Superannuation: what you need to know

As compulsory superannuation approaches its 25th birthday, the federal government is planning to enshrine the objective of the $2 trillion system in legislation. But do you know the basics about how it works? The Money asks two super industry experts to share their inside knowledge.

How does it work?

'We have a mandatory system in Australia,' says Sally Loane, the chief executive of the Financial Services Council, which represents Australia's retail and wholesale super funds.

'This means that by law, 9.5 per cent of every Australian's salary is paid to a superannuation fund, which is invested for the long-term to help provide a higher standard of living for all Australians in retirement.'

Why is it important?

'Superannuation helps raise standards of living for our retirees over and above the minimum age pension, and at the same time, reduces the cost to taxpayers of supporting retirees,' Loane says.

'It is critical that the super system enables as many Australians as possible to self-fund their retirements, as future projections show we have a shrinking tax base and a lower workforce participation rate.

'In the next three or four decades we will have fewer and fewer workers paying taxes to support greater numbers of Australians who have retired from the workforce. This will create an unsustainable and unfair burden on generations of younger Australians.'

What are the advantages of super compared to other investments?

Loane describes superannuation as a diversified investment that reduces risk for Australian savers by investing in a range of asset classes, including shares, property, global equities, bonds and cash.

'Diversification is designed to minimise the risk to investors, whilst still securing strong returns over the long term,' she says.

'Other investments, such as residential property, concentrate risk in a single asset. In conjunction with high rates of debt, concentrated risk could have catastrophic consequences for retirement savings should markets incur significant losses.'

David Atkin from industry fund Cbus says another advantage is the tax incentives the government provides.

'Contributions to a fund can be made from "before tax" income and the earnings of the superannuation fund are taxed at a low rate—a maximum of 15 per cent,' he says.

'In retirement, or some years before retirement, a superannuation fund can be "rolled over" or transferred to a fund that pays you an ongoing income stream. That fund pays no tax on the fund earnings, and the ongoing payments you receive are received tax free if you are age 60 or older.'

What's the best thing I can do to maximise my super?

Loane encourages people to become engaged with the superannuation early in life—ideally from the first salary they ever get—and not wait until they are approaching retirement.

'Even while in their twenties, people should think about the savings they will need to support the lifestyle they want in retirement and make annual contributions, in addition to the minimum contributions required under law,' she says.

'A small contribution in your twenties or thirties will grow steadily over the 30 or 40 years before retirement and can make a significant boost to savings. The magic of compound interest means that a small sum can grow to a very substantial one over the long-term if it's managed well.'

She also says people should 'engage their brain' and shop around to make informed choices about which superannuation fund provides the investment choices, insurance and services that best suit their personal needs.

How much do I need?

'The amount we need to comfortably retire is dependent on our income before we retire and our personal circumstances,' Loane says.

'The FSC recommends that everyone aims to save enough to fund an annual income that is equal to 65 per cent of the income they were earning before retirement.

'For example, for an average income earner on $80,000 per annum, we expect they would need around $52,000 each year to sustain their quality of life throughout their retirement. This requires at least half a million in accumulated savings, in addition to any age pension payments a retiree may be eligible to receive.

'For a more detailed, personalised assessment of what is adequate, the FSC recommends you seek financial advice.'

When can I access my super?

'You can access your super after you retire, provided that you are over the "preservation age", which is 60 years for most Australians,' Loane says.

'Surveys show us that significant numbers of Australians now say want to work longer than did previous generations—because they have to, for financial reasons, because they want to, for personal enjoyment, and because they're more able, as they're fitter and healthier.

'Many people will spend over 30 years in retirement, almost as much time as they spent in the workforce, and require sufficient savings to last them such a long period of time.'

How do the special transition to retirement super arrangements work?

Loane says these arrangements allow someone to receive an income from their superannuation after they have reached their preservation age whilst continuing to work.

'This helps retirees to continue to build up their super by allowing ongoing contributions, and also moves their superannuation savings into the "tax free" retirement phase,' she says.

'These strategies encourage older Australians to remain in the workforce by providing a tax benefit, rather than retiring early.'

What should I be aiming for—a lump sum, a pension or a combination of the two?

Both Loane and Atkin recommended that people seek financial advice to answer this question.

'Generally, though, retirees should aim to save enough to receive an income stream from their superannuation,' Loane says. 'A lump sum may be appropriate where your balance is small, or you need to settle a mortgage on your family home, but the most important thing is to seek financial advice before making a decision to withdraw a large lump sum from a superannuation account.

'The aim of super is to provide a steady income stream throughout your retirement to maintain a comfortable standard of living. It is important that you do not over-consume your super savings early in life as this will leave you reliant on the modest age pension later in retirement.'

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