Paying attention to costs and taxes can improve your retirement

Keeping Retirement Simple – Part 7

If you depend on a water tank to provide your water during a long hot summer, the last thing you want is for it to have a number of leaks.  It’s the same for your retirement nest egg – your savings and super.  If it’s going to provide you with lifetime income, you have to protect it against leakage from paying away too much in costs.

So, retirement funding Principle #7 is: Costs and taxes matter.  It’s generally better to have less of them. 

It’s a simple idea.  Returns on your investments add to your retirement resources.  Costs of investing and taxes reduce your resources.  

What’s complex is that it’s often hard to appreciate how much costs and taxes can impact you; there are many different types; and they’re often hidden below the surface.  

Main types of costs 

Taxes are probably the biggest cost to focus on.  And the good news is that superannuation mostly helps you reduce it.  Super has major tax concessions wrapped up in its design.  It’s typically the best way to save for retirement because of those tax advantages.  The government has set it up to give us incentives in saving for retirement.  

That’s wonderful.  Now we just need to understand the tax benefits and make the most of them.

Understanding the complex Contributions rules is the challenge.  There are so many rules.  Some contributions – such as the superannuation guarantee and salary sacrifice – get concessional tax rates, so you save money by contributing vs saving outside super.  Others, such as personal after tax contributions– don’t get immediate tax benefits but benefit from the lower tax rates on earnings inside super. 

The rules on contributions are truly complex. You can see our Super contributions explained article.  And advice may help you really make sure you understand the rules and don’t miss out.  Retirees have a number of options for make-up contributions that you just may not be aware of.  

Finding a tax edge in retirement: One of the best features of super for retirees is the opportunity for tax free income.  The income stream of a super fund, the so-called “Account Based Pension” provides regular income, which has its earnings and its distributions treated as tax free.  So, at some point in their 60s, depending on when they want to start drawing down, people can switch from “Accumulation” to “Decumulation” and stop paying taxes on their earnings in super.  

Going tax free in retirement might save the super member about $6-700 in earnings per $100,000 in super.  So, if you had, say $500,000 in super, the annual savings might be around $3,000 to $3,500 depending on how you’re invested and how markets do.  That’s a pretty big savings.  

But surprisingly, many Australians are late to move into an Account Based Pension if they move at all.  PWC data shows that less than 50% of 70-74 year olds have made the move.  That’s lost earnings opportunities for retirees (and a gain for government coffers) – boo!  There are some reasons why you may not want to move to tax free status…but most would benefit in terms of tax savings from the move. If you need some advice on this, we can help.  

Investment and Super fund costs

It’s also important to pay attention to super and investment fund costs.  It’s surprising what small differences in costs can make in your retirement spending.  Other things equal, it’s best to have low costs, as costs come out of the returns you earn…and you’ll recall from Part 3, our principle #3 which states that The more you earn on your investments, the longer your savings will last and the more you can spend.  That means what you earn, after costs.  

See what fund fees can cost you:

Let’s take a couple with $500,000 in super and eligibility for the Age Pension.  Let’s say they had the choice between three funds with similar investment strategies…but very different costs. One fund had annual charges amounting to 0.75% of member assets, another charges of 1.25% and the third 1.75%.  If each fund earned 6% before fees on investments, and received the Age Pension, then the couple could expect $69,500 per year(increasing with inflation) up to age 92 with the lowest cost fund but only $68,200 per year with the fund charging half a percent more per year and $67,000 with the most expensive fund.  Those are really quite big differences, simply due to fees.

It turns out there is quite a range of fees in super funds.  And in managed funds which you might use for your non super investments.  While most large super funds operate in a competitive market and offer competitive pricing, there are still plenty of high cost funds out there.  So, it may pay to shop around.  The general problem with picking super funds is that you can’t predict the return (and past performance really is NOT a good indicator of future returns) and you can’t really know what’s going to happen; the only thing you might know in advance is the costs. Our retirement forecasting appointments can help you get a better understanding of what your long term prospects could look like. 

So, pay attention to taxes and other costs.  There’s money to be saved and made.  Money to fund your retirement.