Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 156

Rules can change, but the final score still matters most

Amid the furore over the potential changes to superannuation rules, investors should not turn away from the continuing taxation benefits. Super is still the best place to save for retirement for the majority of people.

I am reminded of events during the GFC. It was as if some investors had a view on how the game should be played, rather than how it will be played. There is no point sulking over the rights and wrongs of retrospectivity, but rather, focus on the remaining advantages.

As the GFC was unfolding, some bearish friends seemed certain the whole financial system would collapse and probably never fully recover, especially after the fall of Lehman Brothers. The problem in their case was that more than anything, they wanted the system to collapse because it deserved to collapse.

Their only question was timing. Inevitably, I’d pipe up, “But don’t you think governments might take some action to prevent the complete destruction of the global economy?”, to which the reply was usually, “Investors should have known the risks and they will have to pay the costs.”

(My preference was that the destructive impact of the GFC should have been more widespread. The buying opportunities would have been even better and the lessons imparted would have been better learned. It would have been a lot longer before they were repeated.)

However, the job of an investor is to discount probabilities. The likelihood that the governments of the major economies of the world standing idly by seemed fanciful, so I steadily deployed capital into the ongoing destruction of the markets. I finally ran out of available funds in February 2009, which was only a month before the market eventually bottomed.

Understanding the rules

It is critical to operate within the rules of the system to achieve the best results, even if you don’t agree with the rules. For example, you may think that negative gearing is a foolish system that causes more harm than good and distorts the market. But while the system exists, if you intend to own investment property, you need to understand the system and structure your financial affairs to create the greatest long-term benefit. As Kerry Packer famously said, “Of course I am minimising my tax - if anybody in this country doesn't minimise their tax they want their heads read”. If the rules on negative gearing change and the benefits disappear, then you must find the most advantageous setup available under the new regime.

Another under-exploited opportunity is when couples find themselves in different tax brackets. Investment earnings should be in the lower-earning spouse’s name, and opportunities such as superannuation spouse contributions’ should be thoroughly investigated.

Superannuation remains a place where people can exploit the rules of the game, provided there is a willingness to lock precious capital away and notwithstanding the ever-changing rules of the system.

Consider the taxpayer in the 37% tax bracket who expects to be in that bracket for the rest of their working life and then retire in 20 years’ time. The table below shows the different path of $10,000 saved inside and outside of superannuation. For simplicity, the investor will make 10% per annum, equal parts earnings and capital growth with the after-tax earnings reinvested.

The capital saved out of ordinary income begins life as $6,300 (after paying 37% tax on $10,000 income). The capital contributed pre-tax to superannuation begins its life as $8,500 (after paying the 15% contributions tax). The immediate disadvantage of ordinary savings leaves the saver with only 74.1 cents ($6300/$8,500) for every superannuation dollar.

The pernicious effect of the higher tax rate widens the advantage by roughly 0.7c per dollar every year, culminating in the amount saved out of ordinary earnings being worth only 60.5% of the same amount saved behind the shield of superannuation. That is, in this 20-year example with the same earnings rate, the investor has $30,191 when saving outside super while they have $49,871 inside super, making the non-super investment only 60% of the super balance.

Comparison of saving outside and inside superannuation

Comparison of saving outside and inside superannuation

The Government still wants people to fund their own retirement

If you are nervous about potential changes to the superannuation system, remember that the Government wants you to fund your own retirement. They may poke around to extract additional tax revenues from the enormous superannuation savings pool, but it remains the place where the average saver is likely to generate the best return on an after-tax basis.

Know the rules of the game and exploit them to your greatest advantage.

 

Tony Hansen is Chief Investment Officer at Eternal Growth Partners. This article is for general educational purposes and does not address the investment needs of any individual.

2 Comments
Ramani
May 20, 2016

Tony Hansen

While most of us saw GFC as the inevitable culmination of asinine asset liability mismatch, securitisation taken to a fine art form without substance, intermediaries placing themselves ahead of consumers and investors, auditors colluding with managers in falsifying valuations and the mythical belief that Governments can never fail, you appear to divine - decades later - missed opportunities.

The rest of us lack the blinding hindsight you have retrospectively been endowed with. The next Nobel prize in medicine (ophthalmology) is surely in the post...

Sure you are not working behind the scenes to provide more opportunities via GFC Mark- 2?

Despite all this, your conclusion that super is the best long term savings vehicle for most is fair. In this case, the end justifies the means, and we will overlook your medical escapades.

Tony Hansen
May 21, 2016

I certainly am doing nothing that I'm aware of to expedite the next GFC. I abhor and avoid leverage, and so avoid it entirely. I am likewise leery of most other forms of complex financing.

Believe me when I say that it was with a cautious hand and no sense of where we would be seven years hence when I was deploying my life-savings into the wreckage wrought by the GFC.

All I was attempting to do was to assess the risk/reward and make what appeared to be the economic choice that would provide the greatest benefit for my family.

I was very fortunate, that like every other major midnight in the history of capitalism, a new dawn eventually came.

It is that self-same assessment of risk/reward I encourage others to employ by stacking the tax system in their favour in utilising the superannuation system to the greatest extent they can.

 

Leave a Comment:

     

RELATED ARTICLES

Superannuation and retirement policies

YourSuper will save $17.9 billion! Surely you’re joshing

Three retirement checks for when you have enough

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Strategy

$1 billion and counting: how consultants maximise fees

Despite cutbacks in public service staff, we are spending over a billion dollars a year with five consulting firms. There is little public scrutiny on the value for money. How do consultants decide what to charge?

Investment strategies

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Financial planning

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.

Strategy

Many people misunderstand what life expectancy means

Life expectancy numbers are often interpreted as the likely maximum age of a person but that is incorrect. Here are three reasons why the odds are in favor of people outliving life expectancy estimates.

Investment strategies

Slowing global trade not the threat investors fear

Investors ask whether global supply chains were stretched too far and too complex, and following COVID, is globalisation dead? New research suggests the impact on investment returns will not be as great as feared.

Investment strategies

Wealth doesn’t equal wisdom for 'sophisticated' investors

'Sophisticated' investors can be offered securities without the usual disclosure requirements given to everyday investors, but far more people now qualify than was ever intended. Many are far from sophisticated.

Investment strategies

Is the golden era for active fund managers ending?

Most active fund managers are the beneficiaries of a confluence of favourable events. As future strong returns look challenging, passive is rising and new investors do their own thing, a golden age may be closing.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.