At the end of the day, it always boils down to what your goals are, your time horizons and what your intentions are for your money. Are you investing to fund your retirement? Or are you investing for something else? This will ultimately give you your answer.
This article will give you a big picture overview of the benefits and downsides of investing inside super versus investing outside super.
Benefits of investing in Super
Super is a low tax environment which is often taxed less than your marginal tax rate so it’s a tax-effective place to invest your money.
The super tax rate before you retire (called accumulation phase) is 15% which is lower than your marginal tax rate if you earn over $18,200 p.a. (not taking into account the Low & middle-income tax offsets for simplicity). When you retire (also called pension phase) the tax rate is 0%. There is no tax to pay on any earnings, capital gains or withdrawals. It is a completely tax-free environment.
Tax is the biggest expense you will have in your life so investing in a low tax environment for a long period of time can make a significant difference to your overall wealth, especially when you sell the assets in pension phase and there is no capital gains to pay.
Combine this with the power of long term investing for compound returns and you have an excellent place to grow your wealth.
Not only is it a low tax environment once your money is in the Super environment but there are considerable tax concessions for putting your money in. At the end of the day, the Government wants you to be financially independent and able to fund your own retirement. Why? Because if you are not, you are a liability on their balance sheet as theyhave to pay you a pension or part pension for as long as you live.
This is a large expense considering people are living longer, and the baby boomers are moving into retirement (going from tax payers, to tax consumers in the form of pensions). Therefore there are generous incentives for you to grow your wealth to fund your retirement.
Benefit 1. You can use your pre-tax earnings (Concessional Contributions) to save for your retirement. The Super tax rate is 15% and if your marginal tax rate is higher than this you get the tax savings between your marginal tax rate and the super tax rate.
For example, say you earn an additional $1,000 before tax and your marginal tax rate is 45% (plus 2% Medicare levy):
Outside of super, you will start with $530 (1,000 x (1-47%)) and any dividends/capital gains will be taxed at 45%.
Inside super, you will start with $850 (1,000 x (1-15%)) and any dividends/capital gains will be taxed at 15% or less (see benefit 2 below).
That is a tax saving of $320 or .32c in every dollar you put into super (while in the highest marginal tax bracket) and your money is now in a lower tax environment compared to your marginal tax rate.
This is the most beneficial example but the same principles apply for whatever your marginal tax rate is.
There are also after-tax concessions (Non-Concessional Contributions) to help you get more money into the low tax environment. There are limits for both of these concessions but it is a pretty good deal if you are saving and investing for retirement.
Benefit 2. If you have capital gains and you have held assets longer than 12 months while in accumulation phase you get a ⅓ discount so effectively you only pay tax at 10% on any gains. You can also offset any losses against any gains and you can carry these losses forward.
Benefit 3. Your assets are protected from creditors within the Super environment. If you are in business this is a good place to shelter your assets if you are at risk of being litigated against or you are at risk of your business failing. This is a legal way to ensure your standard of living in retirement is not jeopardised if you are in business.
Downsides of investing in Super
Downside 1.The main downside of investing in Super is that you cannot touch the money until you meet a condition of release or you retire. This can mean the money is tied up for a long time and you are unable to touch it.
If you need this capital then it doesn’t make sense to invest extra cashflow into Super. But if you don’t need it before you will meet a condition of release, it is a great place to invest to let the power of compounding work for you in a low tax environment.
Downside 2. You are legally required to sell or withdraw money each year at a progressive rate when in pension phase. This is because the government wants you to get the money out of the zero tax environment and get it circulating around the economy again so they can collect tax revenue on the money.
Downside 3. There is much complexity and many rules to adhere to around Super, and it is an ever-changing landscape so it can be hard to keep track of all the changes. This is an unfortunate aspect of Super but this is why it is always best to speak to a licensed financial adviser so you can stay on top of the latest rules and take advantage of the many benefits. You can book a no-obligation free call with me here to discuss the many rules and strategies around Superannuation and investing with MacroBusiness.
Benefits of investing outside Super
Benefit 1. The main benefit of investing outside Super is flexibility and the absence of limits on how much you can invest. You have a range of different structures you can invest through. You can invest in your individual name, joint names, through a trust or a company structure. This gives you an enormous amount of flexibility to legally plan and minimise your tax affairs, to provide asset protection and for estate planning purposes.
Benefit 2. If you hold the investments through your personal name or in joint names you are eligible for the 50% capital gains discount.
Benefit 3. If you invest through a family (discretionary) trust you can decide which beneficiaries you distribute the income and gains to, whilst also taking advantage of any capital gains discount; this can significantly help you minimize the amount of tax you pay.
You can also carry losses forward with most structures but it is always best to seek specific tax advice as this is a complex area.
Downsides of investing outside Super
Downside 1. You are ultimately going to have to pay tax at your marginal tax rate or at the company tax rate on any earnings or gains and this is likely higher than investing in the Super environment.
Downside 2. If you invest in your individual name or joint names your assets may be exposed to creditors and predators depending on the structure you use. Again always seek advice from a licensed professional regarding this.
Final Thoughts
People are often sceptical or hesitant about investing in Super because of the seemingly constant changes and the political risk. However, please keep the following in mind. Will there likely be more changes in the future? Yes. Will there be major changes to the fundamental structure of Super, in that it is a low tax environment to grow your wealth for your retirement? Unlikely. Why? Because Super has to be a more attractive place to invest your money than investing outside of super to incentivise people to save for their retirement so the government can minimise that liability or expense.
In short, if you need the money before retirement it would be best to invest outside of Super, If you don’t need the money anytime soon and want to invest for your retirement then it would be much more advantageous to invest inside super.
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Samuel Kerr is the Senior Financial Adviser at the Macrobusiness Fund, which is powered by Nucleus Wealth.
The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Samuel Kerr is an Authorised Representative of Nucleus Advice Pty Limited, Australian Financial Services Licensee 515796. And Nucleus Wealth is a Corporate Authorised Representative of Nucleus Advice Pty Ltd.