Enhancing personal and super wealth through deductible contributions: HLB Mann Judd

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Making additional contributions to superannuation has become much easier since 1 July, and offer a number of significant benefits, says Jonathan Philpot, wealth management partner at HLB Mann Judd Sydney.

“With discussion focussing on the tax advantages of using family trusts and negative gearing on property, the tax benefits of superannuation contributions are being overlooked.

“Superannuation is still a very tax-advantaged investment vehicle and making additional contributions is a good way of reducing personal taxable income compared to, say, negative gearing into property, as people get a much greater personal tax deduction,” he said.

Mr Philpot said that making additional contributions has become particularly important as the maximum contribution caps continue to be reduced.

“The tax considerations are only a small part of why maximising super contributions is a good idea, and why the changes that came into effect on 1 July are so useful.

“By taking advantage of personally deductible contributions, Australians can start building their superannuation savings in a meaningful way from a much younger age, and the new rules from 1 July mean this is now much easier to do.

“In the past, employees had to elect to salary-sacrifice in order to make additional superannuation contributions and receive the associated tax savings. Now, people earning salary and wages are able to make voluntary contributions to superannuation on their own behalf and claim a tax deduction in their personal tax return.

“Without additional contributions, people are unlikely to have enough in their superannuation to give them the comfortable retirement they may be looking for.  It is no longer possible to make large contributions close to retirement to lift the level of their funds, and workers need to take a steady long term approach from a younger age.

“In fact, people will need to start consciously building their superannuation in their 40s, and should be trying to contribute as close to the maximum of $25,000 a year as they can, as their main form of long-term savings.

“By making additional deductible contributions through to age 65, people can significantly grow their super balance and potentially get it well above a million dollars.”

Mr Philpot uses the example of a 40 year old with a superannuation balance of $100,000.

If they commit to making the maximum concessional contribution of $25,000 a year, their superannuation balance would reach $1.3 million by age 65 (assuming an average return of 5% p.a. net of inflation [real return]).

Starting balance at age 40 Balance at age 65
$100,000 $1,303,261
$150,000 $1,453,532
$200,000 $1,603,804

In contrast, a 50 year old with the same opening balance would be significantly worse off, reaching just $661,000 by age 65 with the maximum contributions.

Starting balance at age 50 Balance at age 65
$100,000 $661,169
$150,000 $757,934
$200,000 $854,698
$250,000 $951,462
$300,000 $1,048,226

Mr Philpot said it can be difficult for people to commit to making additional superannuation contributions but they need to be aware of what it will mean to their retirement lifestyle.

“For most people in their 40s, repaying the home mortgage is – understandably – the main focus. While this should continue to a be a focus, once people have their mortgage under control, it is worth considering using the offset account to make additional concessional contributions to super (see example below).

“Relying solely on the superannuation guarantee contribution of 9.5 percent is unlikely to allow most people to save enough for a comfortable retirement – something that many people still seem to be unaware of.”

He added that the new changes to superannuation contributions doesn’t automatically spell the end of salary sacrifice arrangements.

“The changes don’t necessarily mean people should cease their salary sacrifice arrangements, as they have two main benefits.

“Firstly, it is an automated savings option, making it easier for people to chip away at growing their wealth as it can be a struggle to come up with funds at year end to contribute to superannuation.

“Secondly the tax benefit is immediate, as it is pre-tax dollars that are salary sacrificed, whereas when using the personal contribution method people have to wait until lodging their tax return for the tax refund,” Mr Philpot said.

Example:

Take the example of Sam, who earns a salary of $110,000. Sam’s employer makes the mandatory superannuation guarantee contributions of $10,450 per annum (i.e. 9.5 percent) on his behalf.

At the end of the 2018 financial year. Sam decides to take $14,550 from his offset account and contribute it to his super fund to reach his maximum concessional contribution limit of $25,000.

When Sam lodges his 2018 tax return he will be able to claim a personal superannuation deduction of $14,550, leading to a tax saving of $5,075 (39 percent including Medicare levy x $14,550). The contribution would be taxed at 15 percent within his superannuation fund ($2,183) so Sam’s overall tax saving would be $3,492, a 24% return on the $14,550 contribution.

If the interest rate on Sam’s mortgage is five percent a year, he would need to generate a return greater than this when investing the $14,550 in order to be ahead. The hurdle rate needed is likely to be lower if the funds are invested in superannuation as opposed to being invested in his own name, due to the low tax rate applied to superannuation earnings.

For example, where the amount is invested in superannuation, to beat the five percent cost, the fund would need to achieve a before tax return of six percent a year, which is more favourable than investing in Sam’s own name where he would need to achieve a before tax return of 8.3 percent a year.

 

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HLB Mann Judd Sydney is a firm of accountants and business and financial advisers, and part of the HLB Mann Judd Australasian Association.

 

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