Superannuation confuses many people, and recent reports about a "secret tax" on your superannuation, which is alleged to be costing retirees millions of dollars, may have confused some even more. The tax referred to is certainly not a secret, but plenty of retirees are not really aware of it, and could be better off financially with a change in their superannuation strategy.
But as usual, it is not "one size fits all". The tax referred to is the 15% tax on the earnings of your fund in accumulation mode. I'm sure you all know that while you are working your superannuation builds up in accumulation mode, where the earnings are taxed at the reduced flat rates of 15% on earnings, and 10% on capital gains. Withdrawals are tax-free once you reach age 60, but not everyone realises that fund earnings continue to be taxed at these rates until you start a pension.
If you convert to pension mode, all earnings on your money become tax-free, but you are required to draw a minimum annual pension. The amount you must draw depends on your age and your balance at June 30 of the previous year. For example, if you are aged between 65 and 74, your first year's pension must be at least 5% of the balance at 30 June in the year before you start the pension.
One of the most important factors in how long your money will last is the net rate of return you achieve on your portfolio after fees and taxes. Over the last 10 years the average balanced accumulation fund has returned 7.2% a year, and the average balanced pension fund 8%. This means a person with $500,000 in super can get an extra 0.8% return by switching to pension mode. That's about $4000 a year, which is not to be sneezed at, and would be a good strategy for many retirees. But as I stressed before, this is not a "one size fits all" strategy.
CASE STUDY Bill and Marcia are aged 66 and 55 respectively. They took some good advice when Bill retired, and moved all his superannuation into Marcia's name, where it will be exempt from Centrelink testing until she reaches her pensionable age of 67. The current balance is $800,000. They read about this "secret tax on superannuation", realised that Marcia's fund was in accumulation mode, and immediately moved her superannuation into pension mode. What they didn't realise is that the moment they did that, the whole balance became assessable for the age pension asset and income tests, so Bill lost his pension of $28,852 a year. Making a major move without advice cost them dearly.
There are two lessons here. The first is the cost of inertia - one of the most common afflictions of people in the investment space. Those of you out there who have left your superannuation in accumulation mode by default may have paid dearly for not getting advice on whether moving it to pension mode would be better you. The second lesson is the danger of making major moves without taking specific advice for your own situation.
If you feel you can't afford advice, remember that good advice should save or make you significantly more money than it costs you. And ask yourself if you can afford to make mistakes. In my experience, paying a little bit of attention to your finances and investing the effort and costs to get accurate, specific advice always pays off in the long term.
- Noel Whittaker is the author of Retirement Made Simple and numerous other books on personal finance. Email: firstname.lastname@example.org
- This advice is general in nature and readers should seek their own professional advice before making any financial decisions.