To many business owners, your business is not just your biggest asset but also your super fund. You generally think that it will fund your retirement plan. The current super guarantee (SG) is 9.5% of an employee’s ordinary time earnings. However, if you’re a sole trader or in a partnership, you generally don’t have to make SG for yourself. But when you retire, you might be glad you did.
According to the Association of Superannuation Funds of Australia (ASFA), only 27% of self-employed people aged 60 to 64 have more than $100,000 invested in super. The reasons why many people have not contributed to their super fund are varied, but there are a few common reasons with the self-employed:
- I can fund my retirement with the proceeds from the sale of my business.
- Super is too boring and slow.
- I am afraid of losing money in super.
ASFA research tells us those self-employed with a degree qualification tend to have higher super balances. However, you don’t need a PhD to get your super organised. You only need to have a clear vision of the retirement you want; set a desired figure and strategy with a trusted adviser; and take action to work towards your goals.
Let’s look at those three reasons in more detail.
REASON 1: I can fund my retirement with the proceeds from the sale of my business
Business owners normally make a decent income while working, but they have very little to live on in retirement because they tend to reinvest most of their profit into the business. This strategy is good in theory and allows them to optimise the use of their cash resources to expand their business or invest in property. However, if they rely on selling their business to fund their retirement, it may be worth less than they think, or it may be too hard to sell.
Are there other ways to prepare for retirement? The amount you can contribute to superannuation is limited, so you need to start contributing to super as early as possible. That is how you build a separate pool of retirement savings – by maximising your superannuation.
REASON 2: Super is too boring and slow
Building wealth is a long-term game. If you are looking for a shiny get-rich-quick scheme, you may end up disappointed, or even worse, lose your hard-earned money in investment scams. The truth is that there is no easy and fast way to build wealth.
Superannuation has been specifically designed for retirement. Hence, the government gives you very generous tax benefits. If you want to claim a tax deduction, the maximum that can be paid into your super each year is $25,000. If you’re not claiming a tax deduction, then you can contribute up to $100,000 per annum. You may be curious about why you would contribute a large amount to your super if there is no tax deduction. It is because the tax on investment returns in your super is only 15%, which is much lower than most people’s marginal tax rate. Income from super may also be tax-free once you retire at age 60 or over. The main strategy here is to convert your asset to tax-effective ongoing cash flow for your retirement. The following examples will show you how your superannuation can help you achieve your dream retirement.
Investment returns in super pay 15% tax. If you invest in something outside super, then you must pay tax on investment returns at your marginal tax rate. There are significant differences in the outcomes between super and non-super investments across year spans. The figures in Table 1 reveal the varying results from 10 to 30 years, assuming you contribute up to the maximum of $25,000 per annum in your super (which becomes $21,250 after 15% contribution tax) with a rate of return of 8%.
Table 1. Different Returns between Super and Non-super Investment
|Super (15% tax)
|Non-super (37% tax) *
|Non-super (45% tax) *
Note: Amount invested = $25,000/year ($21,250/year after 15% contribution tax)
Rate of returns: 8%, since 1992. The median growth fund with super has returned 8% per annum (Superguide).
Compound frequency = annually, compound interest is the addition of interest on the principal sum of investment.
*Income tax rate excluding Medicare levy
The income stream from the super pension at age 60 or over is tax-free. Assuming you have investment assets of $1.5M which generate $75,000 income per annum (5% of the return), the figures in Table 2 show the difference in income after tax between the super and non-super investments at retirement.
Table 2. The difference in income after-tax between Super and Non-super Investment
|$16,341 (at a marginal tax rate)*
|Annual income after tax
* This is based on 2020-21 income tax rate
The amount of income you derive from investments at retirement will decide the quality of your life. With a higher income, you can enjoy holidays of four to six weeks every year, regular good quality restaurant meals out, and private health insurance. This may not be possible with less income after tax.
REASON 3: I am afraid of losing money in super
Risk comes from not knowing what you are doing. We can’t either avoid risk or control the investment market, but we can understand and manage the risk.
Useful tips for minimising risk and maximising your retirement savings include the following:
Diversify your investment: Diversification is about managing the risks/rewards trade-off by selecting a mix of investments that help you achieve more consistent returns over time. Buying a single asset like property in your SMSF is an example of poor diversification.
Dollar-cost averaging: You add money to your super fund every fortnight or month instead of contributing once a year. You are then reducing the risks and increasing the returns over time.
Invest in the right investment option: Taking too many or too few risks will not help you achieve your goals, especially if you are close to your retirement age. Choosing the right investment can provide greater rewards over the long term.
Choose the right super fund: There are many options – industry super funds, retail super funds, super wraps or self-managed super funds (SMSF). Having access to professional advice can help choosing a super fund best suited to your needs.
Start early: You can benefit from compound interest by starting your investment early. The best way to arrive early at your destination is to start early.
Invest enough money in your super: The fundamental challenge of investing is to invest enough money so that you have a real shot at achieving your retirement goals.
Superannuation is important for business owners. By making regular and smart super contributions throughout your working life, you are more likely to have significant savings for your retirement. In addition, planning to top up your super via business sale proceeds or transfer of assets allows an ongoing tax-effective income leading up to your ideal retirement. The quality of your life at retirement will depend on the decisions you make today. Superannuation is a complex area, and you need to work with a trusted adviser who understands your needs and maximises the best outcomes from regular contributions, succession, and sales opportunities for you to enjoy the life you want at retirement.
General advice disclaimer
This information has been provided as general advice. We have not considered your financial circumstances, needs or objectives. You should consider the appropriateness of the advice. You should obtain and consider the relevant Product Disclosure Statement (PDS) and seek the assistance of an authorised financial adviser before making any decision regarding any products or strategies mentioned in this communication.
Whilst all care has been taken in the preparation of this material, it is based on our understanding of current regulatory requirements and laws at the publication date, Sep 2020. As these laws are subject to change you should talk to an authorised adviser for the most up-to-date information. No warranty is given in respect of the information provided and accordingly neither Alliance Wealth nor its related entities, employees or representatives accepts responsibility for any loss suffered by any person arising from reliance on this information.