We all understand the importance of Superannuation. It’s our nest egg which will determine how comfortable or uncomfortable our retired life would be. Yet, when it comes to the technicalities of Superannuation, it rarely is more than a black-box for us. Thanks to books like The Barefoot Investor, there is now considerable awareness around the fees that Super Funds charge. But that’s only one part of the Super puzzle. We hardly ever give due importance to the next steps of analysing and choosing the right portfolio within Super. Salary sacrifice meets a similar fate in our hands.
Though the concept is a simple one but it isn’t the default setting for our Super. Hence it ends up becoming out-of-sight-out-of-mind for most of us. That’s perhaps because it winds up being the lowest in the pecking order of how we utilize our savings.
As our take-home salary goes up, so do our discretionary expenses. With the extra pocket-money, some of us end up spending on upgrading our lifestyle. Some will start renting a bigger house or perhaps buying one. Others will swap that old car with a shiny new one with all the bells & whistles.
And if somehow we are able to resist spending it, we hardly ever think about investing in Super. Our biggest worry is that the money would be locked away for too long. We know there are some tax benefits, but don’t quite understand them too well. And, a more FIRE specific question is that if there is a plan to Retire Early, then how would the baton be passed between investments outside super and within super.
In this post we look at why we decided to salary sacrifice even though the popular opinion amongst the FIRE community is different.
Superannuation in 2020
Super has been more in the news recently than ever before, due to the government allowing partial early access to those who have lost their jobs to COVID. This has brought to light both the positives and the negatives of Super.
Any money saved or invested is only good if it can be used when it is most needed. Therefore at times like these, having access to your Super is such a relief. The forced saving and the ability to prematurely access it only under extraordinary circumstances is a good thing, in our opinion.
The flip side is that there is too much dependence on government policies and on the Super funds. For such a big amount, that it will eventually (hopefully) become, we should have more freedom to use it for some big-ticket-item purchases such as a house purchase. With ever increasing property prices and the associated costs, a first-time buyer needs every penny to fund the deposit. Also the government is in the driver’s seat. So it can decide to change the rules of the game anytime such as changing the preservation age i.e. when one can access the amount in Super, changing how Super is distributed while the Super holder is alive or after he passes away.
Standalone Super Evaluation
We’ve recently started working in Australia. So our accumulated Super amount is nowhere close to what it would have been, had we started our respective careers here. As per figures from The Association of Superannuation Funds of Australia’s (ASFA) October 2017 report, the average combined balance for our age group ranges around $76k. And if you have been following our networth updates, it is easy to deduce that we are nowhere close to that number. In fact, we are just at 35% of what we should have been compared to the average.
As an investment and saving instrument for retirement, there could not be a more efficient vehicle than Super. The tax benefits alone trump whatever independent investment growth projections one can assume.
A hypothetical case or is it!
We used the Moneysmart compound interest calculator to see the impact of an investment of $10,000 made ‘In Super’ vs ‘Outside Super’.
|Investment ‘In Super’||Investment ‘Outside Super‘||Growth Needed to |
Match ‘In Super’ Investments
|Amount after 30 years||$720,814||$572,411||$720,771|
It turns out even at a marginal tax rate of 32.5% (ignoring medical levy), the investment ‘In Super’ ends up being almost $150,000 more than the investment ‘Outside Super’ after 30 years. To match the same returns as those from ‘In Super’, our ‘Outside Super’ investment would have to have an average return of 7.24% per year. That would mean outperforming the Super by 1.24% every year for 30 years!
And then there are further tax benefits on the income generated within Super. But yes, the fact that the holder has to wait till he reaches preservation age to access the amount can be putting off for quite a few.
A great resource from ATO to calculate how much Super you’re expected to have when you retire.
Super as a part of the FIRE plan
When we started to read about Superannuation as a part of the FIRE plan, we found many interesting blogs. A very educational series from Life Long Shuffle and a calculator for finding the right balance between Super and DIY investments from Aussiefirebug gave us a lot of guidance.
We tried the calculator to project our ‘2 stage retirement plan’ as termed by Aussiefirebug in the blog. It projected that we could achieve retirement after 12 years, assuming all conditions remain as they are now (graph below). Not going by the exact numbers to take the decision, but this blog and the calculator helped us decide that investing in Super is a viable strategy and one should not rule out Super when it comes to Retiring Early specifically in Australia.
Enter Salary Sacrifice. Say what?
