Superannuation… we all know it’s there, but we don’t tend to pay it too much attention until, before we know it, retirement is creeping up and we start to wonder what’s going to replace our salary once we retire.
So, what is superannuation and how does it work? In this article we are going to dive in and explain what it is, how it works and some hidden benefits that have been vying for your attention for years.
What Is Superannuation?
Superannuation is an incentivised system designed to encourage you to save towards your retirement. Your super builds-up through contributions made by you or your employer and is generally inaccessible until you reach retirement. Your superannuation balance and any contributions are invested while you are still working, to help your balance grow faster.
Your superannuation consists of an accumulation account which receives contributions. If you are an employee in Australia, your employer is required to make mandatory contributions into your accumulation account on your behalf. You may even choose to make additional contributions in the form of salary sacrifice or personal contributions (in fact, your 65 year-old self is pleading with you to do this right now!). If you are self-employed or not working, you are able to make personal contributions, some of which you can claim as a personal tax-deduction.
Once you are retired, or transitioning into retirement, you can use your super accumulation balance to start an income stream. This can provide you with an income to assist in covering your living expenses…. and presumably a little bit left over for sex, drugs and rock ‘n’ roll.
How Does Superannuation Work?
Superannuation works as an effective means of simultaneously helping you fund your own retirement while reducing the pressures on Australia’s social security system. Through mandatory employer contributions and tax-incentives, you are encouraged to build wealth within superannuation, with the intention of fully or partially funding your own retirement.
These incentives and mandatory measures are what makes superannuation work and continue to thrive.
The following steps explain how superannuation works in a practical sense:
1. Choose a Superannuation Fund
If you are an employee, or have been in the past, you may have had a superannuation fund setup for you by your employer. You can choose to continue using this superannuation fund or open a different one. If you are self-employed, you simply find a superannuation fund that suits your needs and make an application to open an account with them. For those of you who like greater control over your super and more investment flexibility, you may decide on a Self Managed Superannuation Fund (SMSF); however, you need to understand the onerous responsibilities and have a sufficient super balance to justify the costs associated. If you like a simple life, an SMSF might not be for you.
2. Decide Super Investment Options
Each super fund allows you to choose one or more investment options within your account. Your super fund allows you to choose from a specific menu of investments, usually ranging from ‘safe as a bank’ to ‘strap me in, let’s go for a ride’ and everything in between. The idea is to choose investments that are aligned with your appetite for risk and expected to produce the level of returns to help you meet your retirement goals.
3. Make Super Contributions
If you are an employee, your employer is required to make contributions to your chosen account at the current rate of 9.5% of your salary (before tax). Unless you have a dodgy employer who thinks you won’t notice if they don’t pay your super; in which case you should report them.
You may even choose to make additional contributions to your super account. If you are an employee, you can salary sacrifice or make personal contributions. If you are self-employed, you simply make contributions to your account, either personally or from your business, based on advice from your accountant.
4. Choose Insurances in Super
Often, your super fund will have personal insurance options available to you, such as Death, TPD and income protection. You may choose to apply for insurance cover within your super fund in line with your needs. The main benefit of holding insurance within super is that it can reduce stress on your personal finances; however, you need to be aware of the limitations, accessibility risks and tax implications of holding insurances within super.
5. Transition Into Retirement
As you near retirement, you can begin to consider how superannuation can be used to help you transition into retirement. For example, it could supplement work-related earnings if you reduce to part-time work or allow you to implement tax-effective retirement strategies.
In fact, in the 10 years leading into retirement is usually where you can get the most benefit from superannuation through maximising contributions and tax-effective strategies, without tying up your money for too long.
6. Convert Into a Retirement Income Stream
Once you are completely retired, your superannuation can be converted into a retirement income stream and allow you to achieve your desired level of retirement income for the remainder of your life. Yep, it’s time to live the life you’ve dreamed of. It’s time to boogie.
Benefits of Superannuation
The main benefit of super is that you receive tax concessions for contributing to and investing in super. By making salary sacrifice contributions to super, you can reduce the amount of income taxed in your personal name. You can also claim a personal tax deduction for certain personal contributions made to super. Both of these types of contributions will reduce the amount of personal income tax you need to pay.
Making additional contributions to super means you are willing to sacrifice now to allow you to have more in retirement as a result of compounded investment earnings and tax concessions.
Once contributions are made into your super accumulation account, any investment earnings within the account are taxed at a maximum of 15%, which can often be lower than the tax on investment earnings if you were to invest outside of super. Then, once you retire and start an income stream, all investment earnings are received tax free.
The tax benefits of superannuation can increase your super and support you for longer in retirement. And, as Kerry Packer famously said,
“… if anybody in this country doesn’t minimise their tax, they want their heads read; because as a Government, I can tell you you’re not spending it that well that we should be donating extra”.
Chris Strano created SuperGuy to help the average punter navigate through the complex and ever-changing super rules. It has since become one of Australia’s leading digital super resources.