Consistent with most developed nations, Australia provides incentives for people to save for their retirement. Being self-sufficient in retirement reduces the need for Age pensions and other forms of Social Security.

But saving for your retirement means sacrificing the here and now. Money socked away for your 70s and 80s, is money that you can’t enjoy in your 20s and 30s. The opportunity cost is real, so the incentives need to be meaningful.

Fortunately, our superannuation system does indeed provide meaningful incentives in the form of tax concessions. There are tax concessions throughout the entire life of your superannuation journey. But I find that sometimes the biggest tax concession of all is overlooked or underappreciated. This week I want to ensure that you understand exactly where the greatest opportunity exists so that you are making the most of the superannuation tax concessions.

Superannuation Phases

Our superannuation system is divided into two quite distinct phases. The first phase is the accumulation phase. This is the period whilst you are working and building up your retirement savings. The second phase within our superannuation system is the pension phase, sometimes also rebranded as the income stream phase for those who fear that the word pension means that you’re old.

During the accumulation phase, earnings on your super are taxed at just 15%. Capital gains are even better, just 10% provided the asset has been owned for at least one year.

Money that either your employer contributes, or that you contribute and claim a tax deduction, is included in the total income attributable to the fund, and therefore taxed at 15%. For most of us, this is considerably less than if we were to instead accept that income as cash and pay our marginal taxes.

For those on incomes above $250,000, you do have to pay an additional 15% tax on the contributions made, but this still represents a tax saving given that had you instead received this money as cash, you would have paid 45% tax plus Medicare.

The key point to take away is that there are tax concessions provided during the accumulation phase. In my experience, even if people don’t understand the technicalities of exactly what is happening under the hood, they broadly understand that they are saving tax by contributing to superannuation.

The Pot of Gold

What I’ve observed is often underappreciated however, is that the real pot of gold at the end of the rainbow arrives when you get to the pension phase.

At this point, there is 0% tax on earnings, including capital gains. Because you are in pension phase now you are drawing money out. There’s 0% tax on these drawings as well. This is extraordinarily generous. Indeed it is so generous that governments of the past several years have been progressively introducing rules to limit how much of your retirement savings can go into the pension phase.

At present, the maximum that you can put into a tax-free pension is $1.9 million. This is known as the Transfer Balance Cap. It gets adjusted for inflation every few years, so it will rise in the future.

This is an individual threshold, so a couple, if they can manage to split their superannuation savings evenly, could potentially have $3.8 million invested entirely tax free once they are beyond age 60 and have met a condition of release.

Even if you invested this amount of money conservatively, say it earned 5% per year, that’s an income of $190,000. Entirely tax free. Just incredible.

And yet I still get questions from people asking about withdrawing all their money from super when they retire!

Dear Financial Autonomy listener. If you get nothing else out of this podcast for the next 10 years, please, please take away this point. Superannuation pensions are the best tax deal around. Superannuation pensions are the whole point of the superannuation system. The superannuation system doesn’t exist to help you build wealth for the next generation, or help you buy a holiday house or fund your business. Superannuation exists to one day provide you with retirement income, and as a result the tax incentives to direct you towards using it for this purpose are extraordinarily generous.

The maximum you can get into a tax-free pension, as I’ve already mentioned, is currently $1.9 million. In thinking through your strategy then, a high priority is considering how you can best utilise this cap.

Many people will have investments outside of superannuation. Perhaps an investment property or two. Maybe some shares. Perhaps even some shares that have been granted by your employer. As you approach retirement, and potentially even in the early years after you have retired, a key strategy action should be to consider how these non-super assets can be sold down, and the capital contributed into super such that you can use as much of your pension cap as possible.

Sometimes I see people with a relatively modest amount in superannuation pensions, and then two or three investment properties. This is absolutely nuts. Quite aside from the fact that the investment properties produce fairly poor net income, and a whole lot of headaches, they remain accessible for capital gains, and if the rental income is high enough, perhaps income tax as well. You would almost certainly be so much better off if these properties were sold and the proceeds instead placed into a tax-free superannuation pension, assuming you have the room within your cap.

I think I’ll leave it there for this week, hopefully you’ve taken my point. The sweet spot when it comes to superannuation savings is the transfer balance cap, currently $1.9 million. If you are fortunate enough to have a significant level of wealth, your top priority as you approach retirement should be to ensure you use this cap to its maximum extent.

If you need advice on how to maximise your super and your retirement planning, that’s exactly what we do at Guidance Financial Services. Learn more about our retirement planning services below.

Visit our retirement planning page

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