Our Federal Treasurer Peter Costello is neither financial planner nor elite athlete but he gave all working Australians some great advice recently - pace yourself. Costello is in the process of overhauling the super system and dramatically simplifying the way the pension phase works. The new rules kick in from July 1 next year but the flip side of the pension simplification is that getting big lump sums into super late in your working life is going to get harder. So Costello's suggestion is to pace yourself and turn the super sprint to the retirement line into more of a middle distance event. What he was signalling is that perhaps the biggest change that has to occur to take full advantage of the new super regime is in our attitude to super and how we use it.
The old approach of clearing the decks through the middle ages - paying off the mortgage, investing the bare minimum in super and then ramping up contributions in the last few years to stash away enough money to fund your retirement will not work as well going forward. The proposed new rules cap the maximum you can contribute in any one year period so if you want to take full advantage of the zero tax on withdrawals for super the challenge is getting the money in under the super tax umbrella in the first place.
In the short term there is a window of opportunity for people with the wherewithal to contribute up to $1 million before July 1 next year as part of the transition arrangements to the new system. But most people simply do not have a lazy $1 million to spare so to take advantage of the retirement tax break the solution has to be about saving smaller amounts over longer periods of time. This is the aspect of the super rule change that needs to get the ear of people who are in the 20 to 30 year old age bracket. Whether they are paying attention and are ready to listen to the message is another thing entirely. Let us look an example of the difference starting young versus older can make. Take a 25-year-old earning $40,000 with $5,000 in existing super and compare that with a 55-year-old earning $80,000 and $50,000 in existing super*. Let us look at the difference starting young versus older can make. Take a 25-year-old earning $40,000 with $5,000 in existing super and compare that with a 55-year-old earning $80,000 and $50,000 in existing super. If our 25-year-old does nothing but accept the minimum 9% super guarantee contribution by the time they are 65 they will have $394,000 in super in today's dollar terms assuming an average market return of 8%. Let us look at our 55-year-old. She realises she does not have enough in super so begins salary sacrificing $20,000 a year into super. She does the sums and realises even with that extra saving her retirement benefit (assuming the same 8% market return) has a projected value of $372,000. She believes that she will need $30,000 a year to live on in retirement. At that rate the super will be spent by the time she is 85. Not a bad result but as she is in good health feels she needs a bigger comfort zone. The only option is to dramatically increase contributions but naturally that severely curtails today's lifestyle. Now consider the position of the 25-year-old. He only has $5000 in super and realises that $394,000 is not enough. So he begins salary sacrificing $100 a month extra into super and by the time he turns 65 that gives a projected retirement benefit of $512,000.
So somebody on half the salary ends up with a more comfortable retirement horizon simply by saving a small amount more over a longer period of time. Peter Costello thinks it is about pacing yourself. To others it is about letting the magic of compounding returns over the long-term help take the pain out of saving for retirement.
Of course for the 20 or 30 year olds there is the real issue of legislative risk - a future government changing the rules can never be discounted. But perhaps the biggest challenge of all is getting younger Australians to understand that with super they are in a race against time. Smart Investing
By Robin Bowerman
8 September 2006
Principal & Head of Retail, Vanguard Investments Australia
http://www.vanguard.com.au/
25th-November-2006 |