For the uninitiated, it essentially means that you contribute an additional amount to Super (yes, additional!) over and above the mandatory employer contribution of 9.5%. This when done directly by the employer on behalf of the employee from his pre-tax salary is called Salary Sacrifice. It forms a part of the Super concessional contribution cap, the upper limit for which is $25,000 per year including the employer contribution. Any amount within the concessional contribution cap is taxed at 15% and not at your marginal tax rate.
As with all things, Salary Sacrifice has some good bits and some not-so-good bits. Let’s go through them.
The good bits:
- It is deducted by the employer and hence operationally is simpler to manage once set-up.
- Again, this is forced discipline as you won’t have the money in hand to spend on something that you want and perhaps don’t need.
- Easier tax calculation.
The not so good bits:
- Increased dependency on your employer. With the often encountered horror stories of employers not paying even the 9.5% of Super, giving them the responsibility of even a bigger amount is down right scary!
- In case of a job change the entire process of set up has to be repeated and depending on how efficient the relevant departments are, it can be a pain.
- You may need to routinely track and monitor each salary slip to verify the deduction and match it up with the super statement.
- Plan in advance to stay within the concessional contribution limit, as the responsibility lies with the individual and not with the employer.
Alternative to Salary Sacrifice
If you still wish to utilise the concessional limit without routing the additional payment through your employer, the good news is it is possible and is not that complicated as well.
It involves informing your Super Fund as outlined by the ATO. You send them a form called ‘Notice of Intent to Claim or Vary a Deduction for Personal Super Contributions’ and can be downloaded from ATO’s website. As the amount you deposit will be from your post tax salary, you can claim a tax deduction on that amount. This is to be detailed in the Notice of Intent mentioned above.
Because I hadn’t set up Salary Sacrifice with my employer for the last FY, I ended up following this route and submitting a Notice of Intent. The process was quite simple and my Super Fund HostPlus guided me well in the process. If you have any doubts while doing this, do call your Super provider.
What about the money being locked up forever? One acronym – FHSSS
This is perhaps the elephant in the room. We now know how (and why) to make voluntary contributions to Super but what if we need the amount for an important and a big purchase. While you can anyway access your Super in case of a severe financial hardship, terminal medical condition, temporary or permanent incapacity, on compassionate grounds and ofcourse due to Covid-19. However, specifically for voluntary contributions, you can get access for the First Home Super Saver Scheme.
First Home Super Saver Scheme (acronymed as FHSSS) was introduced in the Federal Budget 2017–18 to “reduce pressure on housing affordability” (straight from ATO’s website). Which in the simplest terms, is a saving within Super for one’s first home. Please note the FH in FHSSS. Yes, it has many conditions and again the dependence on ATO to determine how much money can be withdrawn and the time within which the amount can be utilised.
Now, many in the FIRE community shirk at the thought of buying a house. We’re renters as well and currently have no plans of buying a house in the near future. But we do appreciate that there is an emotional upside to buying a home that you can call your own and the need might creep in, no matter how much you deny it!
So how much can you withdraw under FHSS? You remember the voluntary contributions you were making to your Super, turns out you can access that amount for purchasing your first home. Both concessional and non concessional contributions are considered under this program. To help calculate how much of an amount one can withdraw, taking into account the yearly and total limits:
- 100% of the non-concessional (after-tax) amounts
- 85% of concessional (pre-tax) amounts.
The application needs to be sent to the ATO, who co-ordinate with your Super provider to release the amount. Yes it is a slow (ish) process with a minimum of 15+ days to get the amount. So applying for it when you have decided to buy a house will make sense rather than when you have put down the holding deposit.
For more details, please refer to the ATO website.
Why did we decide to Salary Sacrifice into Super
The decision can be attributed to the following factors:
- Lower taxation
- Volatile external investment environment
- Forced discipline of investing
- Possibility of withdrawing the amount for first home purchase
We decided it was worth topping up an additional amount within the voluntary concessional limit for a few years and close to the FHSSS limit, which is $15000 per year and $30000 in total for an individual. That’s the call we’ve taken for the year 2020. We intend to re-evaluate this decision every year.
If we go ahead with a house purchase, we will need this amount only then. And if we don’t then we would have utilised the tax benefit and invested in the long term. This does not impact our investment strategy outside of super, which we have maintained at the same levels.
This is not a purely “by the projection of numbers” investment but a bit of “long term + tax saving + maybe a house purchase down the road” decision. Let’s see how this one pans out.
Disclaimer: This blog is based on our understanding of Superannuation and it’s functioning and anyone reading is recommended to do their own research.