Super savings

Superannuation is not the most exciting investment structure you could name, but it remains the most effective tax environment in which to save for your retirement; and it has the law on its side.

Since compulsory superannuation was introduced by the Keating government in 1992, the pool of Aussie superannuation funds has grown to $1.2 trillion, largely on the back of what they call the Superannuation Guarantee: that is, the guarantee that employers must pay at least 9% of your wages or salary into a complying super fund. And it is currently proposed that the rate be increased to 12%.

This is the most important part of super – that it is compulsory. You have to be a part of it, whether you like it or not.

It has become an article of faith in all political parties that Australians – and the Commonwealth Treasury – would be better off with a population of self-funded retirees than with millions of aged pensioners.

And with this background, successive governments have attempted to tweak the relevant law to make superannuation as attractive as possible.

For a start, the Superannuation Industry (Supervision) Act allows for contributions into a super fund to be taxed at the low rate of 15%.

In normal circumstances, if you invested in shares or a managed fund, your investment dollars would be after-tax. That is, you’ll be investing with what was left over after the ATO had taken the 25% or 30%.

So your money is already going further by investing it via a superannuation structure.

The second big advantage is what happens to your funds while they are in a superannuation fund. As your capital produces income, that income is taxed at only 15%. Capital gains inside super are also taxed at 15% unless the asset has been held for more than 12 months, in which case the tax is 10%.

In the normal course of events, your capital gains on, for instance, shares, are taxed at your top marginal rate. That is, you would normally be taxed as if those capital gains were extra income on top of what you earn as wages or salary. Note that should you hold shares for more than 12 months, the rate of capital gains tax is halved.

This is particularly powerful when you consider the compound effect – the growth produced by interest earning interest, pushed along by regular contributions. When it’s being taxed at a low rate, it has the chance to produce compound growth.

The law also allows you to enjoy the benefits of franked credits on shares in your fund – in this system, the company you’re invested in passes on some of its tax credits to the shareholders, and you enjoy reduced taxes because tax has already been paid by the company before distributing the dividend.

It’s another way to boost income from the super fund.

Of course, capital gains tax is halved once you have owned an asset in your own name outside super for 12 months or more. But this is more than balanced by the reduction in capital gains tax within your super fund: once you have owned the shares within the super vehicle for more than 12 months, your tax rate on that capital gain drops to 10%.

You should also not forget the arrangement you can make for insurances via your superannuation fund. Through super, you can hold life and TPD (total and permanent disability) insurance, with the premiums paid from the earnings of your retirement savings. The payments are tax deductible to the fund.

For many people, this eases the cash flow difficulties that could mean they wouldn’t normally take these insurances.

The laws governing super really come into their own when it’s time to take your retirement savings out of the superannuation vehicle.

When you turn 60, you can draw down your superannuation as a lump sum with no tax on the pay-out. If you want to put the sum into an annuity and have it support you, you can do that tax free when you turn 60.

Of course, the current compulsory employer-funded 9% of wages is not enough to retire on, but the law is kind to people who want to top-up.

If you’re 50 or under, you can put up to $25,000 extra into your super fund with no more tax than is paid on your compulsory contributions.

If you’re over 50, you can put in up to $50,000 in extra contributions without paying extra tax.

And you can still top up with an extra $150,000 per year of non-concessional contributions i.e. out of your after tax dollars and pay no tax. Under the age of 65 you may contribute up to $450,000 this way under the “bring forward rule” (bringing forward two additional years of non-concessional contributions).

Perhaps the biggest aspect of the law that’s on your side with super, is that it is locked away.

The SIS act allows for early draw downs on super in only extreme cases of medical distress or severe financial hardship. But it’s very, very difficult to succeed at this.

Which is why super is still the best way to save for your retirement: it’s compulsory, its tax treatment allows for the compound effect, and you can’t touch it until you retire.

Which is what you really want once you do retire.