Please know that I am not a qualified financial adviser and while my job may require me to advise on billion-dollar transactions it is always under the supervision and rigour of my bosses and my bosses’ bosses. What I’m about to share with you guys is what a friend of mine shared with me over the course of a few dinner conversations.
This post is about superannuation (super). It took me some time to put it together because I experienced writer’s block, and I experienced writer’s block because it was not a very sexy topic to talk about. So instead of trying to convince you (and myself) that super is sexy, let’s try this instead.
If I were to tell you that by reading this blog you will be $100 richer every day from now, perhaps you’ll be inclined to stick around a little longer? Well this blog aims to do just that.
Recognising not everyone’s from a finance background, I’ll try and keep it simple. And before you come knocking because you lost all your money, please keep in mind that the examples below are based on simple assumptions and while the fundamentals should prove true for most people, your individual circumstances may vary the outcome of what I’m about to show you.
Path to financial freedom through super
- Get a job, earn some dosh ($$$)
- When you have some cash to spare, consider making voluntary contributions into your super bank (S-Bank)
- Grow your S-Bank by continuing to make contributions into your super each year
- This way, you’ll get to keep more of your hard earned money and pay less tax
- Once you’ve got a good amount in your S-Bank, set up a self-managed super fund (SMSF). I’ll cover steps 5 and beyond in the next post
- There’s lots you can do with a SMSF, probably more than you’d ever imagined (e.g. buy your home, start your business)
- Understand the importance of compound interest (here‘s one to help you)
- The combination of good investments and low tax over time will best allow you to achieve Financial Freedom.
Yours to download for free is my Supermodel which ties in with the explanation below.
Bob and Mary both earn $80,000 a year (no sex discrimination here). Come tax time, Mary, having read this blog, decides to max out her super contribution ($30,000 at the moment) while Bob contributes nothing other than what his employer has already contributed, which is 9.5% of his salary (or $7,600).
Post tax season, Bob and Mary’s finances will look a bit different:
- Mary takes home $41,000 and contributes $28,000 (post tax) towards her super
- Bob takes home $56,000 while his employer adds another $7,000 towards his super (post tax)
- When the ATO comes knocking, Mary pays $10,000 in tax while Bob pays $15,500
- Mary pays $5,500 less tax because 1) Mary has reduced her taxable income by voluntarily contributing to her super and 2) her super is generally taxed at a lower rate (unless Mary’s earning minimum wage)
- Mary also pays slightly less for medical levy since it’s determined by taxable income
- After tax, Mary manages to keep 86% of her money while Bob only manages to retain 79%
- Over the next 5 years, if Mary and Bob continue to earn the same wage, Bob can pay up to $36,000 more in tax vs. Mary, depending on the effective tax rates on the super.
- The message for Part 1 is therefore pretty simple. Where possible, make voluntary contribution into your super to minimise your tax.
That’s great, but I’m only 25
At this point, some of you must be wondering why bother. I’m only 25 and it’s gonna take me another 10 years to save up for a house deposit in Sydney let alone putting money into super (medium Sydney housing price just cracked a million bucks, ouch).
So over the next post, I’ll explain how your super money can go further and be more accessible than you’d ever imagined. We’ll go through how to own your first property quicker, ways to make your super money work for you and undercover some of the worrying facts about the existing SMSF system.
The boring stuff you should know
- While your super is supposed to be taxed at 15%, most super funds receive tons of franking credits which are used to reduce your effective tax rate (i.e. the actual tax rate on your super). This means you’ll end up paying even less tax. Franking credits are unnecessarily complex but good to get your head around (you can read this). Essentially, it’s when tax has already been paid on an investment and you get to claim some money back because your tax rate is lower
- The higher your income, the better off you’ll be making voluntary super contribution as the gap between the effective tax rate on your super and your taxable income tax rate further widens
- Of course you can choose to be like Bob and make good use of the take-home cash instead. After all, Bob takes home an extra $15,000 by not making a voluntary contribution. This $15,000 you can invest in shares and/or put it in a bank while you’re saving for a house, but just be mindful that whatever profits you make from this $15,000 is subject to personal income tax which is going to be higher than the tax rate you enjoy on your super. Personally, I believe that unless you’re an investment guru or are in the knows about financial markets, the chance of you out-gaming the market for a sustained period is pretty abysmal so you may do better choosing a high growth super option
- If you’re already tight on cash then this strategy is not gonna work for you (I feel obliged to go off on a tangent here and urge you to re-assess your spending habits but I’ll put a plug on it and save preaching the minimalist lifestyle for another time). If you’re behind on your credit card debt and/or mortgage, then pay those first. Nonetheless, there are times when it still makes sense to continue making contribution into your super despite you being in debt. For instance, I ran the numbers for my mum and even though she’s paying interest on her mortgage, it was still better off for her to forego making mortgage repayments and put that money into her super instead (after taking into account a bunch of factors specific to her). Ultimately, it becomes a balancing exercise between the tax saving on the one hand and the extra interest you’re servicing on the other.