It is Never too Late to Make a Difference
If you hope to self-fund your retirement and your superannuation is all you have, then you need to accumulate an amount of at least $500,000 and a lot more than that if possible. For homeowners, your super is likely to be the second only in value to your home. For non-home owners it could well become the highest value asset you own.
Saving even half a million dollars seems like an impossible task. But it is not necessarily, because you don’t have to save it all. You only have to save enough capital, and save it quickly enough and early enough to allow sufficient time for the law of compounding returns to kick in and do an ever-increasing amount of the work for you.
You may not realise it but your superannuation is invested in managed funds. It is also a compulsory, long term, regular savings plan operating in the lowest tax environment we have in Australia. It is fueled by the regular contributions that your employer makes on your behalf but there is another force at work behind the scenes. That is, a never-ending investment process. Growth returns and reinvested distributions (similar to dividend income) earned by your investment also cause your superannuation balance to increase. So your money makes money even though you may not be watching it.
Obstacles that get in the way of this money making process include:
- Breaks in employment i.e. no contributions
- Economic downturns (e.g. the GFC)
- High product fees and adviser fees
But by far the biggest obstacle to this money making process is owner neglect. There are ways of cushioning the adverse effects of an economic downturn, overcoming unemployment and reducing high fees. But neglecting your super for 30 years is guaranteed to lose you a fortune.
Let’s look at two fictitious examples.
EXAMPLE 1 – NEGLECT
Let’s say you are suddenly and magically aged 50 and on a salary of about $70,000. Your earliest access to your super is 10 years away. You have a total superannuation balance of $50,000, split between two funds. Your current employer contributes $1,400 each quarter (after 15% tax) to a fund which has $30,000 in it. Your other fund has $20,000 in it and now it is lonely and neglected since you changed jobs. Let’s assume the investment return in the neglected fund roughly equals the fees and other costs, so it doesn’t grow and it doesn’t go backwards. The fund to which your employer is now contributing on your behalf achieves a net annual return of 6% after all fees. After 10 years, your balance in this fund would grow to about $131,500 while the fund you neglect remains at $20,000. (I am being kind here because there is every chance that fees would eat into it). In this example, your total super at age 60 would be about $151,500.
Your first mistake was not consolidating your two funds into one. As a result, you have just blown the opportunity to earn a further $16,000. Why? Because the quarterly contributions of $1,400 were added to a fund with $30,000 in it instead to a fund with $50,000 in it. The law of compounding returns works a lot better on a higher balance, not just regular contributions. In your neglected fund you had neither working for you. The investment return that was actually working hard for you sadly had only 60% of your super to work with.
This example highlights the cost of owner neglect. It is not only neglect of scattered superannuation that hurts you financially. There is also widespread neglect when it comes to high fees, default investments, mismatched risk, poor growth & earnings, decreasing insurance benefits, static premiums, and no thought to possible beneficiaries. In most cases, all are accepted and none are ever questioned, regardless of the fact that every single one of these items is within your power to control and change to your advantage.
So when you are saving and investing, whether in superannuation or not, the seven (7) basic elements you need for the Law of Compounding Returns to work well for you, are:
1) A bigger balance is always better
2) Add more of your own money to it regularly
3) Injecting a lump sum will suddenly accelerate earnings
4) Allow it to run for a longer time, provided that the investment is going well
5) Every bit of investment return counts but you should be comfortable with the associated risk
6) Keep fees or costs as low as possible to achieve the desired result
7) Also think about who receives all this money if you pass away
EXAMPLE 2- LET’S DO A SUPER MAKEOVER
Now let’s assume the same starting circumstances (i.e. 50 years of age with $50,000 in super) but instead of ignoring your super and simply letting it drift along for 10 years, you finally see the light and decide to give it a makeover.
Firstly, you consolidate your entire $50,000 into one fund. You do some research and find that no two super funds are the same and if you look around, you can do very well for yourself. You also realise that the two funds you have aren’t suitable because one has high fees and the other is not portable. So decide on a personal super that is portable, meaning you can take it to every future employer. The fund has a good name; is simple to access and operate online; it has enough investment options for you to choose from; and it has a relatively low fee structure. Your employer is fine with the change because you do have the right to choose your own fund.
Secondly, you decide on an investment mix with a level of risk you feel very comfortable with. As a result of this and and lower fees, you find that your total annual rate of return (after fees) has now increased to 7.0%. My point here is that 1% can make a big difference over many years and it doesn’t have to be achieved by taking on unwanted investment risk. You also realise that you have access to quality insurance cover that actually increases (with indexation) as you get older instead of decreasing to almost nothing at a time when you are most likely to need it. Like all insurance in super, the premiums are automatically deducted from your super account.
Thirdly, because you now know about the law of compounding returns, you realise that your 7% rate of return will make a greater difference on a larger balance, so you decide to increase the total balance of your fund to $100,000 to by adding a $50,000 lump sum as a non-concessional contribution. This simply means you add your own money. This could be from your savings, an inheritance or money from a property you sold.
Fourthly, because you only have one chance at making this 10-year period count towards your retirement, you also decide to salary sacrifice more of your gross salary into super. You ask your employer to contribute more for you. Although it will decrease your take-home pay, it will increase your retirement savings and lower your income tax. You will be paying more tax at 15% and less at your top marginal rate (32.5% in this example). So let’s assume that the quarterly contributions now made by your employer on your behalf increase from $1,400 to $1,700.
Lastly, you have thought about who should receive your money in the event you pass away, and you complete a valid Nomination of Beneficiary form and send it to the fund Trustee. You are not sure whether it should be binding or non-binding so you ask a financial adviser.
In this example, the result over the same 10-year period is a whopping $299,000. That is double the $151,500 you would have resulted in the neglect example. You had to change a few things to do it but you should feeling a lot better about facing retirement And there is more. Because you now realise that time invested is your friend, you decide to carry this strategy on for a further 5 years to age 65. Your balance grows to around $464,000. So how happy are you feeling now?
My examples are built on financial mathematics and general advice, and show you how it is possible to get near that $500,000 mark if you try.
So why is $500,000 my magic minimum target amount? Ok let’s say you retire at age 65 and decide to draw a pension income stream from your super. To receive it as a tax-exempt pension including no tax on investment earnings, you must draw a minimum amount each year equivalent to 5% of the 1 July opening balance of your fund each year. This minimum rises by 1% at 75 and a further 1% at 80. If you draw at least this minimum amount at age 65, 5% of your super disappears in that year.
However, it is still invested. That is why it is called an account-based pension. You draw until the money runs out. So as you can see, preserving your capital invested is a big deal. So it stands to reason if you make at least a 5% return on your money during the year, your super balance stays much the same.
I know that $25,000 (i.e. 5% of $500,000) isn’t a fortune, but with no debt, you can start to avoid starvation. If you can get a higher return on your money, such as 6% or 7% a year, then you can take a higher tax free pension draw (e.g. $30,000 & $35,000 respectively) without eating into you capital. Even if you only make 5% investment return and you draw 8% ($40,000) per year, your invested balance is dropping, but slowly and in a controlled way. Do you see what I’m getting at?
I won’t name names here but there are quite a few well known super funds that achieved 7% and a bit more last year in their balanced investment (mid-range risk) options; and their fee structure is quite low. I’m just saying … it is never too late to make a difference!