Review your superannuation strategy

Promises in the 2013 election campaign mean it’s time to review your superannuation strategies. So today I want take you on a decision-making journey.

A good friend of mine vowed many years ago not to invest large amounts of his savings in superannuation because he said that the regulations were too uncertain. It was better to save in his own name and that of his wife – aided by a little property-based negative gearing. A great many Australians still have that view. For my part, I took exactly the reverse attitude and back in the 1970s concluded that superannuation was the only way I could fund a comfortable retirement given the personal tax rates. I wasn’t prepared to undertake extensive negative gearing of property, although I did dabble in that area at one time.

As it turned, out I was right. There were a great many changes to superannuation but most of them were grandfathered, and during the last three decades it has remained a very tax-effective way to save.

Then came the Costello changes, which further enhanced superannuation. But the Costello changes have been eroded by the latest tax increases, and the fact is that it is now much harder to get money into superannuation.

But now we are entering into a third phase of superannuation regulation, and I think it is an appropriate time for all Eureka readers to revise their superannuation strategy.

You may end up in concluding to go with my friend and stay away from superannuation or you may follow my path. The important thing is that you should make a review.

Super ceasefire declared

The game changed last week when the ALP said that it would not make major changes to the superannuation rules for at least the next five years. The Coalition has made a similar promise. So now we have looming stability in superannuation for the next five years, and by that time the number of people on the voters’ register who are dependent on superannuation will have risen substantially as part of the ageing of the population. It will be extremely difficult for any party to change the rules significantly in 2018 given that we will have had five years of stability. Of course politicians can lie, but I think superannuation is now one of the safer areas when it comes to changes in government regulation.

When I was younger it was possible to put large sums into superannuation and get a tax benefit. That is no longer the case and the amount of money that you can invest in superannuation and gain a tax deduction simply is not sufficient to provide for a comfortable retirement.

What superannuation has become for a lot of people is a way of saving so that that tax on your savings is 15%, and that covers both longer-term capital gains and income (remember that under the latest Shorten changes the old capital gains taxes are grandfathered).

And of course your first $100,000 of superannuation income is tax-free if your fund is in pension mode.

So, by contrast, if you invest on a personal basis your income is taxed at the income tax rate that goes as high as 47%, and your capital gains are taxed at half your income tax rate.

Working for longer

In coming decades a lot of people are now simply not going to retire at 55, 60, 65 or 70 as was originally planned because they don’t have sufficient funds to do so and/or they want to keep active for as long as they can.

That means that if you are saving on a personal basis your working income quickly puts you into tax brackets that are around 37 cents in the dollar, and so income from your savings is taxed at that rate (albeit capital gains are taxed at half income rates). In my view, being able to insulate your savings into a tax bracket of 15% is an attractive option for many people.

Of course, those who negatively gear are able to deduct interest against their income and if the asset they have invested in goes up it certainly causes a substantial increase in wealth. But if the asset goes down it can devastate the person’s wealth. So it is a higher risk exercise going in that direction, albeit potentially very rewarding.

One warning. Although both parties have said they won’t change superannuation dramatically, I would be very wary of the current borrowing situation in superannuation to foster dwelling investment. As I have written previously, real estate agents are getting into this area and it smells of abuses, which I think are going to be curbed by the next government whether it is the Coalition or the ALP. And I don’t think such a change would be classed as interference in the basic superannuation thrust. Accordingly, if you are planning to head in the property investment/borrowing direction with superannuation I urge you to do it now because I am not sure it will be available later. In addition the lower interest rates are likely to boost housing prices.

Given that tax deductible investment is limited to low amounts – $25,000 for those aged under 60 and $35,000 for those aged over 60 – is it worthwhile to invest your after-tax savings dollars into superannuation? You can invest $150,000 of tax-paid dollars a year (or $450,000 every three years if you are aged under 65).

Using after-tax dollars

Very clearly the government is trying to restrict the use of the tax deductibility concession, encouraging people to boost their superannuation savings with tax paid dollars. Yet relatively few people do this because, in years gone by, you could save big sums via superannuation and get a tax deduction – albeit that there was a tax on the way in. I would urge Eureka readers to at least consider whether it is worth saving via superannuation after paying tax on your earnings. However, if your income is over $300,000 you are taxed 30% on the way in. That reduces the attraction.

Once you are over 60 superannuation is relatively easy to extract money from, but you do need to set your fund into “pension mode”. But if you are still earning sufficient to live on, the money maybe best left in superannuation to be taxed at much lower than income rates. Most people use self-managed funds so you have control over your money. Assuming you are in pension mode, once your reach 60 there is not a great deal of difference between money in a superannuation fund and money that you have in your own name. It is true that to get access to your funds you must put your fund into pension mode, and that means you must pay out 4% of the fund up to age 65, and then 5% between 65 and 75. The proportion rises from then on. But, of course, until you are aged 75 you are able to re-invest that money back into the fund and build it up if you don’t need the cash. To contribute to superannuation at ages over 65, you must pass a work test but it is not onerous.

I am very grateful to have a savings vehicle that enables my income from savings to be taxed at just 15% after $100,000 tax-free (and if your spouse is in the fund, then there is $100,000 tax-free level for him/her too). As you get older you become more risk averse, so negatively gearing and exercises like that have less attraction.

I believe superannuation for a great many people is the best way to save in the current environment. It is a lot better being taxed at 15% on income than between 30% and 47%. So I believe we are now going to see further big rises in superannuation investment because we do now have stability in the savings rules for this product.

If of course you have a business, want to go deep into negative gearing, or you have particular avenues of savings, then superannuation may not be for you. But for a person who has a regular salary or contract-type income, then it remains the best way to hold savings.