Technical terminology is okay if it provides shorthand for complex ideas.
But in superannuation, jargon tends to push people away.
That’s a pity, because super is built on basic concepts.
So if you’re feeling a bit confused by it all, here are the five ideas you need to get your head around it:
- Super is a tax arrangement: it is not an investment. You are putting money aside for your retirement (9% of wages) and the government encourages you to do this with tax benefits on contributions and investment earnings. It is the most tax-effective way to save for retirement.
- Super is income replacement: when you no longer work for income, you’ll need to replace this income using your assets (i.e. property and super). The income replacement rate is the percentage of your working life salary that you’ll need to earn in retirement. The sweet spot for singles is around 70% of average salary to live comfortably. For couples it’s more like 55% of combined salaries.
- Establishing a goal: you’ll need assets to generate your replacement income. So, you need a goal. Assume that your investments return 5% per annum. This means you must have enough assets so that when they earn 5% per annum, they produce your replacement income. For example, if you earn $60,000 per year, you’ll need a lump sum of $840,000 to replace your working life income. Your goal should include owning your home by retirement.
- The compound effect: often referred to as earning interest on interest. It works like this: if you put $1,000 into a fund that returns 10%, after one year you earn $100 interest. If you reinvest the principal amount plus the interest ($1,100), then next year you have $1,210. You’ll double your money in seven years by reinvesting like this. Now, add to this a regular contribution, over forty years and with extra contributions and occasional lump sums, in a tax concessional fund, and the compound effect is turbocharged. Superannuation is – in effect – a 40-year compound effect.
- Planning: Most super funds cater to people wanting low volatility and low returns (cash, bonds), through to high volatility and high returns (local and global shares). And all points in between. Generally, people close to retirement choose low volatility-return options while people in their twenties choose high volatility, because they have the time to weather downturns and make their gains. You should match your life stage and goals to your investment profile. Planning covers life insurance, home equity draw-downs, transition to retirement, annuities and special concessions for some Australians. These can be complex so you should take some advice from a professional.
Complexity aside, most Australians can create a retirement plan with a pad, a pen and an internet connection (remember to only rely on information from organisations with an AFSL).
The complexities will emerge – they always do. But you can start towards a comfortable retirement by taking control, setting a plan and empowering yourself to pursue your goals.