university or in addition to an apprenticeship.
If you were not aware of your super fund, chances are the employer opened a new account for you. Some employers will only make SG contributions into a particular fund.
As a result, you may have more than one super fund. Having 3, 4 or 5 super accounts is not uncommon.
This is not a good scenario.
Why?
Fees. The operators of super funds charge fees to manage your money. Some more than others.
If you have multiple super funds, you are paying more fees than you need to.
What you can do is, “rollover” your other super funds into your preferred super fund. This will consolidate your retirement funds into your preferred account, making your retirement funds easier to manage.
Warning: Pay attention to whether you have insurance in these funds and whether you wish to retain the insurance. You may have been provided default insurance when you first joined the super fund. Check your annual statement, the super fund website or app, or call them to see if you have insurance.
Types of super funds
Most super funds fall into one of the following categories:
- Retail
- Industry
- Public sector
- Corporate
Retail Super funds:
Usually run by banks or investment companies and are open to anyone. They have a wide range of investment options and charge higher fees as these companies usually answer to shareholders of the company. Often, many of these funds require you to be with a financial adviser to open the fund.
Industry Super Funds:
Anyone can join the bigger industry funds. Specialist funds may only be open to people working in a certain industry, for example, healthcare workers. These are not-for-profit funds and are run solely for the benefits of the members (account holders) of the super funds. No shareholders to answer to. As a result, fees are often lower than compared to retail funds.
Public Sector Super Funds:
Public sector funds are for government employees.
Corporate Super Funds:
A corporate fund is arranged by an employer, usually a large company, for their employees. The employer may use an industry or retail fund so fees may vary.
How do you find these super funds?
https://www.ratecity.com.au/superannuation/companies
https://moneysmart.gov.au/how-super-works/mysuper-funds-list
https://www.ato.gov.au/YourSuper-Comparison-Tool/#results
https://www.canstar.com.au/providers/superannuation/
If any of these links no longer work, search “list of super funds Australia”.
Overall, industry funds tend to have lower fees, however, they often have far fewer investment choices and poorer reporting capabilities.
Some industry funds have a special section, that costs extra, that provides access to ASX 300 companies or Exchange Traded Funds. Like a retail fund.
Some funds offer a lifecycle investment strategy option. This means that the risk profile of your investment will automatically become more defensive as you get older.
It all depends on the level of involvement you want with your super. I highly recommend at least a minimum awareness of the following:
- How many funds you have. Subject to retaining insurance, ideally you should have one fund.
- The ratio of growth to defensive assets (E.g., 85% growth, 15% defensive)
- Are you happy with this?
- Fees
- Long-term performance (7 years plus)
For most of you I recommend keeping it simple and pick a fund that invests across a range of different asset classes which aligns with your appetite for risk (some will add up the growth assets for you as it can be hard to tell which of the investments are growth assets).
All about fees
As you have professionals managing your money, it is only fair that they charge for their efforts.
However, the more they charge, the less you have in retirement. The difference between total fees of 1.0% vs 1.5% may not look much, but over a lifetime with the effect of compounding, the results can mean tens of thousands of dollars at retirement.
As fees are charged on a percentage basis, the higher the balance of your account, the higher the fees you pay.
This is why controlling fees is important.
Do you want the money in your account or theirs?
Of course, fees should not be the only consideration:
- Long-term performance of the investment options
- Features of your super fund
- Some have a great web-based experience, others poor.
- Level of reporting you want.
- Range of investment options. Ethical options?
The more features a super fund offers the more expensive it will be.
Typical super fund fees:
- Administration fees – The fees to run your account.
- Investment fees – This may cover fees paid to investment managers and amounts paid to external parties, such as brokers and government authorities. These may also include transactional and operational costs.
- Performance fees – Some super funds charge a separate performance fee once certain targets have been exceeded.
- Investment switching fees – For example, if you change investments from the Balanced option to the High Growth option, you may be charged a fee to implement the change.
- Buy/Sell spread – When you make contributions, withdrawals or switch your investment options, you are buying or selling investment units. The buy/sell spread is the fee charged to process the purchase or sale of the units in the investment.
The product disclosure statement or the fees guide will (as required by law) outline all the fees that are payable to manage your money.
As a part of my job as a paraplanner (technical support to the financial adviser), fees are a significant focus when comparing funds. If we recommend moving to a fund with higher fees, we must strongly justify why we have made that recommendation. Usually, we move clients to cheaper super funds. Unfortunately, this requires specialist software not available to most people.
