Eureka Report: Three boosters for younger super starters
Following the May federal budget and release of draft legislation, we now have relative certainty around the superannuation environment post July 1 next year. For some, the changes will mean that immediate recalibration and restructure is required – for example, retirees with pension balances over $1.6 million.
It is, however, those in the early stages of their working life who would be wise to think about the new super world; and how time can overcome some of the disadvantageous developments. The challenge here will be getting the spotlight shining on retirement planning when the need may seem so far away.
The recent changes announced include cuts to the amounts that can be contributed to superannuation, specifically a reduction in the non-concessional contribution limit to $100,000 per annum from $180,000 and a reduction in the concessional contribution limit to $25,000. The concessional contribution limit, which captures the superannuation guarantee and any additionally pre-tax sacrificed amounts, for example, will apply to all regardless of age from July 1 next year. The cessation of age-related caps means that there will no longer be the ability to make greater use of superannuation in those years leading up to retirement, as has historically been commonly advised.
The combined impact will mean many younger Australians may struggle to accumulate a healthy balance in the superannuation environment, let alone make full use of the $1.6m tax-free pension cap. This means that placing sole focus on things like mortgage repayments and funding school fees before thinking about superannuation in the later years of one’s working life may need strategic rethinking. The good news is, time can be the secret weapon if put to use.
Start small but start early – the magic of compounding
Put simply by Benjamin Franklin “Money makes money. And the money that makes money, makes money”. Compounding investment returns is a powerful force which essentially harnesses the impact of time, getting it to do the hard work. This means that simply starting small, being consistent and – most importantly – getting an early start with investment can have a truly remarkable effect over time.
Taking a basic example, an investor contributing $200 per month from age 35 all the way to age 65 will have contributed around 33 per cent less than one who started the very same regular investment plan 10 years earlier at their age 25. Their ultimate retirement balance would, however, be almost half (assumes 6 per cent p.a. return) making for a compelling case. The benefit of grabbing the opportunity as early as possible cannot be emphasised enough. And when coupling with the tax benefit associated with a pre-tax (or tax deductible) contribution to superannuation, the strategy makes for a powerful and super efficient combination.
1. Spouse contribution tax offset
Under new proposals the spouse super contribution rebate will be broadened by increasing the income threshold for which the rebate will apply. A $3000 super contribution for the lower income spouse (earning up to $37,000 from July 1, 2017) will provide the contributing spouse with a $540 personal taxation offset. Missing out on superannuation contributions for even short periods results in major long-term imbalances. A sometimes forgotten allowance, the tax benefit creates great incentive to keep superannuation contributions up for a member of a couple who may be out of the workforce or has reduced working hours for a period of time.
It can, however, be hard to suddenly find the extra cash and justify making the contribution just prior to the end of a financial year; particularly with competing interests of a young family, for example. Planning ahead and instead opting for a regular contribution plan over the course of the year will likely better create the discipline to make it happen.
2. Asset allocation
As well demonstrated in theory and in practice, a portfolio's asset mix will go the majority of the way to determining the long-term return and risk outcomes. When starting out in the workforce, many will hastily complete their superannuation paperwork without a great deal of thought applied to the investment option. This likely then means being placed in the default strategy, which will typically hold exposure of between 60 per cent and 70 per cent in growth-type assets. While this might be perfectly okay for some, it may represent a significant opportunity cost for others who could have had the appetite and profile for a higher-growth exposure. A seemingly small decision which, as history tells us, can have a marked impact over time.
3. Catch-up contributions
Slated to take effect from July 1, 2018 the proposed catch-up contributions allow one to utilise up to five previous years' unused concessional contributions where their balance is less than $500,000. Primarily aimed at those with interrupted employment, the new rule can have a broader application in allowing a super boost for some. The self employed with lumpy incomes will likely benefit but it will certainly also help those who have capacity to make extra contributions in a particular year simply because circumstances changed.
Be it an inheritance, a work bonus, a reduction in fixed costs and suddenly higher discretionary income, etc, utilising the catch-up concessional contribution strategy should be on the table. The benefit of concessional contributions is that they are tax deductible and represent an immediate tax saving alongside the favourable 15 per cent tax on earnings. The stalwart strategy to simply reduce the mortgage as quickly as possible with any surplus cash and think about superannuation later might warrant a rethink.
While some argue that those in their 20s and 30ss have had it too good or easy in some respects, there is no doubt that the golden age of superannuation will be a thing of the past. But opportunity exists for those who are informed, or informed enough to get advice and use the benefit of time to their advantage. This might just be where the baby boomers step in with some guidance for the collective good!