Super in a volatile environment

What are your options for securing your retirement?
 
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01 .Introduction

Super

In brief

  • A knee-jerk reaction to short-term stockmarket fluctuations is a bad idea.
  • Find out the approximate mix of assets your money is invested in; most funds offer a range of investment options.

After four years of annual growth ranging from 14% to 27%, Australian shares have declined in value in 2008. In fact, by June 5, the value of the S&P/ASX 200 index had fallen by more than 12% this year. International shares fell in value too, following turmoil in world financial markets, talk of a recession in the US, and the global ‘credit crunch’. This is unwelcome news for the 90% of working Australians with their retirement savings in superannuation funds; much of the value of most people’s accounts is tied to domestic and international sharemarket performance.

Not surprisingly, there’s renewed interest in superannuation among CHOICE members — particularly those within a decade or so of retirement. People are wondering whether they’re in suitable investments, if they should shift money from shares to a safer haven, such as cash deposits, and how they should manage risk. They’re also asking how much super they’ll need for a comfortable retirement and even whether super is still the best place for their savings, given all the turmoil in financial markets.

CHOICE's verdict on super

Given the uncertainty in financial markets, many are asking if super is still the best place for retirement savings. The answer, from a range of financial industry experts CHOICE contacted, is a resounding yes. Essentially, superannuation is a way to invest in the same things as you’d invest in outside super, while paying less tax. You might have had the same losses outside super — or even worse — after tax. Superannuation isn’t tax-free, but it compares favourably to the alternatives.

Please note: this information was current as of May 2008 but is still a useful guide to today's market. For more recent information, see our article on Future-proof your super 2012.

 
 

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Different ‘asset classes’ offer different levels of risk and potential returns — the higher the risk of losing money, the higher the return you’d expect from that investment.

The main asset classes, ranked from low to high risk (and expected return), are:

  • Cash
  • Fixed interest
  • Property
  • Shares

If share markets are giving you the jitters, you might be considering switching your super away from shares and into a safer haven, such as cash and fixed-interest investments. Don’t make hasty decisions which are likely to have a big impact on the money you have for retirement.

Nine out of 10 super fund members are invested in their fund’s ‘default’ option, which is diversified across different asset classes, spreading the risk. Typically, default funds have about 60% of their money in shares, 20% in fixed interest, 10% in property and 10% in cash.

However, these are just averages; our research found that default funds differ considerably, holding anything from 4% in cash deposits (industry funds) to 15% (commercial funds), for example. Check yours.

Most super funds offer a choice, so you don’t have to go with the default (which is usually a ‘balanced’ option). If you’re planning to withdraw your super as a lump sum in the next year or so, you might want to ‘lock in’ the gains you’ve made by switching to a conservative option that has about 60–70% in ‘safe’ investments such as deposits and fixed interest. Alternatively, if your money is likely to remain in the system for many years, you could maximise your potential returns by switching to a high-growth or ‘aggressive’ option that has 70–80% in ‘growth’ assets, such as shares and property, with the rest invested conservatively. Bear in mind that terms like ‘balanced’, ‘aggressive’, ‘safe’ and ‘defensive’ aren’t used consistently across the industry, so you’ll need to check your fund’s product disclosure statement for its definition.

When making your decision, it’s important to find a match between your investment timeframe, the returns you expect and your attitude to risk. Can you tolerate short-term market fluctuations in the expectation of better average returns over the long term, for example? You don’t have to withdraw your super when you retire or at age 65 — it can continue in the system, accumulating in value and providing you with an income for decades. Many people continue to view super as a long-term investment, even as they edge closer to retirement.

Westpac and Association of Superannuations Funds of Australia (ASFA) produce a regular report estimating the weekly and annual household expenditure for an adequate and a comfortable retirement. There are regional differences — for example, living costs (apart from housing) are higher in regional and country areas compared with capital cities — and perceptions of a ‘modest’ or ‘comfortable’ lifestyle vary, but the figures give an idea of what you need to spend each year.

