Before we can understand how superannuation works, we need to understand what a superannuation fund is and why we have it.
What is superannuation?
Superannuation is money that you or your employer set aside for retirement. This money is accumulated and invested in a superannuation fund which either you or someone else manages. When you reach a certain age, you can draw money from your superannuation fund, and this money generally assists with funding living costs in retirement.
Why do we have superannuation funds?
Superannuation is a critical component of Australia’s retirement income system. The system is made up of three pillars.
- Pillar 1: Means tested age pension. Australians should have a level of income throughout their retirement that provides for a minimum standard of living.
- Pillar 2: Compulsory superannuation. Compulsory superannuation should ensure that a reasonable share of an employee’s income is saved for retirement.
- Pillar 3: Voluntary superannuation. Tax incentives should exist to encourage Australians to provide for themselves in retirement.
As you can see, without superannuation, the foundation of Australia’s retirement income system would be weak.
What ways can we contribute to our superannuation fund?
Compulsory superannuation (Pillar 2)
If you’re over 18 and earn more than $450 before tax in a calendar month from employment, your employer is required to make contributions to your superannuation fund, equal to 9.5% of your ordinary time earnings. This rate is expected to increase by 0.5% each financial year until it reaches 12.0% by the 2026 financial year.
Furthermore, if you work more than 30 hours per week and earn over $450 in a month doing private or domestic work, your employer is required to make contributions to your superannuation fund, regardless of your age.
If you’re a high-income earner and earn more than $57,090 before tax in a quarter, then your employer’s superannuation liability is capped at $5,423.55 for the period.
Many employees are entitled to choose where their employer will pay their superannuation entitlement. They can do this by providing the completed superannuation standard choice form (Superannuation standard choice form | Australian Taxation Office (ato.gov.au)) to their employer. An employer is legally obligated to pay their employee’s superannuation entitlements to the nominated fund within 28 days of the end of each quarter (30 June, 30 September, 31 December, and 31 March).
Non-compulsory superannuation (Pillar 3)
There are several ways you can choose to voluntarily provide for your retirement, and we’ll consider some of these below.
Concessional superannuation fund contributions
If you’re self-employed, you can choose to contribute money to your superannuation fund. You may be entitled to claim a tax deduction for this contribution; however, you’ll need to complete a form notifying your superannuation fund of your intent to claim a tax deduction. In addition to the notice requirement, if you’re 67 years of age or older, you’ll also need to pass a work test. To satisfy the work test, you’re required to work at least 40 hours in a consecutive 30-day period in the financial year you intend to contribute and claim a tax deduction. Effective 1 July 2019, you may be exempt from having to satisfy the work test however the eligibility criteria must be satisfied.
If you’re employed, you can choose to salary sacrifice part of your salary, electing to have the sacrificed salary paid to superannuation by your employer on your behalf. There are generally no limits to the amount of salary which can be sacrificed from an income tax perspective, however if the total superannuation paid by your employer exceeds the concessional contribution cap (currently $25,000), you’ll be liable for additional tax.
These types of superannuation contributions are called concessional contributions. Your superannuation fund will pay income tax on these contributions at a flat rate of 15%.
Non-Concessional superannuation fund contributions
Whether you’re employed, self-employed or unemployed, you may choose to contribute money to superannuation from after tax dollars. If the total superannuation contribution exceeds the non-concessional cap (currently $100,000), you’ll be liable for additional tax. However, in some instances, you can elect to enter a bring forward arrangement. This allows you to contribute up to $300,000 into superannuation, and requires eligibility criteria relating to your age and total superannuation balance to be satisfied.
These superannuation contributions are referred to as non-concessional contributions. These contributions are not subject to income tax in your superannuation fund.
Downsizer Contributions (non-concessional)
Effective 1 July 2018, if you’re 65 years or older, you may be able to make a one-off choice to contribute up to $300,000 of the proceeds from selling your home into superannuation. This is referred to as a downsizer contribution. You’re eligible to make a downsizer contribution if your home was owned by you or your spouse for at least 10 years prior to the sale, the proceeds from the sale are exempt or partially exempt from income tax, and the contribution is made within 90 days of receiving the proceeds from the sale of the home.
This contribution is a non-concessional contribution, not subject to income tax in your superannuation fund, and can be made whether you’re working or not. For this reason, it is a very attractive way to boost your superannuation savings.
Choosing a superannuation fund
According to estimates of the Association of Super Funds of Australia (ASFA), a couple would require a superannuation fund balance of $640,000, and a single person would require a superannuation fund balance of $545,000 to live a comfortable lifestyle in retirement. Based on ASFA’s research stating, the median balance of a 55-64 year old’s superannuation balance is $183,000 (males) & $118,600 (females) (Super Statistics – ASFA (superannuation.asn.au)), it would appear there will be a number of Australian’s who won’t be living comfortably in retirement.
This is just one of the many reasons why choosing the right superannuation fund is important. When you choose a superannuation fund, consider:
- Direct and indirect fee structures,
- Investment options, and
The decisions you make now have the potential to significantly impact the amount of money you will accumulate in superannuation upon retirement. Refer to our recent blog ‘Four Ways to Invest For Retirement’ for a more detailed illustration of this point.
How do you access your superannuation funds?
One of the major impediments to accumulating wealth in superannuation is the restrictions on your ability to access your money. Money is accumulated in your superannuation fund and can only be accessed if you satisfy a condition of release. The most common conditions of release are:
– Reaching your preservation age (60 for those born after 30 June 1964) and retired.
– Reaching your preservation age and commencing a transition to a retirement income stream.
– Ceasing an employment arrangement on or after the age of 60.
– Reaching the age of 65 (irrespective of your employment situation).
– Other grounds relating to incapacity, severe financial hardship, or terminal medical conditions.
Without a significant degree of incapacity, you generally can’t access your superannuation until you reach the age of 60. For these reasons, even once you understand how superannuation works and the associated tax incentives, you should still take a balanced approach to using your superannuation fund as an avenue for wealth accumulation.