Guaranteed 29.77% return! Why don’t more Australians take advantage of Super?

I will qualify, the guaranteed return will depend on your personal tax rate, it could be less, or it could be far more!

It’s got me thinking recently, why don’t more people contribute additional money to super? There are significant tax saving advantages, which if reframed can be considered a guaranteed return! It’s all just how you look at it. While technically it’s not investment returns, it is a reduction in your personal income tax, which could be looked at as an equivalent investment return. Let me explain.

Consider you are a typical Australian, earning the median annual salary of $67,600 as of August 2023 (Australian Bureau of Statistics). If you are a diligent saver, and save 10% or $6,760 of your gross income each year, after you pay your personal income tax rate of 34.5% to the government, you will have $4,428 left to invest personally in your name.

Alternatively, you could opt to contribute the equivalent amount to super. When you contribute money to super, your contribution amount is taxed at the favorable super tax rate of 15%. The after-tax amount that will be invested in super will therefore be $5,746. This is an immediate tax saving of $1,318 or 19.50%.

To reframe the significant tax saving benefit, if you were to invest $4,428 of your after tax personal income, you would need to achieve an investment return of 29.77% to receive the same amount of money (as a tax save) if you contributed to super. If we factor in the long-term return of share markets globally being approximately 10% pa, it would take 2.7 years of investment returns to be in the same position. This is not taking into account the variability of returns and risk required to achieve the return, compared with the guaranteed equivalent return from contributing the money to super and receiving the immediate tax savings benefits.

The long-term benefits of contributing to super is significant. If you chose to contribute the money to super, instead of investing in your personal name, how much extra money would you have? For simplicity, we have not factored in taxes or transaction costs.

If we assumed you started contributing 10%, or $6,760 pa of your income to super from age 25 to age 65, and you earned a real rate of return after inflation of 7% pa, you would have $1,227,400 at age 65. While if you earned the money personally and paid tax at your personal tax rate and invested the remaining, you would only have $945,820. You have earned the same amount of money, however have just made a more optimal choice. 

I have included a table below to show the tax savings benefits of contributing money to super at the different personal marginal tax rates. Put simply, the more money you earn and pay tax on, the larger the benefits of contributing to super.

What is the roadblock? Psychologically, it’s difficult to contribute to super for a few reasons:

1. The money is locked away until you are eligible to access it, usually preservation age. This is age 60 for most people.

2. Lack of understanding of what super is, how it works and how to take advantage of the benefits.
   

If you are in the camp of being more than a decade away from age 60, which I am, the first psychological roadblock of the money being locked away is a tough one to overcome. When we are young, we have many competing financial priorities, whether that be saving for a deposit for a home or paying for a wedding, we need to factor this in, as it is not helpful if we have all this money in super, but cannot access it.

At a minimum, I have decided that I would not contribute any additional money to super unless I have 6 months of our living expenses in savings/cash, which fortunately I do. It’s then a balancing act of saving money both outside and inside of super. If your goal is to retire before age 60, you will need to have investments or savings outside of super to fund you until age 60.

In an ideal world, you would maximise the amount of money you can get into super each financial year that is taxed at the favourable 15% tax rate, which is $27,500 per annum. You would then invest your remaining cash flow in your personal name. I would expect the majority of us are not in a position to be able to achieve this, so it would therefore be a balancing act and hedging your bets by investing in both your personal name and super.

While you are still dipping your toes into saving and investing, and you are more than a decade or two away from 60, to stay flexible, while still taking advantage of the significant tax savings available with super, you could direct 20-30% of your annual savings rate to super each year. If we use the example above, you could contribute 2-3% of your 10% savings rate to super each year and invest the remaining in your personal name. As you get older and have a larger amount of flexibility due to building up more assets in your personal name and likely earning more, you could increase the amount you contribute to super.

Some may argue that you should not invest additional money until you have repaid your mortgage. Putting aside all thoughts and feelings, rationally speaking, if your mortgage rate is 6.5% and you can receive a guaranteed tax saving and equivalent return of 29.77% contributing money to super - think about it! I will let you work that one out. Remember, you can pull money out of super to repay your remaining mortgage at 60 if that is a concern.

What you should do depends on your situation and there is no right or wrong way to structure your savings and investments. This post is meant to be thought provoking. Not taking advantage of a guaranteed 29.77% return is a tough one for me to pass on!

The Financial Poet

Disclaimers:

The principal purpose of this blog is to provide factual information and not provide financial product advice. Additionally, the information is not intended to provide any recommendation or opinion about any financial product.

The advice provided is general advice only as, in preparing it we did not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of this advice, you should consider how appropriate the advice is to your particular investment needs, and objectives. You should also consider the relevant Product Disclosure Statement before making any decision relating to a financial product. This post specifically excludes personal advice.