Super's prime time

PORTFOLIO POINT: Today we explain why Gen Xers need to lay the foundations early for a super-sized super balance in retirement.

The real problem with most people and their superannuation – in my humble opinion – is that too little thought is given to it until too late.

Most people tend not to pay any attention to their superannuation until:

They’re within five or 10 years of being able to access it and then desperately want to know how to make it grow faster and last longer.
It’s become a reasonable sum of money.
They develop a whole-of-life interest in their finances.

These things rarely seem to happen to people until they’ve reached at least 45, and more often 50, based on my experience as a financial adviser.

When you are in your early 20s and 30s, having 9% of your salary going into a super fund is not going to be much. Compounding returns on not very much equals, not surprisingly, not a whole lot more.

In my opinion the basics of superannuation should be added to curriculum of all schools. If it was, and it wouldn’t take much, then people would take an interest in their super earlier and be able to start planning on how to make it grow more quickly.

Generation Xers have plenty of time on their side.

The first instalment of Superannuation for Gen Xers (click here) pointed out that if you were born after June 30, 1964, you cannot access your super until you have turned at least 60, so you certainly have plenty of time to make super work for you.

Traps for young players

The biggest trap for Gen Xers is to not to be actively involved. Do you know who your super is with? Is it spread across more than one provider? Has your super outperformed or underperformed the index? Taking responsibility for your super is the first step.

This includes making conscious decisions on the sorts of risks you want to take. The first thing to know about investing is that risk and reward are inextricably linked. So if you want to have a higher super balance, you are going to have to take more risks and face the possibility of your balance going in the wrong direction.

Fundamentally, this means having more of your money in growth assets like shares and property. So do you know how much of your super is invested in shares and property?

The typical “balanced” fund will have about 60% of their assets sitting in shares and property. If you’re sitting in a balanced fund, then you might not be taking as much of a risk as you’d like to.

Start by calling your current fund and filling in the following table:

-Your super allocation
Asset class	Percentage
Cash
Fixed interest (Australian and international)
x
Property (Australian and international)
Shares (Australian and international)
Alternative assets
x

I’ve left a couple of lines blank. Some super funds have other assets and might break things down further, into “defensive” assets, “infrastructure”, “hedge funds”, “ASX 200” and so on.

First, tally up the shares, property and anything else that sounds aggressive. Next, add the cash, with the fixed interest and defensive assets. Whatever that first number comes to is the level of aggression or level of growth assets in your portfolio. More growth assets should deliver you better returns over the long term (but also more volatility!).

Now ask your fund what other investment options it has; there are probably more aggressive ones but that’s not to say that you should jump into them. But do start asking questions about them so you have something to compare.

The self-employed super vortex

Most employees are covered by the Superannuation Guarantee. Their employers have to pay 9% into super for them every month, or every quarter.

The same does not apply to the self-employed. You don’t have to contribute to your own super fund, if you are not actually an employee drawing a salary from your business. Many young businesses struggle with cash flow. They might not think they can justify tipping $5000 or $10,000 into super when there are so many bills to be paid.

This is a trap because there won’t necessarily be a trigger to start paying to super. But the “I’m building my business” excuse can’t last forever. If you wake up 10 or 15 years down the track without having put anything in your super, you’re then going to run into the “concessional contributions” problem where you are penalised for putting in too much over too short a period (click here).

Insurance

Gen Xers tend to have lives that are full of debt, full of kids and full of dreams.

Insurance is what should allow you to sleep at night in the knowledge that if “sh-t happens”, your family, or yourself, will be able to survive financially and even continue on with some of those dreams.

It might sound obvious, but your ability to breathe and to work is what provides the ability to service the debt, feed, clothe and educate the kids and consider travelling overseas, take on a bigger house or buying an investment property.

I’m not going to go into full chapter and verse about the need for insurance here. But I am going to point out that superannuation can be used to fund a portion of your insurances.

Super can be used to fund:

Life insurance.
Total and permanent disability (TPD) insurance.
Income protection insurance.

Each has different tax advantages and disadvantages held inside or outside super. (For what it’s worth, I generally recommend life and TPD inside super and income protection outside.)

If you’ve got big debts, an expensive lifestyle, a partner, or young kids '¦ then you need some, possibly all, of those insurances. Being able to fund some of them inside super means you can potentially use your non-super money to help pay down the mortgage.

The major argument against using super to pay for some insurances is that you’re taking away money that could be working for you inside your fund. Fine, but if you’re 40 years old, have $80,000 in super, more than half a million dollars in a mortgage, and about $300,000–400,000 of private school fees to look forward to '¦ then the cost of a proper protection policy to cover you for $1.5 million to $2 million is going to look pretty cheap.

Gearing in super

The gearing rules for superannuation were rewritten in September 2007. This was, coincidentally, about six weeks before the top of the market. The rules were tweaked in mid-2010.

Gearing in super is actually prohibited, but there are some exceptions. Aren’t there always?

Until 2007, those exceptions were limited to instalment receipts (such as the Telstra 1, 2 and 3 floats, where the second instalment was essentially an interest-free loan), internally geared managed funds and instalment warrants.

You can now gear anything that a managed fund would normally be allowed to invest into. This includes property and shares. However, there are some pretty stringent rules around those. And they are largely only available to SMSFs.

Gearing adds risk to investing in super. But it will be appropriate for some Gen X super investors.

Few super platforms allow any sort of gearing. These tend to be limited number of retail super funds, which will give access to some limited forms of geared share funds, both Australian and international.

If you want to take advantage of gearing in managed fund super – and this is certainly not a recommendation – then you’ll probably need to switch to a retail platform/fund that offers the option.

For those with SMSFs, gearing is a distinct possibility. Particularly those who are comfortable with gearing outside super – that is those who use margin loans or borrow to invest in property. The problem is ... do you have the money?

When to start considering an SMSF

There is a lot to be said for running your own super via an SMSF. However, it’s not all beer and skittles. There is a very serious side to being a super fund trustee. And a lot of work.

For the moment, I’ll assume you’re interested in investing, believe you have the time to devote to it, and understand the risks of getting it wrong.

So when should you consider starting your own SMSF?

The very rough rule is that it’s a minimum of $200,000. The reason for that is that there are certain costs that are unavoidable in SMSFs that you must pay directly. They include accounting and auditing, plus some government fees and charges. They might add up to about $2000 to $2500, in which case, they represent about 1% of the value of your super fund.

That doesn’t include the cost of purchasing or disposing of assets, including your trading fees, or platform fees (if you use a platform), or MERs, if you use funds for exposure to some assets.

However, if you are going to need investment help, then you’ll need to factor in those costs. If that is the case, then you really should have double that figure, or more. That is, more like $400,000 to $500,000.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are advised to consult your financial adviser.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.