Why Do I Love Superannuation?
Say I am 25 years old (not today, not yesterday!), and I have 40 years to retirement.
And let’s say I am on the top rate of tax – so I am losing 47% of tax (including Medicare Levy) on each dollar I earn to invest. Fortunately, my earnings are not so high, so I can avoid the penal rates of tax that apply to very high income earners on their superannuation contributions (the obscurely named ‘Division 293 tax’).
I am suspicious of and do not like superannuation, and so I prefer to take home my pay and invest it in my personal name.
I have earnings of $5000 that I do not need to survive, or that I am willing to sacrifice from funding a lifestyle cost. It might even be a bonus that I have worked hard for. It might have been a whole week of 50 hours including overtime, to achieve an amazing result.
I have to pay tax on the $5000, and at 47% I am left with $2650. That’s $53 per hour for each of my 50 hours.
Then I invest this $2650 and earn 8% over the next 40 years. Still on the high tax rate, the 8% return is really only 4.24% after tax. So the investment grows to $13952.
In 40 years my initial $5000 earnings has not even tripled in value! With the high tax rates and the long time to recover the initial tax paid (which had brought the initial investment down to just $2650), the final result is terrible!
What if I love superannuation?
Instead of taking the $5000 I divert the amount into the tax effective superannuation environment.
Rather than 47% tax, only 15% of the contribution is lost to the Government, leaving $4250 for investment.
And rather than 47% tax being applied to the earnings, only 15% applies (let us ignore the even more beneficial 10% CGT discounted tax rate).
So the 8% rate of return is only tapered to an after tax equivalent of 6.8%.
Which means the $4250, after 40 years has increased to $59053.
That is almost 12 times the initial $5000 – or over $1000 for every hard hour that I worked for that bonus!
It is also more than 4 times greater than the final non-superannuation equivalent of $13952.
That is the power of tax effective investment over the long term, combined with making some smart and difficult decisions, deferring current spending for a wonderful future retirement.
And that is why I love superannuation ….
And one more message here. It can pay to not just focus on the fees you are paying through your superannuation fund. Personally, I prefer to pay a higher fee for the greater chance of a longer term higher rate of performance that more than justifies the fees I pay. Money smartly invested in the best investments over the long term may be a smart cost incurred, rather than paying the least fees for the least intelligence.