The table below shows the results:

  • For a ‘modest’ lifestyle, a single person retiring now would need $363 per week ($18,920 per year). A couple $509 per week, or $26,531 per year.
  • For a ‘comfortable’ lifestyle, a couple would need $939 per week ($48,962 per year), while a single retiree would need $702 per week ($36,607 per year).

Of course, these are averages and individual needs vary. Financial planners often use the guideline that you’ll need 60–70% of your pre-retirement income, each year, in order to be comfortable in retirement. Others think this isn’t enough, and that a mistake people make is thinking that their cost of living will dramatically reduce when they retire. The demographer Bernard Salt points to the ‘baby boomer’ generation in particular (for this example, those born between 1945 and 1965), saying they won’t want to be frugal in retirement and that their expectations of maintaining their current lifestyle will cause many to fall 20% short of the living expenses they need.

A much more ambitious target is to aim for a retirement income that’s equal to the after-tax income you earned before retirement. For example, a couple with salaries of $50,000 and $75,000 will take home about $98,000 after tax, so that’s roughly the income they should aim for. It’s a tall order though — a lump sum of about $2 million would be needed to generate that income, which is well beyond the reach of most people.

What do you need for a modest or comfortable retirement today?
Item Modest lifestyle: single per week Modest lifestyle: couple
per week
Comfortable lifestyle: single per week Comfortable lifestyle: couple per week
Housing — ongoing (assuming you own your home) 65.78 68.03 87.39 89.64
Electricity and gas 12.08 14.40 13.23 15.54
Food 65.68 138.24 130.30 183.69
Clothing 14.64 25.25 30.91 56.38
Household goods and services 48.98 51.87 87.04 92.09
Health 11.91 22.44 50.15 98.62
Transport 73.54 74.35 112.23 113.04
Leisure 44.76 74.11 143.20 205.59
Personal care 25.46 40.13 25.46 40.13
Gifts and / or alcohol and tobacco 0 0 22.14 44.29
Total per week 362.85 508.82 702.04 939
Total per year 18,920 26,531 36,607 48,962
 

Source: Westpac ASFA Retirement Standard, December 2007.
 

Age pension

The maximum Age Pension rate, including the pharmaceutical benefit, is $552.60 per fortnight ($276.30 per week) for singles and $919.40 per fortnight ($457.80 per week) for couples. Your income and assets need to be below certain thresholds to qualify. For every $1000 above the asset test threshold, Age Pension recipients lose $1.50 per fortnight (meaning they get a part pension). The income test also applies; the lower of the two tests determines whether you’ll receive an Age Pension, and how much (contact Centrelink for details of the income and asset test thresholds, and what you’re entitled to).

Even these maximum payments fall short of the income needed for what Westpac and the Association of Superannuation Funds of Australia (ASFA) define as a comfortable — or even modest — retirement, so super is generally the way to cover the shortfall.

According to ASFA:

  • Modest lifestyle The Age Pension provides most of the necessary income. In addition, for both a single person and a couple, your super needs to provide a lump sum for investment of about $100,000 in today’s dollars, to support expenditure in retirement that’s consistent with a modest lifestyle (assuming you’ll invest this lump sum and get returns of 7% per annum).
  • Comfortable lifestyle For a single person the lump sum required for investment to give a retirement income is about $500,000 (again in today’s dollars, and assuming nominal investment returns from then on of 7% per annum), while for a couple it’s just over $500,000.

ASFA adds that the asset test allows most retirees to get at least some Age Pension, including those with $500,000. "As well, over time, as people run down their capital they get more Age Pension. To cover the entire retirement period you need a large spreadsheet. The estimate of capital needed for investment at the time of retirement is just one part of the picture."

