Super’s prime time

PORTFOLIO POINT: Super isn’t “old people stuff”. Today we explain why Gen Xers need to lay the foundations early for a super-sized super balance in retirement.

The real problem with most people and their superannuation, in my humble opinion, is that too little thought is given to it until too late.

Most people tend not to pay any attention to their superannuation until:

(a)     They’re within 5-10 years of being able to access it and then desperately want to know how to make it grow faster and last longer

(b)     It’s become a reasonable sum of money

(c)      They develop a whole-of-life interest in their finances

These things rarely seem to happen to people until they’re a minimum of about 45. More like 50, really, based on my experience as a financial adviser.

And those three things tend to happen later in life. By definition, when 9% of the pitiful, early-part-of-your-career salary in your 20s and 30s is going into a super fund, it’s not going to be much. Compounding returns on not very much equals, not surprisingly, not a whole lot more. And, therefore, it’s unlikely, in most people’s cases, that it will be a sum of money that they worry about.

The base-level commerce and economics classes I was taught in high school covered balancing your bank account, cheque accounts (now almost a defunct skill because of the rise of Eftpos, credit cards and direct debit) and the basics of supply and demand.

The basics of superannuation should be added to the commerce/economics section of all school curricula. If it was, and it wouldn’t take much, then people would take an interest in their super earlier and be able to start planning on how to make it grow.

Generation Xers have plenty of time on their side. The first instalment of Superannuation for Gen Xers (to read it, click here Jamie: Feb 23, 2011) pointed out that if you were born after June 30, 1964, you cannot access your super until you have turned at least 60, so you certainly have plenty of time to make super work for you.

Traps for young players

Whoa! Where do I start?

The biggest trap for Gen Xers is to not get interested in super early enough. Making conscious decisions on the sorts of risks you want to take in super is important. It’s an investment truism that risk and reward are inextricably linked. So if you want to have a higher super balance, then you are going to have to take higher risks.

Fundamentally, this means having more of your money in shares and property.

Do you know how much of your super is invested in shares and property? The typical “balanced” fund will have about 60% of their assets sitting in shares and property. If you’re sitting in a balanced fund, then you might not be taking as much of a risk as you’d like to.

Start by calling your current fund and filling in the following table:

I’ve left a couple blank. Some super funds have other assets and might break things down further, into “defensive” assets, “infrastructure”, “hedge funds”, etc.

First, tally up the shares, property and anything else that sounds aggressive.Next, add the cash, with the fixed interest and defensive assets. Whatever that first number comes up as is the level of aggression or level of growth assets in your portfolio. Higher levels of growth assets mean that there is likely to give you better longer-term growth.

Now ask them what other investment options they have. They probably will have more aggressive investment options. That’s not to say that you should jump into one. But start asking some questions about it so that you’ve got something to compare.

The self-employed super vortex

Most employees are covered by the Superannuation Guarantee. Their employers have to pay 9% into super for them every month, or every quarter.

The same does not apply to the self-employed. You don’t have to contribute to your own super fund, if you are not actually an employee drawing a salary from your business.

And many young businesses struggle with cashflow. They might not think that they can justify tipping $5000 or $10,000 into super when there are so many bills to be paid.

This is a trap because there won’t necessarily be a trigger to start paying to super. But the “I’m building my business” excuse can’t last forever. If you wake up 10 or 15 years down the track without having put anything in your super, you’re then going to run into the “concessional contributions” problem. See last week’s column.

Insurance

Gen Xers tend to have lives that are full of debt, full of kids and full of dreams.

Insurance is what should allow you to sleep at night in the knowledge that if “s—t happens”, your family, or yourself, will be able to survive financially and even continue on with some of those dreams.

It might sound like a truism, but your ability to breathe and to work is what provides the ability to service the debt, feed, clothe and educate the kids and consider buying holiday homes, travel overseas, take on a bigger house, investment properties, etc.

I’m not going to go into full chapter and verse about the need for insurance here. But I am going to point out that superannuation can be used to fund a portion of your insurances.

Super can be used to fund:

• Life insurance
• Total and pemanent disability insurance, and
• Income protection insurance

Each has different tax advantages and disadvantages for the holding of it inside or outside super. (For what it’s worth, I generally recommend life and TPD inside super and income protection outside.)

If you’ve got big debts, an expensive lifestyle, a partner, or young kids … then you need some, possibly all, of those insurances. Being able to fund some of them inside super means you can potentially use your non-super money to help pay down the mortgage.

The major argument against using super to pay for some insurances is that if you’re using super money to pay for insurances, then it’s taking away from money in super growing for your future. Fine, but if you’re 40 years old, have $80,000 in super, more than half a million dollars in a mortgage, and about $300,000 to $400,000 of private school fees to look forward to … then the cost of a proper protection policy to cover you for $1.5 million to $2 million is going to look pretty cheap.

Gearing in super

The gearing rules for superannuation got rewritten in September 2007. This was, coincidentally, about six weeks before the top of the market. They then tweaked those rules in mid 2010.

Gearing in super is actually prohibited. However, there are some exceptions. Aren’t there always?

Until 2007, those exceptions were limited to instalment receipts (such as the Telstra 1, 2 and 3 floats, where the second instalment was essentially an interest-free loan), internally geared managed funds and instalment warrants.

You can now gear anything that a super fund would normally be allowed to invest into. This includes property and shares. However, there are some pretty stringent rules around those. And they are largely only available to SMSFs.

Gearing adds risk to investing in super. But it will be appropriate for some Gen X super investors.

Few super platforms allow any sort of gearing. These tend to be limited number of retail super funds, which will give access to some limited forms of geared share funds, both Australian and international.

If you want to take advantage of gearing in managed fund super – and this is certainly not a recommendation – then you’ll probably need to switch to a retail platform/fund that offers the option.

For those with SMSFs, gearing is a distinct possibility. Particularly those who are comfortable with gearing outside super – that is those who use margin loans or borrow to invest in property. The problem is … do you have the money.

And that leads us to …

When to start considering a SMSF

There is a lot to be said for running your own super via a SMSF. However, it’s not all beer and skittles. There is a very serious side to being a super fund trustee. And a lot of work.

For the moment, I’ll assume you’re interested in investing, believe you have the time to devote to it, and understand the risks of getting it wrong.

So when should you consider starting your own SMSF?

The very rough rule is that it’s a minimum of $200,000. The reason for that is that there are certain costs that are unavoidable in SMSFs that you must pay directly. They include accounting and auditing, plus some government fees and charges. They might add up to about $2000 to $2500, in which case, they represent about 1% of the value of your super fund.

That doesn’t include the cost of purchasing or disposing of assets, including your trading fees, or platform fees (if you use a platform), or MERs, if you use funds for exposure to some assets.

However, if you are going to need investment help, then you’ll need to factor in those costs. If that is the case, then you really should have double that figure, or more. That is, more like $400,000 to $500,000.

*****

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are advised to consult your financial adviser.

Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.