Unfortunately, most people largely ignore superannuation and simply leave it to look after itself. This is not very smart. Rather, there is a range of actions you can take to maximise your superannuation. Here are five that, at the very least, are worthy of close consideration.
1. Accept more risk
One of the best ways to get more out of your super involves adopting an age-based investment strategy. This involves working out how much risk you can afford to take based on your years to retirement. You can then adopt the best risk-adjusted strategy for maximising your chance of getting a higher return.
“Picking the right investment option is important as this will influence how much money you’ll have to retire on,” says Natasha Panagis, technical specialist with the advisory firm Centric Wealth.
Age is crucial when deciding how much risk to take, due to the fact that the more years there are to retirement the more ability you have to recover from a major setback. Not only have the young more years in which to allow their super to recover lost ground, they can also use these years to pump more into super. By taking more risk, the odds of generating a much higher annual rate of return are much better and, if realised, will deliver a much bigger pot of savings at retirement (see “Why your return is so important”).
As for older Australians, those in retirement often become obsessed with avoiding investment losses and so increase their risk of getting poor returns and running out of money. Try to avoid this common error.
2. Dump your fund if necessary
Monitor your super fund’s long-term returns. If the investment option you have chosen is performing poorly relative to those of most other funds, it is time to act. While you may be able to switch to a better-performing option in your existing fund, sometimes you will need to switch funds altogether to get the option and returns you want.
Centric Wealth’s Panagis cautions, however, to make sure you don’t focus solely on performance but also look at fees and insurance. “Make sure you are not losing insurance benefits by rolling over into a new fund,” she says.
And while most employees have the right, under the super choice rules, to switch super funds, this is not true of everyone. Those who aren’t covered by super choice will need to make use of the so-called portability rules. Under these you have the right to transfer all or part of your accumulated super to a new fund whose investment options have generated better long-term returns.
3. Set up an SMSF
If you are prepared to put in the effort, as well as take on responsibility for managing your super, it is worth considering setting up a self-managed superannuation fund (SMSF).
Employees with super choice often can simply switch their existing super to their SMSF. Others will need to make use of the portability rules.
Having an SMSF can help you get more out of your super in a range of ways, including saving fees. But even if your SMSF costs you more to start with, it has the advantage of giving you control over how your super is invested, one potentially valuable option being the ability to use it as a deposit to gear into one or more investment properties.
“Using an SMSF to gear into property can be an effective strategy, but it needs to be handled very carefully,” says Andrew Yee, head of self-managed super at accountancy group HLB Mann Judd. “This is definitely an area where you should pay for top-quality, unbiased advice.”
4. Maximise your tax breaks
Contributions to super made by or on behalf of employees and which are financed out of pre-tax income are taxed, in effect, at 15%. This generates a valuable tax saving for most people, since most employees have a marginal tax rate of at least 31.5% (including the Medicare levy). A smart way to maximise this tax saving, and so get more out of your super, is to direct part of your pre-tax salary into super. This is called salary sacrificing. And it’s not only the tax saving you make when contributing.
The investment earnings generated on your super savings get tax breaks, with income taxed at just 15% and any capital gains at an effective rate of just 10% (a one-third discount for super for assets held more than 12 months).
“In most circumstances salary sacrifice can improve your net income, reduce tax and increase your end retirement benefit,” says Panagis.
But don’t forget that once you put money into super you can’t get it out again until you satisfy a so-called condition of release. For most people, that won’t happen until they retire.
5. Start early, make more
If we all adopted the smart approach to building wealth, everyone would make an effort to understand super when they are young and, most important of all, start implementing the strategies discussed here as soon as possible.
“Starting early can make a huge difference to how much you have when you retire, mainly due to the power of compounding,” says Vamos.
Even a really simple example shows this. Let’s say someone saved $10,000 a year for 20 years while someone else saved the same amount for 35 years, both earning a return of 6% a year. Compounding this amount of annual savings would generate $367,856 after 20 years. After 35 years it would have generated $1,114,348, more than three times as much.
Why your return is so important?
Natasha Panagis, of Centric Wealth, has crunched the numbers for Money to compare the end result when someone’s super earns 8% a year as opposed to a more modest 5%.
We assumed that the employee was aged 30, had 35 years to retirement, had a starting salary of $80,000, which rose 5% each year, and started with a super balance of $70,000. It was also assumed that the annual compulsory super contribution rate remained at 9.25% and there were no salary sacrifice contributions.
While adjustments had to be made to take account of super’s contributions caps (which were assumed to be unchanged), the calculation found that someone whose super fund generated 5% a year would end up with $1.367 million, or around $562,000 in today’s dollars (assuming an annual inflation rate of 2.5%).
In contrast, an 8% earnings rate would deliver an end result of $2.437 million, or just over $1 million more in today’s dollars – a huge extra return. In this case, with a 35-year investment horizon, the extra age-based risk was definitely worth it.
Peter Freeman is a former managing editor of the AFR and edited its Smart Money section.