Why Voluntary Superannuation Contributions are a Bad Idea

Why Voluntary Superannuation Contributions are a Bad Idea

Inaccessible money makes No Pants Money Man sad

Who here has overheard people talking about voluntary superannuation contributions to “minimize income tax” or “help towards retirement”? If you’re planning on becoming financially independent quickly, it’s just plain crazy talk![1]

Superannuation (super)  is Australia’s version of a 401k, except it has a few shitty differences . In short, super is forced savings for idiots. Employers pay superannuation to their employee’s[2], with the intent that over the course of a traditional 40 year working life their employee’s retirements will be self-funded. The legal minimum super contribution is 9.5% of an employee’s gross earnings. Then, the super money is stored in a heavily ever-changing government regulated superannuation accounts, typically controlled by money (fund) managers . These fund managers charge comparatively expensive management fees and “opt-out” insurance policies. Over time the management fees and insurance policies significantly chew into your compounding returns.

In comparison to 401ks, it’s illegal to access your superannuation cash until you’re at least preservation age (current age as of 2016 is 60 years old).  However, there are extenuating circumstances, such as if you are in an extreme financial crisis (i.e., need to fight off a foreclosure on your house). Nevertheless, it’s impossible to legally use your superannuation for financial independence.

The math of voluntary superannuation contributions

In the light of the above, why would young(ish) people want make voluntary super contributions? They are at the mercy of ever-changing government fiscal orientated regulation,  they get charged expensive fees,  and can’t access the money until they are old. However, the argument I constantly hear for voluntary super contribution is this:  Compared to marginal income tax rates, voluntary super contributions  are taxed at a low rate, so money is saved [3].

Tax Savings

Check out this example. Say hello to Stephanie. She’s an average university educated “middle-class” Australian. Steph earns $90,000 a year, and she ‘s pissed at the $22,732[4] in income tax she is paying per annum. Therefore, she decides to salary sacrifice $10,000 of her paycheck  (under the contribution cap limits) into superannuation. Steph swaps her 37% marginal income tax bracket plus the 2% medicare levy (39% overall) for the 15% tax rate of her superannuation fund. She is now only taxed $1,500 on the $10,000 instead of $3,585. That’s an extra $2,085 that is kept in her pocket. Check out the colorful graphs below if pictures are more your thing.

Colorful Graph BoxVoluntary Superannuation Contributions

Voluntary Superannuation Contributions

Potential long term growth on additional super contributions

On a like-for-like basis the $10,000 will grow more inside superannuation because of the tax difference. Hence, assuming a 5% return that is taxed every year over a 10 year investment period, Stephanie’s $10,000 will grow to $15,162 inside superannuation (tax rate of 15%, excludes any fees and insurance costs) and $13,505 outside of superannuation (marginal tax rate of 39%). That’s post tax difference of $1,658.  See colorful graph box #2 below

Colorful Graph Box #2Voluntary Superannuation Contributions

Therefore, on a like-for-like basis, investing in superannuation has the possibility of increasing your returns over the long term. However, the huge negative for people aiming for financial independence is that addition growth is inaccessible until you’re at least 60 years old. Early retirees need access to their investments now – not in 30 years. Besides, even if you did decide that investing additional money in superannuation suits you, there is significant political risk that could lead to long term bad investment outcomes.

Don’t trust the government maaaan

Do you think the Australian Government is likely to meddle with superannuation laws  over the next 30 years? For example, during my adult life superannuation has gone from a tax free environment to being taxed at 15% for compulsory contributions, and penalizing voluntary contributions. Also, the high income earners out there have to deal with Division 263 tax. It’s reasonable to believe future Governments will further increase the super tax rate and raise the preservation age above 60 years old. This is because, Australia, like may other western countries has an ageing population and government debt laden interest bills to pay. Government regulatory is something you have minimal control over. Therefore, when dealing with such long time frames, I’d rather maximize the level of control over my investments by keeping it outside of superannuation. This limits my exposure to significant access restrictions, high-fee money managers and negative government regulation.

Concluding

Moral of the story? If you want to achieve financial independence you need your cash within your locus of control and working for you now, not in 30 years time. Voluntary super contributions strip you of control and removes your ability to achieve financial independence.

Peace Out,

No Pants Money Man

Footnotes:

  1. This article is for all the 20-40 years old in the room. If you’re getting on a bit, chances are this article won’t be very relevant to you.
  2. Employers have to pay superannuation. It’s a legal thing.
  3. Salary sacrificing is when a proportion of your pay is used, for say, addition superannuation contributions prior to income tax being paid, which generally results in less income tax being paid.
  4. If you’re an Australian, head over to paycalculator.com.au to work out your estimated total taxes for a given financial year
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