In this third instalment of a four-part series, actuary John De Ravin shares some of his top tips from his recently released book on personal financial strategies.
The strategies in this article are drawn from Chapter 4 (“Superannuation”) of my book Slow and Steady: 100 wealth building strategies for all ages. This article covers eight of the nine strategies in that Chapter. (The ninth is “find your lost super” but if you’re an actuary or an actuarial student, you’re not supposed to have lost any!).
1) Choose the right superannuation fund.
Since 1992 Australians have been able to choose the superannuation fund to which their employer contributes under Superannuation Guarantee legislation. The great majority of employees simply choose their employer’s default fund, but some funds are “better” than others, which is why APRA is encouraging some funds to merge with other funds, so that substandard outcomes are not imposed on their members. To evaluate whether your fund is a good one or not is not easy, but it is important; a 1% difference in annual returns (after fees) will amount to a lot of money over an entire career. A SuperGuide article by Trish Power will help you through eight steps to reviewing your existing fund. You need to take into account long-term investment performance; fees; insurance premiums and terms and conditions; and services provided by your fund to members.
2.) Make tax-deductible contributions to superannuation.
By making concessional (tax deductible) contributions to super, you effectively reduce your marginal tax rate (MTR) on that slice of your income to 15%. That means that there is a massive benefit to those who save via this medium and whose MTR is at the high end of the Australian scale. It isn’t right for everyone, but there is a very strong rationale for concessional contributions for those on high MTR’s and those who are close to retirement. This means that far too little use of this wealth creation opportunity is being made. For a detailed comparison of the benefits of concessional super contributions relative to applying the same after-tax savings to paying down your home mortgage, see my blog article on the subject.
3.) Make non-concessional contributions to superannuation.
You can also contribute money to superannuation without claiming a tax deduction. Why would you do this? Because superannuation is a very tax-favoured environment: tax on investment income is only 15% in accumulation phase, and nil when you convert your accumulation balance to a pension account. The new limit of $25,000 means that you can’t get a lot of money into superannuation quickly. But the non-concessional limits are more generous: $100,000 a year as long as you haven’t exceeded $1.6 million Total Superannuation Balance (TSB), and (assuming you haven’t used the “bring forward” rule in the previous two years) you can bring forward your next two financial years’ contribution limits and contribute $300,000 in the current financial year.
4.) Make spouse contributions to superannuation.
If your spouse earns less than $37,000 per year you can make a non-concessional “spouse” contribution to their accumulation account of up to $3,000 and the government provides you with a tax offset of 18% of the amount of your spouse contribution. This is a “free gift” and if the $540 benefit is invested in your own super account every year (at a nominal return after tax and fees of 7.5% in a growth fund, earning a real after-inflation return of 5%) then the amount of the accumulated benefit will be $127,265 after a 40-year career in nominal terms and $47,397 in real terms. Not bad for a freebie!
You can also make contributions if your spouse earns between $37,000 and $40,000 but the tax offset scales down linearly to zero over this income range.
5.) Split your superannuation contributions to your spouse.
This is a somewhat subtler strategy than the spouse contribution strategy mentioned above. In this strategy you divert (“split”) up to 85% (ie. the after-tax component) of concessional contributions that have already been made to your own account to your spouse’s account. You will need to apply to your employer to do this, usually in the financial year following the financial year in which the concessional contributions were made to your own accumulation account. This strategy isn’t for everyone but might be worthwhile if:
- Your spouse will reach preservation age and commence an account based pension before you so you want to maximize the balance of your spouse’s account that will earn tax-free income; or
- Your own accumulation account balance is likely to exceed the Transfer Balance Cap of $1.6 million by the time you are ready to commence a pension, whereas your spouse’s account balance is not likely to exceed $1.6 million; or
- You are older than your spouse and are likely to be entitled to some age pension so you want to shield the largest possible amount in your spouse’s accumulation account until your spouse also reaches the eligibility age for the age pension.
6.) Set up a Self-Managed Superannuation Fund (SMSF).
SMSFs are not for everyone but there are significant advantages if you (and your spouse) have large superannuation balances. Rice Warner provides an interesting analysis of the fee differences between various superannuation fund options and the simplified takeaway message is:
- SMSFs with balances of $200,000 or more can provide equivalent value to industry and retail funds provided the trustees undertake some of the administration.
- SMSFs with balances of $500,000 or more can provide equivalent value to industry and retail funds on a full service basis.
Other than the relative costs of the alternative options, the key advantage of an SMSF is greater control over your fund and its investments and the key disadvantage is that to run your own SMSF requires a level of time commitment, investment skill and knowledge of the legal environment. You are the trustee of your own fund and must comply with superannuation regulations and trustee legal obligations; you can get some assistance from your SMSF administration provider but you have the final responsibility.
7.) Establish a corporate trustee for your SMSF.
A corporate trustee entails additional costs (for registration of the corporate entity and fees for annual ASIC returns) but saves significant effort and cost when a trustee is added or removed from the fund. When a trustee is added or removed, the legal title of all fund assets needs to be transferred to the new trustees. There are also some minor advantages of a corporate trustee (in relation to liability of the trustee if sued, and in relation to penalties for administrative breaches of superannuation regulations: a single penalty applies to a corporate trustee but the same dollar penalty amount would apply to each individual trustee).
8.) Buy life insurance through your superannuation fund.
In one comparison that I performed in the book, the cost of life and TPD insurance bought through a large industry superannuation fund was 40% to 50% of the cost of life and TPD insurance bought from retail insurers. This is a very significant consideration but there are some other factors to be considered. For example:
- if the benefits will not be paid to a spouse or dependant, some tax may be payable if you buy cover through superannuation;
- individual death and TPD cover will be renewable beyond the age when your fund’s standard life cover expires;
- the default life cover in many funds is funded by a fixed dollar premium per annum and therefore your sum insured will automatically reduce as you get older unless you take out additional cover, to which underwriting may apply;
- suicide exclusion clauses or pre-existing condition clauses may impact your benefits if you switch covers;
- and finally, your cover through a super fund is usually contingent on the payment of the insurance premiums and if payment ceases (for example because you lose your job) then cover may cease without you receiving explicit notice of cessation of cover.
You can download a free list of all 100 strategies in Slow and Steady from the book’s website.
Read the the second instalment '10 financial strategies for wealth accumulators' and first instalment '10 financial strategies for teenagers and young adults'.
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