There were big changes to super announced in Tuesday night's federal budget. With the ability to contribute only $25,000 a year before tax and $500,000 after tax over the course of a lifetime, it has again highlighted the need to get started early on securing your financial independence.
It's easy to lose track of just how much smaller our capacity to make super contributions is now compared with where we were just a few years ago. There was a time when you could contribute $100,000 pre-tax into super, which meant a viable plan was to focus on paying off your house and getting the kids through school, before thinking about making active contributions to your retirement saving.
All that has changed in recent years, and regardless of who you are, unless you are making additional investments above the current compulsory contribution rate of 9.5 per cent of salary, you are going to struggle to have enough to retire on.
There were some welcome incentives, such as the Low Income Superannuation Tax Offset (replacing Labor's Low Income Super Contribution) and the ability to effectively average concessional contributions over five years, which will assist the self-employed with lumpy incomes and those in the early stages of their career.
However, the reality is that those who have periods out of the paid workforce, or work in low-paid or not-for-profit industries, will continue to find accumulating retirement savings challenging. These people are at a much higher risk of ending their working lives without the security and dignity of independence.
The answer is not to rail against the politicians – the answer is to make the best of what we've got, with these tactics:
As a result of the magic of compounding, contributions made in your 20s are 8-10 times as valuable as contributions made in your 50s and 60s. This is demonstrated by a great chart from Motley Fool, where four people invest $5000 per year for 10 years in the same investment, with the same tax rate.
The saver who starts contributing at 25 and stops 10 years later, ends up with about $787,000 at age 65. This is nine times as much as the 55 year old who starts contributing $5000 per annum in the final 10 years of his working life and finds he only has about $83,000 at retirement.
It might seem unrealistic, but in your early working life, while your wage is lower, you are more likely to be single and have relatively high discretionary income. Conversely, in your 30s and 40s, mortgages and childcare make it really hard to save. It might be tempting to defer saving for retirement until the kids have left home, but in reality it's much harder work.
Little and often
Saving for retirement can seem like a Herculean task, but in reality very small additional voluntary contributions can make a huge difference to the money, and more importantly, the enjoyment, you have in retirement. Say what you like about the industry super fund campaigns during the past few years, but the ads were very effective in pointing out that small differences in inputs, 0.5-1 per cent a year, can make hundreds of thousands of dollars' difference to what you end up with.
If you earn the average full-time Australian wage of $72,800 a year, your compulsory super contributions are just under $7000 per year. If you can make just an additional $166 per month over a 40-year working life into a growth-oriented investment mix, you can end up with around $600,000 EXTRA in retirement savings.
The secret is that you need to make the additional contributions every month, not just now and again. An extra $2000 a year can seem like a lot, but the reality is that achieving savings of $41 a week might come from as little as consistently taking your lunch to work or cutting down on store-bought cafe lattes.
Being forced to make smaller contributions, more regularly, over a longer period might also help improve investment returns. Drip feeding contributions into the market will aid in smoothing out investment returns, particularly during periods of high volatility. This is known as dollar cost averaging and with all the current concern about low absolute returns from all assets classes, it might just be an effective weapon to help build up capital over the long term.
Thinking outside the super square
The collateral damage of superannuation changes is the resulting erosion in consumer confidence in the system. This was reflected in the views of a senior barrister, a super smart, meticulous planner, who has opted out of the super system.
While super provides compelling tax and asset-protection advantages, with the new contribution limits, increasingly it might not offer sufficient capacity to fully fund retirement. My friend the QC has instead opted to create a family trust and drip feed savings, augmented with a small amount of debt, into a broadly diversified portfolio of investments. This might be an answer for those of us who have sold a property or business, or inherited money, and cannot contribute the proceeds into super.
More important than the investment decision is to ensure that monies that would otherwise have been directed to super are not consumed by additional lifestyle spending, such as home renovations or new cars, which might be more fun now, but might result in some misery later.