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Sow the seeds of wealth

Penny Pryor

No matter what stage of life you’re at, saving for the future should be a priority, and even if you’re 30 years from retirement you need to start thinking about making extra contributions.

Brendan Wheeler (below) might be just 26 but superannuation has been on his mind ever since he finished university and started full-time work as a chiropractor. “I’m a contractor so it’s up to me to contribute my super,” he says. “And the fact is, I have to look [ahead]. I may not necessarily have it in my hands now, but I want to make sure it’s not going to waste.”

While he doesn’t make extra contributions into his super on a regular basis, he does when he has a bit of spare cash. He’s well aware of the benefits of compound interest and starting early. Eventually he wants a self-managed superannuation account. “I feel I can get better control investing it myself,” he says. “[Although] they tend to talk about having $250,000 to $300,000 [as a minimum balance], so it’s probably a while off.”

Brendan recognises his approach is unusual for someone from Generation Y. “Most Gen Y live in the instant-gratification world, whereas super is delayed gratification, which doesn’t make super sexy,” he says.

That might be right, but we all need to follow Brendan’s example and get on board early. Depending on your stage in life, saving for retirement may not be at the forefront of your financial planning yet. But the mindset of looking at super later in life will have to change. Even if, like Brendan, you’re 30 years from retirement you need to start thinking about making extra contributions.

Brendan Wheeler, 26, is well aware of the benefits of compound interest and is building his super early.Photo: Michele Mossop

In addition to his $12,000 super balance, Brendan has an $18,000 share portfolio. He would also like to put a deposit on an investment property at some stage. And even though he has these other financial priorities, he still manages to put a bit extra away in super.

Brendan says he likes even numbers and prefers to “round up” his super contributions when he can. It may seem a small thing, but this kind of thinking at Brendan’s age can translate into thousands of extra dollars by the time he reaches retirement.

Felled

It used to be that the caps on concessional contributions, which limit how much extra you can contribute to super and still qualify for a tax concession, allowed you to throw a lot in at the last minute. But the federal government’s decision to lower the limit to $25,000 a year for most of us (including your 9 per cent super guarantee payments), means you now have to start saving sooner to achieve a solid retirement balance – meaning Brendan is on the right track.

The government’s main reasons for the reduction were to protect its revenue and the budget surplus, but a by-product could be a long-term change in our behaviour.

Westpac Financial Services partner David Simon believes lowering the cap is partly to “encourage people to save sooner rather than later”. Most of us are in dire need of a boost if we want our super to support us. And, as Simon notes, “the prize of starting early is you don’t need to save as much”.

That doesn’t mean you end up with a lower balance, just that the power of compound interest reduces the amount you actually have to sacrifice yourself.

The statistics paint a sad, but very real picture, of how many of us don’t have enough in retirement savings. A large percentage – 83 per cent to be precise – have super balances of less than $100,000, according to research by the Association of Superannuation Funds of Australia. In the 30- to 34-year-old bracket, that percentage is 93 per cent. In the 45 to 49 bracket it’s 80 per cent and for 55 to 59-year olds it’s 69 per cent, according to ASFA’s study of balances in 2009-10.

Those numbers should ring alarm bells, especially if you’re over 55. A super balance of just $100,000 at 55, even if you work for another 10 years on a salary of $80,000, will give you a retirement balance of only $212,397. That, combined with government age pension benefits, would mean an annual income of $26,924 until age 90.

That’s not much more than the full government age pension (including pension supplement) of just over $20,000 a year. Neither sum is anywhere near the $41,090 a year ASFA estimates is needed to maintain a “comfortable” standard of living.

So, let’s look at how the three generations should be navigating their way through the forest of superannuation.

Late Generation Y

This is the age when most of us really start to get serious about our finances. If we don’t already have a mortgage, partner and children, we’re probably thinking about those life goals and how we can best manage our financial situation.

These days we pretty much behave like adolescents, financially, up to the age of 30, Simon, of Westpac Financial Services, says.

“Their major goal is spending their money on holidays, buying their first home,” he says of Gen Y. “[People aged] 30 to 45 are young adults – building a family, focusing on the kids’ education and sometimes upgrading to a more manageable home.”

But what you need to add to your list of priorities, if you’re at this stage in life, is superannuation. A little bit of pain at this point can mean so much more gain later. “It’s so important for people to be starting to put in those maximum contributions early,” Dixon Advisory’s managing director of financial advisory, Nerida Cole, says. “In practice it can be quite difficult to achieve that.”