On large super balances, I’ve seen savings of over $7,000 per year. A medium balance saving could be around $2,000 per year.
Unfortunately, it does place a lot of importance on getting it right at the beginning (or at least within the first 10 years). Just at the time you care the least!
As a guide – anything over 1% in total fees (administration plus investment fees) should be seriously scrutinised and more suitable options researched.
All of this can be very daunting in the beginning.
Having read a few product disclosure statements in my time, one, they are boring and two, I believe they are deliberately created to be confusing. Industry fund product disclosure statements are simpler. Retail funds can be far more complex.
But with anything, you just have to start.
Read through the product disclosure statement of your super fund. Call them up if you need to. It’s your money and your super provider should never take that for granted.
Plus, it’s a lot easier to move super funds these days.
It’s not everything but performance matters
The common disclaimer is that past performance is no guarantee of future performance.
This is very true. The best performing managed fund one year often ends up on the bottom of the heap the next. That’s why you should never chase performance.
However, long-term performance, I believe (remember I am not an adviser or investment professional), is a useful indicator of future performance.
The MySuper Comparison Tool from the Australian Tax Office is a useful start. It compares all the MySuper options from most super funds.
https://www.ato.gov.au/YourSuper-Comparison-Tool/#results
The list of funds can be arranged in order of 6-year returns. It’s not perfect, but a good start.
It can help you avoid the poorly performing funds.
Anyway, if a fund has had strong returns for 7+ years, to me, it’s a good indicator of their ability to invest. As long as they regularly remain near the top of the list, I’m happy.
Other ways to get money into superannuation
This gets a bit heavy, but I’ll keep it brief.
Apart from the SG, these concepts are of little benefit to those in their 20’s and 30’s. Your main focus for your money will be in other areas of life. However, many people DO NOT have enough money for their retirement so your super account should be taken seriously. Your comfortable retirement depends on it.
There are two main ways to get money into super:
- Before tax, and
- After tax
Before tax contributions are called Concessional contributions and include:
- An employee’s Superannuation Guarantee. What your employer pays into your super account.
- Salary Sacrifice. This is when you voluntarily reduce your take home pay by a certain amount and that amount is contributed into super. The benefit is that the amount contributed into super is taxed at 15% instead of your marginal tax rate (for example, 32.5%).
- Personal Deductible Contributions. If you are self-employed this area is of interest for you. Many business owners neglect their own super. By making a contribution into super, you can claim a tax deduction of the amount contributed. The contribution is taxed at 15%, but that should be better than your marginal tax rate.
The current (2021) limit on concessional (before-tax) contributions is $27,500 per year.
This may be increased by using the carry-forward unused concessional contributions rule (this may be of benefit for your parents).
After tax contributions are called Non-concessional contributions.
- You can transfer money from your bank account into your super account. As you have already paid income tax on the cash in your bank account, this goes into your super account tax-free.
The current limit on non-concessional (after-tax) contributions is $110,000 per year. Although there is a $330,000 bring-forward rule (this may be of benefit for your parents).
Why are there limits on how much you can put into super?
As much as the government want you to pay for your own retirement, they don’t want to be taken advantage of. Before they tightened up the rules around money going into super, wealthy people put millions of dollars into super.
So?
Remember that earnings and capital gains in super are taxed at 15%. A wealthy person’s tax rate is most likely 45%. In pension mode, earnings and capital gains are tax free. A massive bonus for the already successful.
The Wrap
Key points
- For many, super will be your second biggest investment. For some, their biggest.
- Superannuation is a forced savings account for retirement for employees. Self-employed need to look after their own super contributions.
- When you earn an income, your employer (in most circumstances) will pay an extra 10% of your income into your super account.
- The government then takes their cut (15%) on before-tax (concessional) contributions.
- Your money is invested across different asset classes.
- Is your money invested in the way you want (your risk profile)?
- You pay fees to have your money managed professionally.
- Be careful of high fees. Anything over 1% in total fees is considered expensive. Early on in your super journey fees don’t matter too much as you have a small balance in the account. But always be aware of the costs.
- Long-term performance should be noted. Never chase short-term success (1 year returns).
- Did you get default insurance when you joined the super fund?
- Read your annual statements.
- Dig around on their website to look at the super fund’s investment options, fees, etc.
Discuss super with your parents. How engaged are they with their super accounts? If they have no idea about it, talk to someone that does (financial adviser) or do your own research. Your future depends on it!
Up next …..
The investment universe (for beginners) – Shares
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