Author: Mr DDU.
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What is Superannuation?
Superannuation is a long term investment account which has a lot of rules, regulations and favourable tax benefits.
Superannuation has been around in Australia for a long time (going back earlier than the 1950s) but it wasn’t until 1992 when the Australian Government, working with the Unions, decided that for the long term future of Australia and the affordability of the aging demographics, something had to be done. The Government and Unions decided to sacrifice a 3% national pay rise and instead make it mandatory for all employers to pay that 3% of the employee’s salary into their superannuation account. Between 1992 and 2002 that mandatory contribution on top of normal salaries incrementally grew from 3% to 9%.
As of today, it is mandatory for all employers to pay employees 9.5%. By 2025 this will grow to 12%.
The nuts and bolts of superannuation
Every employee who earns more than $450 in a month, must be paid an additional 9.5% of their gross wage into their Superannuation account. So if someone earned $50,000 during a year then they must be paid 9.5% of that amount into their Superannuation account, which is $4,750. Not bad.
People can also add more money to Superannuation in a few different ways. Anyone can choose to ‘salary sacrifice’, this is adding money from your pre-tax wage to your Superannuation, which is taxed at a low rate of 15% (which is lower than most people’s income tax rate). People aged under 49 can contribute up to $30,000 each year, including your employer’s 9.5% super guarantee contribution. This is called the concessional contributions cap. There are higher concessional caps for people closer to retirement, people aged 50 and over can contribute $35,000 each year including your employer’s 9.5% super guarantee contribution.
So why would anyone do that? Well, other than saving for retirement which can be done outside of Super, the idea is to save on tax.
So far we know it’s saving for the future and saves on tax and, unless you want to work until your time on the Earth is up, you need to be building up a retirement fund to finance your life after you’ve stopped working. This is why the age that I’m allowed to access my Super is set at 60 years old. The pension, which is paid by the Government (if it still exists when I get to that age), is set at 67 years old. That is a loooong way away for me and there is plenty of time to save and grow in 40 years.
How much could a Superannuation be worth in a lifetime of working 40 years?
Let’s say someone is 20 years old when they start working. Let’s say for ease of this example, they will earn $50,000 (in 2015 dollars) every single year. With this income, they get $4,750 Super from their employer every year at 9.5%. Let’s also say that this person is very conservative and just puts it all in interest investments earning 5% a year. How much would they have if they wanted to access it at age 60?
Simply put, earning a reasonable wage, just earning interest at 5%, you would turn your $190,000 ($4,750 x 40 years) into just over $600,000. That’s great right? But what if this person had gone for something with a bit more growth than interest?
A growth rate of 10% is often touted as the average of the last few decades for investments. Who knows what it will be in the future? But for this, let’s guess it’s going to be 7.5%.
Please note: The above graph is very simplistic and does not take into account changing interest rates, tax, increasing super contributions etc.
Retired millionaire status! How easy was that? This graph just goes to show how, with just $4,750 a year and growing at 7.5% you can achieve great things.
Superannuation is a great thing for Australia. Most Australians don’t think about retirement until much later in life (and lose out on all those years of compounding growth). With Super, most of the population is being made to create their own retirement assets even if they aren’t heavily involved in it.
Australians are building huge wealth with Superannuation, as an example, these are some country’s pension assets from 2014:
- Australia USD $1.7 trillion in Superannuation (for a population of 23 million, that’s USD $73,000 per person).
- Canada USD $1.3 trillion (35 million people, USD $37,142 per person)
- Netherlands USD $1.2 trillion (16.8 million people, $71,000 per person)
- UK USD $2.7 trillion (64 million people USD, $42,187 per person)
- USA $14.7 trillion (319 million people, $46,081 per person).
What does it mean for me?
So, we’ve gone through all the positives about superannuation. I mentioned at the start of this that there are rules and regulations. I can’t access my Super money until I’m at least 60 (and this age will probably be higher by the time I reach 60, it might be 65 or even 70). When Super was first introduced it was tax-free, now it’s taxed at 15% (on contributions and investment income produced), in the future it will probably be taxed more. I want to retire a lot younger than 60, which is why I’m not adding any extra money into my own Superannuation other than the mandatory contributions.
You can also just as easily apply these growth calculations to money invested outside of retirement funds (and you get to make your own rules). This is what we are trying to achieve on our journey. We know that if we keep investing, we can do even better than what is shown on this graph.
Thanks for reading this article about our investing journey Down Under.
Onwards and upwards!