Update No. 175 – 08/08/14

This post is a ‘Part 2’; last week’s post is assumed knowledge for this week’s readers. The two should be read as a ‘pigeon pair’.

Australian median total earnings (for an ordinary, full-time person, last published from ABS was the November 2013 figure) is $1,437 per week, or $74,724 annually (I know, we’re an embarrassingly prosperous country). This will be the base assumption for our ‘median’ worker. This person will already under the Superannuation Contribution Guarantee (SCG) have around $7,000 set aside annually, but like our case study from last week, our median earner is a good saver. I will assume they have made the decision to put aside $7,000 (circa 10%) of their income annually.

A person earning between $37,000 and $80,000 finds themselves taxed 32.5c on the dollar. Our median wage earner is saving $7,000 annually, as with last week, we will investigate two savings options.

Option 1, they could earn their wage and save from their take home pay. After paying 32.5c tax on each dollar, they will have 67.5c left to invest or $4,725.

Option 2, they could sacrifice that $7,000 they intend to save from their pre-tax salary, avoiding the 32.5c income tax, but incurring a 15% contribution tax. Our median wage-earner will therefore be deploying 85c on the dollar into investments via Superannuation, or $5,950.

From their savings choices, the decision to save into Superannuation has resulted in an immediate 25.93% gain (5950/4725). For simplicity, we will assume their tax-rate remains constant (32.5% on dividend earnings in the investment held outside of Superannuation & 6.5% on the annual change in the Superannuation based investment). We assume further, they are 35 years old and manage to earn 8% per annum (4% from capital appreciation & 4% from fully franked dividends) with the portion remaining after tax reinvested each year. Finally, we assume they maintain their good discipline and leave both amounts untouched until 65 years of age.

Upon completion of the 30 year investment cycle, the $4,725 invested outside of Superannuation will have become about $49,285. The $5,950 invested via Superannuation will have become a little over $88,000. The 25.93% advantage has grown to an advantage exceeding 78% over the investment period. Through nothing more than the tax-advantages of Superannuation as the rules stand, the exact same decision (to forego $7,000 income) leads to a 78% better final outcome. Should our sensible median wage earner continue to make the same $7,000 sacrifice annually, option 1 would end up with a savings pool held outside of Superannuation (which, depending on our median wage-earner’s retirement income, they may have to pay some tax on earnings/gains) of over $616,000. Option 2 would generate over $992,000 of Superannuation wealth, free to be distributed as a tax-free pension. Bear in mind, those two amounts are entirely separate to the Superannuation Contribution Guarantee the subject would have put aside.

Our final case study will be a ‘high income earner’. In Australia, our top tax bracket of 45c in the dollar commences with every dollar of income over $180,000. A $200,000 income earner will already have $18,500 set aside annually in the SCG. As mentioned last week, the maximum Concessional Contribution is $30,000 currently for an under 50 year old. Someone earning a $200k salary choosing not to top their contribution up to the full $30,000 is quite possibly insane as I will demonstrate.

Our high income earner will be saving $11,500 annually (less than 6% of their income), in order to maximise their Concessional Contribution at $30,000. As with above, we will investigate two savings options.

Option 1, they could earn their wage and save from their take home pay. After paying 45c tax on each dollar, they will have 55c left to invest or $6,325 (of the $11,500 pre-tax salary saved).

Option 2, they could sacrifice that $11,500 they intend to save from their pre-tax salary, avoiding the 45c income tax, but incurring a 15% contribution tax. Our high income earner will therefore be deploying 85c on the dollar into investments via Superannuation, or $9,775.

From their savings choices, the decision to save into Superannuation has resulted in an immediate 54.55% gain (9775/6325). For simplicity, we will assume their tax-rate remains constant (45% on dividend earnings in the investment held outside of Superannuation & 6.5% on the annual change in the Superannuation based investment). We assume further, they are 35 years old and manage to earn 8% per annum (4% from capital appreciation & 4% from fully franked dividends) with the portion remaining after tax reinvested each year. Finally, we assume they maintain their good discipline and leave both amounts untouched until 65 years of age.

Upon completion of the 30 year investment cycle, the $6,325 invested outside of Superannuation will have become nearly $53,700. The $9,975 invested via Superannuation will have become almost $147,700. The 54.55% advantage has grown to an advantage exceeding 175% over the investment period. Through nothing more than the tax-advantages of Superannuation as the rules stand, the exact same decision (to forego $11,500 income) leads to a 175% better final outcome. Should our sensible high income earner continue to make the same $11,500 sacrifice annually, option 1 would end up with a savings pool held outside of Superannuation (which, depending on our high income earner’s retirement income, they would almost certainly have to pay some tax on earnings/gains) of over $716,000. Option 2 would generate over $1.66m of Superannuation wealth, free to be distributed as a tax-free pension (nearly an extra million dollars, despite foregoing the same $345k in earnings over the 30 years). Bear in mind, those two amounts are entirely separate to the Superannuation Contribution Guarantee the subject would have put aside – Tony Hansen 08/08/2014

EGP Fund No. 1 Pty Ltd. Up by 0.61%, trailing the benchmark by 0.13% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 71.40%, leading the benchmark by 41.37% all-time (April 1^st 2011).

^{*1 after 31May 2013 dividend of 2.333 cents per share plus 1.000 cent per share Franking Credit & 31 May 2014 Dividend of 7.000 cents per share plus 3.000 cent per share Franking Credit}

^{*2 calculated based on dividends reinvested}