To encourage Australians to finance their own retirements, the Federal Government taxes (most) super contributions lightly. But many Australians don’t take advantage of this.

Superannuation is both incredibly important and forbiddingly complicated. Most adult Australians realise that a tenth of their salary is diverted into a super fund and that they are meant to live off that money once they retire. Unfortunately, things soon get convoluted once the discussion turns to concessional rates, work tests, contribution caps and preservation age. Below, Zac Ayoubi, a Senior Financial Adviser at ANZ, clearly explains how you can use super contributions to ensure most of your money ends up in your retirement nest egg rather than the ATO’s coffers.  

Super 101

Super is based on a straightforward quid pro quo: the Federal Government agrees to tax Australians’ super money lightly in the hope that they will finance their own retirements. The issue successive Federal Governments have faced is working out how to encourage Australians, especially low to average income earners, to put money into super while preventing high-income earners using super as a tax shelter.

“Super rules make a lot more sense once you understand that the Federal Government wants as many Australians as possible to have enough super money to not need to claim the full age pension,” Ayoubi says. “Exactly what constitutes ‘enough money’ is a subject of debate, but the Association of Super Funds of Australia has estimated that a single person with a paid-off home and access to partial age pension still needs to have accumulated $545,000 in super to enjoy a ‘comfortable’ retirement. The Government allows people to have up to $1.7 million in their super fund. That ceiling incentivises people to accumulate sufficient money in super to be self-funded retirees, but prevents the wealthy gaming the system for tax-minimisation purposes.”

The power of compound interest

Few Australians pay much attention to super until retirement starts looming on the horizon. But Ayoubi points out that those who play the long game can turn small contributions early in their working life into huge sums.

“Imagine someone gets a job at 15, earns $10,000 over a year and puts $5,000 of that into a fee-free bank account paying a fixed seven% interest rate,” he says. “Even if they never put another cent into the account, they will have $147,285 in their account at age 65.”Superscript:1

Super doesn’t quite work the same way given super funds charge fees and the ATO takes 15% of the return you make on your super money. But the moral of the story is that upping your super contributions just a little bit in your twenties, thirties and even forties can translate to having a lot more money available when it’s time to take that round-the-world cruise.

How super money gets taxed differently from ‘normal’ money

Let’s assume you have $100,000 in your super and, over the course of a year, you get a 10% return on it, meaning you now have another $10,000. You don’t get to keep all that money – the taxman takes 15% (i.e. $1,500). But you do get to keep a lot more of it than is the case in many other scenarios.

“Most Australians earn between $45,000-$120,000 and pay a marginal tax rate of 32.5%,” Ayoubi says. “That means $0.325 in every dollar they earn between $45,000-$120,000 goes to the ATO. More often than not, they pay that tax rate not just on their salary but also on any other income they make. For instance, if you earned $10,000 in interest from a savings account, this would be added to your taxable income and you would have to pay your marginal tax rate on it. That means you’d pay $3,250 in tax.”

Capital gains tax rates vary depending on the circumstances in which an asset is bought and sold, but the same principle applies. “Let’s assume an average income earner sells an investment property within 12 months of buying it and makes a $100,000 profit,” Ayoubi says. “This $100,000 will be added to their taxable income and taxed at their marginal tax rate. Assuming they have no other income for the year, that means the tax office will take $32,500 of the profit they made.”

The individual with a savings account and the one who sold the investment property get access to the return on their investments, after the ATO takes its substantial cut, immediately. That doesn’t happen with the returns people earn on their super money. But the relevant point is that it’s a lot easier to build wealth paying 15% tax on your investment returns than it is paying 32.5%. (Or 45%, if you earn over $180,000.)

“People should also be aware there’s no ‘double-dipping’ by the ATO when it comes to super,” Ayoubi says. “You pay 15% tax on the money going into your super account [see below] and 15% on any returns you make. But whatever is in your account when you retire is all yours; there are no taxes to pay when it comes time to start drawing down your super balance.”

How much of my salary can I put in super?

The 10% of the income that salary earners automatically have diverted into their super is taxed differently from the remaining 90% that you receive as salary in your bank account.   

“If you earn $100,000, $10,000 of that is taxed at 15%, meaning the ATO takes $1,500 and $8,500 ends up in your super account,” Ayoubi says. “But you have to pay tax at your marginal tax rate plus the Medicare levy (i.e. up to 34.5%) on the remaining $90,000. That means the ATO takes $21,517 and only $68,483 ends up in your bank account.

But, if they are so inclined, most Australians  could have a larger portion of their income taxed at the 15% rate.

“Employers are compelled to divert 10% of your income to super but most of us could divert 20-30% of our income to super and remain under the $27,500 yearly cap on concessional super contributions,” Ayoubi says. “Of course, the trade-off for having the money lightly taxed is that you won’t be able to get your hands on it,  except under exceptional circumstances, until you’ve reached retirement age. But those Australians who do make voluntary super contributions will enjoy both the benefit of paying less tax in the short term and the benefit of compound interest over the longer term.”   

Can I put a windfall into super?

Women who’ve taken time out of the workforce to raise children and self-employed people who’ve ploughed every available dollar back into their business can often find themselves with modest super balances in middle age. Fortunately, they can usually top up their super balance if they come into some money via an inheritance or the sale of their business.

“The rules around ‘lump sum’ contributions are complex,” Ayoubi says. “But, long story short, older people with modest super balances can usually either make an annual deposit of $110,000 per financial year or bring forward three years and add $330,000 into their super account without paying the usual 15% tax. The ATO treats ‘windfall money’ differently to ‘salary money’ and doesn’t tax it when it’s deposited into a super account.”

Should I split my super with my partner?

If one person is earning a relatively high income and their partner is working part-time or not at all, super contribution splitting can be a good idea. (Essentially, this involves the higher income earner directing a proportion of their income in the super account of their partner.)

While there can be some financial benefits to super contribution splitting, especially in regard to reducing ‘assessable assets’ to qualify for Centrelink benefits, couples typically do it out of a sense of fair play.

“Unless you earn a lot less or a lot more than average, there isn’t likely to be a big financial upside to contribution splitting,” Ayoubi says. “Couples usually do it because they don’t believe it’s right that the partner who isn’t earning much, often due to childcare responsibilities, should miss out on growing their super.”  

Should I put money into super even when it’s not lightly taxed?

As long as your balance remains under the $1.7 million cap. Whilst you can continue to put money into your super if the balance is 1.7 million, you will be liable to pay tax on the excess balance earnings. As  Ayoubi says, it’s rarely worth putting money into super if it will be heavily taxed. “If someone has lots of money that they are not sure what to do with, I’d suggest they talk to a financial adviser about their investment options rather than just deposit it in their super account,” he says.

Please seek professional advice

Making decisions about the optimal level of super contributions is no simple matter. It involves factors such as your age, assets, debts, relationship status, marginal tax rate, current income, likely future income, current outgoings, likely future outgoings and the other investment opportunities you have available. Plus, rules around the tax treatment of super contributions can and do change regularly. So, it’s always a good idea to get expert input on using super contributions to reduce your tax bill.

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