You need to estimate whether you’re on track to accumulate your required super balance. Some excellent free online calculators can help you:

  • The Australian Securities and Investments Commission’s calculator estimates what your superannuation will be worth when you retire, based on the assumptions you enter. The rate of investment return you assume is critical; test some different scenarios. The calculator also shows the impact that high fees can have on your retirement nest egg. Go to FIDO.
  • AMP has a ‘retirement simulator which helps you determine how many years your super money will last in retirement.
  • Free independent information: The National Information Centre on Retirement Investments (Nicri) provides free, independent and confidential advice. Go to Nicri for more.

You may need to think about strategies to invest more in super before you retire, as well as ways to maximise your returns at the appropriate level of risk.

1 Salary sacrifice

If your employer allows it, making additional contributions from your pre-tax salary is an effective way to boost your super and pay less tax. Be aware that reducing your taxable income through salary sacrificing may also reduce your employer’s contributions to your super fund (usually equivalent to 9% of your base earnings). Try to safeguard these existing contributions before salary sacrificing, by negotiating to maintain your total package value.

2 Free money from the government

Under the co-contribution scheme, people who earn less than $58,980 per year as employees, and who make an after-tax super contribution, can get an additional contribution from the Federal Government. It works on a sliding scale: if you earn less than $28,980, the Federal Government contributes $1.50 for every extra dollar you put in, up to $1500 per year if you contribute $1000 into your super above what your employer pays in. The co-contribution decreases on a sliding scale (it reduces by five cents for every dollar you earn over $28,980) and stops for those earning more than $58,980.

3 Make a contribution on your spouse’s behalf

Tax offsets can be claimed (up to a limit) on super you pay on behalf of your spouse if they have a low income, or no income at all.

4 Make after-tax contributions

They are taxed at lower levels, but there are annual limits for different age groups.

5 Pay lower fees

On average, consumers pay about 1.3% of their super fund balance in fees every year — even when fund managers perform poorly. High fees take a large chunk from your investment returns, so try to pay less. Industry funds often charge lower fees than commercial retail funds, as they don’t pay commissions to financial advisers and are not-for-profit. Pay for financial advice separately when you need it.

6 Review your investment choices

Select a well-diversified mix of assets that reflects your investment timeframe and willingness to accept risk and market volatility. ‘Growth’ assets such as shares are volatile in the short term, but over the long run have given a much better return than safer havens such as cash deposits and fixed-interest funds.

While investment earnings outside super are taxed at your marginal tax rate (up to 46.5%), with super you’ll pay:

  • 0% tax on the way in if you make an after-tax contribution.
  • The tax on pre-tax contributions, such as employer and salary sacrifice payments, is 15%.
  • 15% on the earnings (growth) of your fund, deducted automatically. Often, the actual tax applied is less, after concessions.
  • And no tax applies to fund growth in the pension phase (after you retire).
  • 0% on withdrawal Since 1 July 2007 benefits (withdrawals) paid from taxed super funds to most people aged 60 or older are completely tax-free, whether taken as a regular income or a lump sum. However, some funds don’t qualify, such as Commonwealth Government funds and some state government super funds.

Contribution limits

Super’s principal attraction is lower tax — unless you invest too much. Briefly, here are the rules if you are aged 50-plus and trying to get as much as possible into super before retiring:

  • Pre-tax contributions: these contributions, for which a tax deduction has been claimed by an employer or self-employed person (and include the employer’s 9% super guarantee payments), are taxed at 15% on the way into your fund.
  • The annual limit on contributions (including the 9% super guarantee) is $50,000 — except people aged 50 and over, who can contribute up to $100,000 pa, indexed annually for inflation, until July 2012, when the $50,000 limit applies again, plus an allowance for inflation.
  • If you exceed these limits, a 31.5% penalty tax applies (in addition to the usual 15% tax). After-tax contributions These are not taxed on the way in, unless you exceed the limit. The limit is $150,000 pa for over 65s who satisfy the work test. Under 65s can contribute up to $450,000 over a three-year period. Conditions apply. Over 75s can’t contribute to super. The penalty tax if limits are exceeded is 46.5%.

