Eight reasons to invest outside super
By Scott Francis July 11, 2011
PORTFOLIO POINT: It's a great place to accumulate wealth, but super is only one part of a sound investment strategy.
One of the new sacred cows of personal finance in Australia is superannuation. Politicians, investment managers and financial planners all sing its praises at any opportunity but it’s important we understand they all have vested interests.
Politicians want constituents to fund their own retirement, investment managers take percentage-based fees from superannuation assets and the bread and butter of any financial planner is superannuation advice.
There is no doubt there is some justification for super’s high profile: as a compulsory, tax-advantaged retirement scheme its attractions have been well documented by Eureka Report over the years.
There are, however, eight distinct limitations that illustrate why it should only be one plank of a much broader investment strategy.
1: It won't be enough
The first reality of superannuation is simple and profound: for most of us it won't be enough to fund our retirement. This lies in the history of superannuation, started in the early 1990s with a compulsory contribution rate of 3%, which increased to the current level of 9% in July 2002 – only nine years ago. It will be increased to 12% – a level seen as adequate – by 2019.
That means that only people who are aged about 27 now will have had contributions at the 9% level through their working lifetime, and only people who are 12 now will have contributions at the 12% level throughout their working lifetime. For those of us older than 27, we have to find a way to supplement our compulsory super, be it be through additional contributions such as salary sacrifice, or investments outside super.
Our general target should be having about 20 times our planned retirement income in superannuation and investment assets by retirement – and most of us are going to have to do some very heavy lifting to get there. The idea that super will be a panacea for a happy and adequate retirement is flawed.
2: It isn’t available until much later on
Superannuation is structured as a retirement savings vehicle – available to most people only once they reach the age of 55 to 60 – depending on their age. By doing some rough back-of-the-envelope calculations we find that super is available for the final third of our life, but is no of great use to us until then.
Prior to that age investment strategies such as creating a cash reserve, buying a house or building an investment portfolio can all prove much better investment strategies than super, depending on how they are executed.
Cash is an increasingly attractive asset class, following changes that see a 50% tax discount on the first $1000 of income from bank interest. Property has proven a very stable investment for many Australians and over long periods shares have proven to outperform all other asset classes.
Another wealth generation strategy people is borrowing to invest, one that generally works better outside of superannuation rather than inside it.
3: The downside of borrowing to invest
Although borrowing in superannuation has never been easier, for tax reasons it may work better for many people outside of super. Consider the stereotypical negatively geared investment property. An average property valued at $450,000 might generate $17,500 of income a year on costs of $30,000 a year (interest, rates, agent fees, maintenance). This is an effective loss of $12,500 a year.
If this is used to reduce taxable income within the superannuation environment, the tax benefit of this is worth $1875. For someone on the top tax rate, the tax benefit is worth $5813. Borrowing to invest – whether in shares or property – is a common tax-management strategy that will almost always work better outside the low tax environment of superannuation.
4: Is it the best place for property?
Superannuation is a saving scheme where the end game, for most people, is funding retirement. Once a superannuation fund is in the pension phase it has the added benefit of having a 0% tax rate, while requiring increasing minimum withdrawals to be taken from the fund every year.
Investment properties owned in superannuation – especially where they make up a large part of the superannuation portfolio – are not well suited to this retirement phase as they are illiquid assets that can't be sold off in instalments to fund pension payments.
So what’s the alternative? Perhaps buy the property in your own name and pay it off using the tax advantages while you are working then use the income it produces to help fund your retirement. Most people would worry about paying tax in retirement, but the reality is that people with investments outside super often pay very little tax in retirement.
5: It is not the only tax-free option in retirement
Given all the talk about super’s tax-free status, one of the most underrated aspects of retirement planning must be the Senior Australians Tax Offset (SATO). SATO allows a single person to earn $30,870, and a couple to earn $53,360 and pay no income tax.
This means that even if a single retiree of age pension age had $500,000 in an investment portfolio producing $25,000 a year of income they would pay no tax – or a couple with $1,000,000 earning $50,000 of income would also pay no tax, without using superannuation.
This leads to an inevitable question: should we put extra personal contributions into superannuation?
6: The cost of getting investments into super
A key aspect to this answer is whether or not there are costs involved in getting money into superannuation. When the window to make $1 million super contributions was around, many people sold assets to make contributions – and paid significant amounts of capital gains tax in the process. Where there are significant tax or transaction costs involved in moving an asset into superannuation, it has to be carefully weighed against the expected benefit.
Consider an investment property or share portfolio bought 30 years ago for $100,000 and now valued at $500,000. If this is sold there are likely to be transaction costs (brokerage or real estate agent fees), plus capital gains tax of more than $60,000 – even if the seller is only in the 31.5% tax bracket.
Careful analysis might well suggest that a person is much better off avoiding these significant costs, and continuing to own these assets in their own name – where SATO will ensure that no income tax is paid on the earnings once a person gets to age pension age.
7: A $25,000 limit on tax
One of the undoubted benefits of superannuation is the ability to make tax-effective contributions. This is now limited to a seemingly arbitrary $25,000 a year, meaning that many people will need to find alternative investment strategies to prepare for their retirement.
8: Estate planning
Superannuation funds vary in what they allow for people to do to manage their estate planning situation. For example, some funds allow a person to make a “binding death benefit nomination” to someone in an “interdependency relationship” with them, effectively providing certainty about where a superannuation death benefit will be paid, while others do not (for more on this, see Who’ll get your super?).
Some funds allow an “anti detriment” payment in the case of a death – effectively a refund of contributions tax paid that can be worth tens of thousands of dollars – while others do not. Then there are issues of tax, with superannuation death benefit payments to non-dependents facing tax consequences. Understanding these issues adds complexity to a person’s estate planning although, to be fair, no one ever said that superannuation would be easy.
Don’t get me wrong, superannuation certainly does have its benefits – not least of all are its tax benefits for contributions and fund earnings. Eureka Report has gone to great lengths to explain exactly what they are and how you can use them to your benefit. But it is possible to overstate the advantages of this investment vehicle.
Listening to some people will give you the impression that super is the cure to all things. It is important to understand the many limitations of superannuation and make sure these are offset with other investment strategies in building a robust personal financial situation.