Dixon encourages its clients to start salary sacrificing as soon as possible, if they’re able to do so. “The power of compounding interest can be a huge difference,” Cole says. “It can be done, if you’re quite disciplined about it.”

Cole suggests directing salary increases, no matter how small, into super. “When you get that 2 or 3 per cent pay increase, divert that straight away into your super, so you’re not noticing the difference in your cash flow,” she says.

Still not convinced? Here’s another way to look at it. If you want to have a “comfortable” retirement to age 91, you need to salary sacrifice 6 per cent of your pay now, on top of your compulsory super.

But put that off until age 45 and you’ll have to kick in an extra 11 per cent until you retire. Delay until 55 and you’ll need to sacrifice 22 per cent of your pay – as long as the caps don’t get in the way.

For those of you thinking it’s much more important to concentrate on clearing your mortgage, or at least building up the equity in the property so you can upgrade later, consider the tables below. In almost every circumstance, you’re better off putting surplus money into super rather than paying off your mortgage.

If that seems contrary to everything you’ve ever been told about responsible financial management, you need to remember the superior tax treatment of superannuation. Any before-tax contribution is taxed at just 15 per cent rather than a personal income tax rate possibly as high as 46.5 per cent (including Medicare).

“The great thing about salary sacrifice is it’s before-tax money, so you’re not feeling it as measurably as if you’re using after-tax savings,” Simon of Westpac says.

It’s after-tax money you use to pay down your home loan.

In another contrary financial message, it looks like you might be better off contributing everything you can to super and then paying off your home when your super money becomes available to you. But more on this later.

Generation X

Once you’ve hit the hurdle of middle age, super should be something you’re really starting to consider properly, because sand is definitely starting to run through the hour glass.

Simon of Westpac is blunt. “There are many ways you can cut the maths, but the thing is getting people to realise the earlier the better,” he says. “From 45 onwards is where a sense of urgency [is required].”

You must be diligent. As always, the more you do now the less you have to do later.

If you do leave it until later, the more you’ll be behind in the race to a comfortable retirement, because of the revised contribution limits.

At this age, you need to have a detailed budget that includes an allowance for extra super contributions. “Try to apportion some of that and gross it up into superannuation,” Simon says.

You’ll need to ask yourself some serious questions as you write a budget, such as: “Are two international holidays a year worth no holidays in retirement?” or “Is upgrading my luxury vehicle every year worth driving the car I retire with for another 20 years?”

Every financial decision you make now involves an “opportunity cost” in retirement and you need to place a real value on these, advisers say.

Look at it this way and you may be more inclined to salary sacrifice a sufficient amount at this stage to avoid having to make massive payments later. “It’s working out the difference between a want and a need,” Simon says.

“It’s not about being a scrooge, it’s about being realistic, about being balanced, about making sure. It’s on an individual basis, but it’s all about prioritisation.”

Although the tables below show that it’s usually better to make payments into superannuation rather than onto the mortgage, building up a reasonable amount of equity in your home is probably still a good idea, from the perspective of fiscal responsibility, Cole says.

“Until there’s a reasonable level of equity in the property, the prudent thing, to provide flexibility, is to pay down the mortgage.” She suggests clearing 50 per cent of your mortgage as a good rule of thumb.

Cole worries that the reduction in concessional contribution limits may not have a positive long-term effect on people’s retirement saving. “It’s disincentivising people to save,” she says.

“We have a huge gap in terms of retirement shortfall and increase in life expectancy. It seems like there’s a bit of a conflict there in terms of discouraging saving.”

Baby boomers

Unfortunately, if you’ve got this far without a retirement strategy you’re really going to have to start doing some hard work now.

Our calculations, which assume a retirement age of 65, indicate you’ll have to start siphoning as much as 22 per cent of your income off into super from age 55, compared with just 6 per cent if you were 35.

Let’s take two people, both aged 30 with incomes of $80,000 and superannuation balances of $50,000. They share the same goal of a super balance of $1 million when they retire at the age of 60.

Colonial First State’s senior technical manager, Craig Day, explains that if one person starts salary sacrificing 12.25 per cent of her income at age 30 and increases that by 5 per cent every year until retirement, making sure never to exceed the concessional contribution cap of $25,000, she’ll reach her goal at retirement.