Go to Australian Taxation Office website for more information about tax and superannuation.

The number of self-managed super funds (SMSFs), or ‘DIY’ funds, almost quadrupled in the last 12 years; 25% of superannuation is now in SMSFs.

To make a DIY fund work, you generally need:

  • At least $200,000 to $250,000
  • Some investment expertise
  • The time and interest to run a super fund
  • An understanding of trustee responsibilities and the rules

However, statistics from the Minister for Superannuation, and the Australian Taxation Office (ATO) throw doubt over whether SMSFs are the best option for many people.

Too expensive

DIY funds, particularly those with small balances, can be very expensive to run. High costs detract from investment returns. The ATO found that the proportion of operating expenses for SMSFs with balances under $50,000 is 10.5% of assets. In comparison, low-cost (non-SMSF) funds charge as little as 0.75% each year, while offering professionally managed investments along with the ability for you to control your own money — for example, through share trading. SMSFs with balances between $50,000 and $200,000 cost 2.63% to 3.55%, and SMSFs worth more than $200,000 had average costs of around 2.3%.

Not enough money

30% of SMSFs have less than $200,000, which is generally the recommended minimum. However, the average balance per member is over $400,000, so plenty of wealthy people have DIY funds too.

Don’t know the rules

An ATO survey found that 21% of SMSF trustees had ‘low’ or ‘low to medium’ knowledge of their legal obligations. 15% didn’t have an investment strategy, and 25% were unaware of the restrictions on the type of assets that could be bought from ‘related parties’ such as friends or business associates.

There’s a big divide between the retirement nest eggs of men and women; the Association of Superannuation Funds of Australia estimates that the average superannuation payout for men in early 2008 will be $155,000, compared with $73,000 for women. And women generally live longer than men, compounding concerns about this shortfall and its impact on retirement living standards.

There are several factors that contribute to this situation: women often earn less money and are more likely to take a career break to look after their children. And while women are out of the workforce and not being paid, they don’t receive regular 9% superannuation guarantee payments.

The Australian Institute of Super Trustees (AIST) supports the introduction of a maternity super guarantee payment by the government.

“The average seven-year career break taken by most women is one of the main reasons for their low super balances on retirement,” AIST says. “For a 30-year-old female with an annual salary of $50,000, taking a career break of six years could cause them to miss out on $77,000 in retirement savings at age 65.” (That’s based on annual investment growth of 8%).

In the absence of paid maternity leave, AIST supports the introduction of a superannuation baby bonus of up to $4000, to be paid into super (it’s based on 9% of the average salary over 12 months). AIST is also calling for an extension of the co-contribution scheme and a lift in age pension payments.

In the meantime, what can women do to boost their super balances? Check Boosting your fund for ideas.

Note: New ‘super splitting’ rules mean that in a divorce settlement superannuation can be treated like other assets, so one spouse could be entitled to a share of the other’s super.
30 June 2007 was the deadline set that allowed investments of up to $1 million in super before penalty tax kicked in. Before that you’d always been able to invest large amounts in super, but from July last year, caps were introduced (see contribution limits).

Hype around the ‘once in a lifetime opportunity’ resulted in many investors selling other assets, such as investment properties, and even borrowing money, to invest in the tax-beneficial environment. Many investors subsequently experienced a significant drop in the value of their super funds, as share markets slumped after the June 2007 investments were made. Some investors fell foul of the technical rules (for example, they invested more than the limits allowed) and got a hefty tax bill . Others borrowed money to invest in super and now have to decide whether to repay their loans or hope for markets to pick up.

If you’re in one of these situations, licensed financial advice might help. But in general, remember that super is for the long term — even for those close to retiring and considering investing in a pension. Negative returns in share markets can be expected every five or six years, but it’s the long-term average that matters most. Try not to overreact to short-term market fluctuations and declines.
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