Many super funds have had a reasonably good year these last 12 months. This will likely trigger a barrage of adverts and promotions that boast of this or that return beating this or that benchmark.

Higher Super Fund Returns

The point of this post though, is to look at super fund returns from a different perspective, and that is the real world returns of the last few years. We’ll do this by returning to some of the basics for super funds.

Higher super fund returns guessing game

OK. Here’s a test to see how familiar you are with super accounts today…

Let’s say your employer is making a $10,000 contribution into your fund this year. It doesn’t matter if it’s all your employer’s money or part from your employer and part your own “salary sacrifice” into super but the key is that your employer makes the payment. We’ll keep the game easy and say that this $10,000 payment has been the same for each of the last 5 years. Here’s the guessing bit…

After 5 years, what do you think that the balance of your fund would be?

Remember, you will have paid in $50,000 by that time. What do you think the balance would be if your super account earned a consistent 10% per annum? (ps. we are going to assume the return is in a straight line, so no up’s and down’s).

What would your $50,000 of super payments be worth?

The answers are at the end of  this post. So, how well did you do? Were you spot on or close or wildly out? The aim of this post is to highlight the difference between expectations and most likely outcomes for superannuation payments. Most people would expect that all of the money that they pay in to their super fund will be earning income or growing in value. However, the superannuation system is more complex than that.

Super fund guessing game – Part 2

Now here’s the second part of that guessing game… IF you were paying $10,000 a year into your super through your employer, and your fund earned the current term deposit rate of (say) 4.5%, how long would it take before your account balance was equal to the amount you have paid in…?

The answer…?

Somewhere early in the 7th year. Seven years before you do nothing more than earn your money back! Is that what you expected?

Super contributions tax

By now you have probably guessed what is going on here. When you make a contribution to a super fund for which someone, somewhere, will be claiming a tax deduction – there will be a contributions tax payable by the super fund. In the case we looked at above, your $10,000 contribution attracted tax of $1,500 leaving a net $8,500 available to be invested into your super fund. Even if you earned 15% on your contribution in that first year, your net $8,500 would only grow to $9,775. As you can see, the contributions tax has a very large impact on how your account balance will look at the end of the year.

Please don’t interpret this as being an argument against the contributions tax. A 15% tax rate is a very good rate indeed, and for many people this will be much better than taking the super payment as cash wages instead. The average Australian worker will pay a much higher rate of tax on their wages, so the concession available through super is quite generous. However, the impact of the super contributions tax is often understated, and in my experience most people are not aware of just how that impact will alter their super fund balances at the end of the year.

What about existing balances?

The examples above apply for someone who starts with a nil balance in their super account. Logically, if you already have a pool of dollars in your super and it grows at even a modest rate then that may be sufficient to “hide” part or even all of the impact of the super contributions tax. For example, if our person paying in $10,000 as a tax deductible payment were to have $50,000 as an existing account balance then earning the same 4.5%, they would be ahead overall at the end of the first year – but not by much. That person would have an end of year balance of $61,133. It’s quite likely that this would be a little deflating, if they were not aware of how the contributions tax was going to reduce their overall return.

What about the exceptions?

There are always exceptions! For example, some older funds (generally government funds) do not pay contributions tax, and the account balance grows pretty much from day one if we were to use the examples above. However, there is no such thing as a free lunch. Members of these super funds will generally encounter a 15% tax on rolling over or accessing their super lump sum. The dollars of the tax will look bigger but there really is no difference whether the 15% is deducted at the “front end” through contributions or whether it is deducted at “the end”. This was the idea many years ago, when the taxes at retirement were reduced and taxes at the time of contribution were first legislated.

There are also a few quirks under the current super tax laws for people on lower incomes but for the most part, a super contribution by your employer is going to incur that 15% tax – and it will impact on the way your super fund statement is going to look at the end of the year.

ANSWERS : Super Balances after 5 years

At 10%, your account balance would be $57,083. The figures below show how your $50,000 would look at earning rates ranging from 3% through to 10%:

•   3%  $46,481
•   4%  $47,880
•   5%  $49,316
•   6%  $50,790
•   8%  $53,855
•   9%  $55,448
• 10%  $57,083

Notes:

• Please remember that this is a game – nothing in this post is to be considered personal advice and you must not act in any way as if this were personal advice. It is simply an example of how super cashflows work, and an attempt to bring some clarity to an area that in my experience, is often misunderstood by the general public.
• Super fund returns are NOT straight-line. Even a cash account will show varying returns, as the rate alters with Australia’s relative global economic status. i have used a straight-line return for my guessing game simply because that takes away the complication of the wild variations in returns that are possible in the average fund.
• For the sake of simplicity, i have ignored fees in this estimation, and have used returns after fees have been deducted. Although fees have a large impact on returns, the point of this post is to look at the impact of government taxes on estimations and outcomes for the average super fund member.