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Self Managed Super Fund (SMSF) Article
A Young Man's Guide to Super

By Tony Negline.

This article may be out of date.

18th April 2007

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There are many ways to save for retirement.  It is important to know some of the ways because it is surprising the differences that can arise and how big an impact those difference make over the long term.

If you are a wage and salary earner there are two principal ways – via salary sacrifice or using after-tax salary and making undeducted contributions.  The more you earn the more tax effective salary sacrifice contributions will be.

For example if you earn $40,000 your marginal tax rate is 30% (you will pay less if you are eligible for Family Tax Benefit).  You take home salary will be about $32,600 which means you tax bill would be about $7,400.  Now assume that you decide to take some of your after tax salary and make a $1,500 undeducted contribution.  There is no tax on this contribution when it is paid into the fund.  After the contribution you would have $31,100 on which to live.

As part of a plan to encourage contributions to super the government is also prepared to contribute up to $1.50 for every dollar of undeducted contributions made by those with assessable income and reportable fringe benefits less than $58,000 and satisfy some other qualification criteria.  Assume all is above board in our example then the government would contribute $900.  This will also be classed as an undeducted contribution.  Your total undeducted contribution is therefore $2,400.  This amount will always be paid out tax-free.

On the other hand suppose you wanted your employer to make salary sacrifice contributions for you.  Assume you ask you employer to salary sacrifice $1,500.  This means your employer would pay you $38,500 in salary.  Your take home salary will decrease to $31,600 or $6,900 in tax.

To compare the two strategies correctly we must also take into account the 15% tax – or $225 – that the super fund will pay on the employer contribution (salary sacrifice contributions are deemed to be employer contributions and are taxed in the financial year they are made).  Total tax from this strategy is therefore 7,125 which is 4% less than using the undeducted contribution route.

However the undeducted contribution is $2,400 whereas the net salary sacrifice contribution is $1,275.  The government contribution route hence ends up in front.

It’s the winner for another reason – undeducted contributions including the co-contribution are always paid out of a super fund tax-free including on a members death if paid to non-dependant beneficiaries.

The same does not apply to employer contributions.  Upon death these will be taxed at 16.5%.

It must be acknowledged that without the government co-contribution the salary sacrifice strategy is initially more tax efficient.  In fact if you are not eligible for the co-contribution, for example because you earn more than $58,000 then you may be better off using the salary sacrifice system.

Some might argue that these difference in contributions are relatively small and ultimately don’t matter to a person’s retirement income levels or to assets that an investor might want to distribute to their successors.  If only they were right.

Their mistake is to ignore the power of compound interest.  Einstein once described it as the most powerful force in the universe.  One dollar invested over 40 years earning 5% p.a. compound will be worth over $7.  To get the same end result after 10 years assuming the same earning rate you would need to invest $4.  If you only wanted to invest $1 for ten years but wanted to receive $7 in year ten then your earning rate would need to increase to over 21% per annum.

An earning rate of 5% is nearly always less risky than 21% per annum.  In effect slow and steady is often the best policy.

There is a clever way to calculate how quickly your money doubles.  It is called the rule of 72.  Simply take 72 and divide it by your earning rate and this is roughly the number of years it takes for your money to double.  For example a 5% return means that you are doubling your money every 14 and a half years.  This is a very handy way of working out what your current retirement assets might grow to by the time you retire.

From July 2007 those wanting to contribute more than $50,000 per annum in employer salary sacrifice contributions will need to be especially careful because from that date “excess concessional contributions” will be taxed at 46.5%.  For five years between July 2007 and 2012, those over 50 will have a threshold of $100,000.

A similar system will apply to undeducted contributions made above the various caps that will apply from July 2007.  These contributions will be known as “excess non-concessional contributions.”  Very high income earners therefore need to be careful about what type of contributions they make.

One final point about salary sacrifice contributions, they are extremely tax efficient but recent Australian Bureau of Statistics data shows that only about 10% of the workforce currently use them.  This is despite the fact that most employers allow it.

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