Should you invest outside of super?
Mark, Director of Personal Finance Morningstar Australia, answers a reader question about investing outside of super. Mark answers a reader question about investing outside of super.
Mark to market: Should you invest outside of super?
Question:
Hello Mark –
I read your article “Are we being ripped off by super “as I have been thinking a lot about this question, and even wondering if I’m better off not putting extra in my super and rather putting it into ETFs etc myself, despite the tax benefits of super.
Answer:
My recent article asking if we were getting ripped off by super struck I nerve. I received a lot of emails. People expressed their dissatisfaction with their super funds. They complained about customer service. They advocated for SMSFs, member direct options and particular retail and industry funds. I also received the email questioning the wisdom of investing outside of super.
My approach with a question like this is to first do the maths. The answer to any investing question will ultimately come down to what you are trying to accomplish. But you need to understand the maths to provide context for the decision. I am going to run a scenario to see how much an investment outside of super might cost you.
The tax outcomes will vary based on personal circumstances. In my scenario I am assuming an investor contributes $10,000 a year to super for 20 years. The total return is 8% a year and 20% of that total return is received in income annually which is reinvested after the taxes are paid.
The income is taxed at the marginal tax rate for the non-super investment and 15% in the super account. At the end of the 20 years a capital gain is generated for the total gain. Given this holding period I will use the discounted capital gains rate in both the super and non-super account. I’ve assumed the investor pays a 45% marginal tax rate.
The total value of the super account is $459,198 and the non-super account at the highest marginal tax rate is $396,449. The impact of taxes given my scenario is 16% less money if you invest outside of super. Obviously, any change to my scenario including different tax brackets, more frequent trading and the generation of short-term capital gains would increase or shrink the gap.
What I did not address in my scenario was the tax savings on contributions into super. To contribute $10,000 a year into super after the 15% tax on concessional contributions requires earning a pre-tax contribution of $11,764. At the 45% marginal tax rate it takes earnings of $18,181.
To keep the model consistent, I will assume that $10,000 pre-tax is contributed into both super and non-super investment accounts. The super contribution is $8,500 post tax and the contribution into the non-super investment account is $5,500.
After 20 years the super balance is now $390,019. The non-super balance is $218,046. Under that scenario you would have 79% more money in super.
Why invest outside of super?
The tax benefits from investing within super are obvious and illustrated by the scenario I outlined above. But you don’t get anything in life for free and along with the benefits come restrictions. There are rules that dictate the circumstances and timing of when you can remove money from super and for most people that means waiting until preservation age. There are rules about how much is required to be taken out of super once you’ve started withdrawals. The rules and the tax benefits of super can change at any time.
One reason for investing outside of super is to avoid those rules. For instance, if you are trying to retire early you likely need to invest outside of super. Same thing if you have a different goal you want to accomplish before preservation age. There is much more flexibility outside of super than in super. You just pay a price for that flexibility.
Finally, there is the case of fees. In my original article I argued that we are all paying too much in super fees. There is a level of fees that would counteract the tax benefit from money being in super. You can invest outside of super cheaper than inside of super. There are some legitimate reasons for this. I just happen to think the fee differential is higher than it should be.
Under the last scenario I ran which include the tax savings on super contributions there was a 79% difference in wealth generated after 20 years in the super and non-super investment accounts. All things being equal you would have to pay fees of 5.71% of assets annually in super to counteract the tax savings. Super fees are high. They aren’t that high.
In the case of non-concessional contributions super is less appealing. That was the scenario I ran originally which resulted in a super balance that was 16% higher than the non-super balance. Over this 20-year scenario the fee differential in super would have to be 1.50% of assets annually to eliminate the tax advantages in super.
The people that pay the most in super fees as a percentage of assets are in high-cost funds and have low account balances where the fixed nature of the admin fees takes a toll. It is unlikely that any of those people are paying 1.50% more than a low-cost ETF. Anyone who happens to be paying that much in super fees likely wouldn’t be in a position to make non-concessional contributions. For most people that are considering non-concessional contributions super remains the best choice.
Final thoughts
The tax savings of super are undeniable. The fees should be lower but they don’t counteract the benefits of lower taxes in super. As always, what matters is what you are trying to achieve. If the restrictions on when you can access your super don’t align with your goals it makes sense to invest outside of super. If not, super remains a great way to save and invest for retirement.
If you're considering investing outside of super and want to understand the potential benefits and risks, reach out to us for personalized advice tailored to your financial goals. For any further information regarding this article, please call Humble Goode on (08) 7477 8252.
General Advice Warning:The information on this website is intended to be general in nature and is not personal financial product advice. It does not take into account your objectives, financial situation or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation and needs. In particular, you should seek independent financial advice and read the relevant product disclosure statement (PDS) or other offer document prior to making an investment decision in relation to a financial product.