The other person doesn’t start thinking about retirement until they’re 50, when they do some calculations and realise that to reach $1 million they’ll need to make the maximum concessional contribution annually until retirement, and put in a further $37,000 a year after tax (a non-concessional contribution) for 10 years.

Our thrifty saver will outlay just over $268,000 compared with the more than $500,000 the procrastinator will have to stump up. Those sums show the importance of getting as much money as possible into super early, when you can funnel it in from pre-tax dollars.

“If you’re in a fully taxable environment you’re going to have to earn more than if you’re in a tax-free environment,” says Westpac’s Simon.

So if you’re starting now, with a rather small balance, you’ll need to make significant annual contributions to achieve a big enough balance to sustain you in retirement.

Of course, you could rely on the pension. But will a fortnightly income of $712, plus a supplement of $60.60 if you’re eligible, really be enough for everything you want to do in retirement?

Don’t forget that we’re living longer , which means there’s a real possibility you might be relying on that income for 30 years in retirement.

Follow the breadcrumbs through the woods while you can.

35 $50,000  $500,000 25Super $3767 35 $50,000  $500,000 25Super $69,318
Age Income
level
Mortgage value Years left on mortgage Super or
mortgage
Amount better
off at 65
35  $50,000  $500,000 25 Super  $3767
45  $65,000  $350,000 15 Super  $3103
55  $80,000  $200,000 5 Mortgage  $76
Are you better off putting an extra $1000 a month into super or on your mortage?
Age Income
level
Mortgage value Years left on mortgage  Super or mortgage Amount better
off at 65
35  $50,000  $500,000 25 Super  $69,318
45  $65,000  $350,000 15 Super  $41,198
55  $80,000  $200,000 5 Super  $16,196

Source: MoneySmart super v mortgage calculator (www.moneysmart.gov.au). Assumes mortgage rate of 6.5%.




35 $50,000  $500,000 25Super $3767 35 $50,000  $500,000 25Super $69,318
Age Income
level
Mortgage value Years left on mortgage Super or
mortgage
Amount better
off at 65
35  $50,000  $500,000 25 Super  $3767
45  $65,000  $350,000 15 Super  $3103
55  $80,000  $200,000 5 Mortgage  $76
Are you better off putting an extra $1000 a month into super or on your mortage?
Age Income
level
Mortgage value Years left on mortgage  Super or mortgage Amount better
off at 65
35  $50,000  $500,000 25 Super  $69,318
45  $65,000  $350,000 15 Super  $41,198
55  $80,000  $200,000 5 Super  $16,196

Source: MoneySmart super v mortgage calculator (www.moneysmart.gov.au). Assumes mortgage rate of 6.5%.

35 $50,000  $500,000 25Super $3767 35 $50,000  $500,000 25Super $69,318
Age Income
level
Mortgage value Years left on mortgage Super or
mortgage
Amount better
off at 65
35  $50,000  $500,000 25 Super  $3767
45  $65,000  $350,000 15 Super  $3103
55  $80,000  $200,000 5 Mortgage  $76
Are you better off putting an extra $1000 a month into super or on your mortage?
Age Income
level
Mortgage value Years left on mortgage  Super or mortgage Amount better
off at 65
35  $50,000  $500,000 25 Super  $69,318
45  $65,000  $350,000 15 Super  $41,198
55  $80,000  $200,000 5 Super  $16,196

Source: MoneySmart super v mortgage calculator (www.moneysmart.gov.au). Assumes mortgage rate of 6.5%.

35 $50,000  $500,000 25Super $3767 35 $50,000  $500,000 25Super $69,318
Age Income
level
Mortgage value Years left on mortgage Super or
mortgage
Amount better
off at 65
35  $50,000  $500,000 25 Super  $3767
45  $65,000  $350,000 15 Super  $3103
55  $80,000  $200,000 5 Mortgage  $76
Are you better off putting an extra $1000 a month into super or on your mortage?
Age Income
level
Mortgage value Years left on mortgage  Super or mortgage Amount better
off at 65
35  $50,000  $500,000 25 Super  $69,318
45  $65,000  $350,000 15 Super  $41,198
55  $80,000  $200,000 5 Super  $16,196

Source: MoneySmart super v mortgage calculator (www.moneysmart.gov.au). Assumes mortgage rate of 6.5%.

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