Recently, Angela – a sole trader new to investing – dropped us a line with a really good question:
"What are the differences between putting more money into superannuation compared to exchange-traded funds (ETFs) ?”
It's not just Angela who's curious. Many of you have asked us the same thing, which really highlights that there's more than one way to invest for the long term.
So, in this episode, we'll weigh the pros and cons of each option, and consider how the latest tax changes might sway our strategies.
Keep in mind that we're only here to share insights and our own research on these topics (which we hope will help you think through your options!). That said, there's no substitute for tailored advice. We always suggest sitting down with a financial adviser or tax accountant who can align investing strategies with your goals, needs and unique circumstances.
Superannuation in a nutshell
Superannuation (also called super ) is Australia’s investment structure designed to help us build wealth for retirement. It’s similar to having an investment broker, but tailored for our future financial security. Super isn't an investment itself, but a vehicle through which we can invest.
Our employers are required to contribute 11.5% of our salary to our chosen super fund (this is set to increase to 12% by 2025). Beyond this mandatory contribution, we can also make voluntary contributions to boost our super. These voluntary contributions come in two forms: pre-tax (concessional) and post-tax (non-concessional), each with its own annual cap. In other words, there’s a limit to how much you can put within those two super contributions.
Pre-tax contributions (concessional) are made before our personal income tax is applied. It offers a reduction in our taxable income and is taxed at a lower rate within the super fund. This method includes salary sacrifice or personal contributions that are tax-deductible, capped at $30,000 annually.
On the other hand, post-tax contributions (non-concessional) are made after personal income tax has been deducted. While we’ve already paid tax on this money before contributing it to super, we still benefit from the special super tax rate on any income or dividends generated within the fund. This method, however, does not offer the initial tax savings that pre-tax contributions do, and is capped at $120,000 annually.
If we look at it from money-saving perspective, concessional contributions tend to be more attractive due to the immediate tax advantages. But, once you hit the cap, additional contributions must be non-concessional unless you are eligible for catch-up concessional contributions (which we will explore later).
Now, it’s worth mentioning that even though we don't get an initial tax break with non-concessional contributions, any money we make from investments within the super fund – like dividends – is taxed at a lower rate than it would be outside of super. So, yes, there are still tax benefits, but it’s not as big of a tax savings in comparison.
We know: the rules around super can be pretty complex. But, the main idea is that investing inside your super offers some solid tax advantages, which can really help boost your retirement savings. Just keep an eye on changes regarding the contribution caps and understand how pre-tax (concessional) and post-tax contributions (non-concessional) work.
Potential pros of investing inside your superannuation
- Tax benefits within superannuation fund
Earnings inside super are taxed at a flat rate of 15%, which is typically lower than your personal income tax rate. For comparison, from July 1st, if your income falls between $18,200 and $45,000, you'll be taxed at 16% income tax rate (a decrease from the 19% previously). And if you earn between $45,001 and $135,000, the rate jumps to $4,288 plus 30% on amount over $45,000.
- Range of investment options available
Super funds allow you to invest in property, infrastructure and private equity. Self-managed super funds (SMSFs) offer even more flexibility and control, though they come with additional fees. There are also simpler super funds with “set-and-forget” options where you can just park your money and contribute to it over a long period.
One thing that’s appealing about super is that it makes investing simple through a funds system called ‘MySuper’. ( As a side note, an investor could potentially achieve the same simplicity with VDHG ETF or the BetaShares’ diversified funds. )
Through a MySuper account, you can typically choose among popular fund choices like AustralianSuper, UniSuper, and Hostplus. If you don’t know where to start, these funds typically offer a tool on their website to help you see where contributions are going. They offer detailed insights into their portfolios and asset allocations so you can decide if it’s for you.
- Made to keep you from spending your savings
A notable feature of super is that it's locked away until retirement. Obviously, depending on your situation and needs, this can be both a pro and a con. On the upside, it discourages frequent withdrawals and changes in investment strategy. However, it also means you can't access these funds early if, for instance, you’re retiring early or buying another investment.
Of course, there are conditions where accessing your super early is allowed, such as financial hardship or certain medical conditions. But, generally, superannuation is designed to be a set-and-forget investment.
Regardless, if you're someone who tends to dip into savings frequently, super might be a good way to ensure your investments stay untouched and grow over time.
Potential cons of investing inside your superannuation
- You can’t access your super until “ preservation age ”
When we think about our super funds, there are a few kinks to iron out. As we’ve mentioned above, you can't tap into your super until you hit your preservation age, which for most of us, is around the age of 60.
But, it's not as simple as turning 60 and instantly accessing your funds. There are criteria you need to meet. And this means that, even at 60, your super might still be off-limits until you're 65 or 67, depending on several factors described by the Australian Taxation Office (ATO).
- There’s a cap on how much you can contribute
It's not a free-for-all where you can dump large sums, like an inheritance or proceeds from a property sale, into your super. You’ll have to consider contribution caps and check whether you are allowed to add more money through catch-up (carry-forward) and downsizer contributions . For instance, some folks are able to make a downsizer contribution after selling a property provided they have reached a certain age.
It’s hard to get all the nuances about these rules into a single podcast episode. However, you can always look up the details on the ATO website to get the specifics for your situation.
Now, because these rules can get pretty complex, it’s easy to overlook a rule that could have big consequences. So, when big life changes are on the line, we always recommend getting professional financial advice to avoid potentially expensive missteps.
Potential pros of investing outside your superannuation (in shares or ETFs)
- Accessibility and liquidity
When it comes to personal finance, there can be benefits in keeping our options open and staying in control. That's exactly why many of us are drawn to investing outside of superannuation – in shares or ETFs. Their accessibility and liquidity in particular make them a popular investment option.
If you’re new to the term 'liquidity,' it simply means how quickly and easily an investment can be converted into cash. With ETFs and shares, you can log into your brokerage account, sell them on any trading day and get your cash fast. In contrast, super funds are ‘frozen’ as they are typically locked away until retirement.
- You can customise your investment portfolio
Unlike the limited choices often presented by typical super funds, investing directly in the market means you can handpick your assets – be it individual shares, ETFs, or even real estate. You have the autonomy to decide where and how your money is invested in a way that meets your personal financial goals and risk tolerance.
- Additional income stream in the form of dividends
When you invest in a company or fund that’s performing well, they might share a slice of their profit with you in the form of dividends . Now, while it’s true that dividends are taxable, it’s still money that comes to you. You essentially have another income stream to fund some of your living expenses.
Sure, your super fund earns dividends too, but they're automatically reinvested. You can’t access that money, along with the rest of your super, until preservation age. In contrast, when you invest outside super, those dividends are yours to use right now, not decades down the track.
Potential cons of investing outside your superannuation
- More taxes and more admin work
Unlike the 15% tax rate inside a super fund, investing outside your super means you have to grapple with your marginal tax rate. And for many of us, that's around 30%, effectively doubling what you'd pay if you were to invest within super. It's a significant jump, and one that’s hard to ignore.
With that said, you need to do your research to keep on top of every dividend and tax detail. And unless you're into that sort of thing, it might mean getting a tax accountant to help out. Basically, it's a lot more hands-on compared to the ease of a super fund, where you set things up once and let compounding do the rest.
- You might be tempted to make speculative investments
Super funds are also neatly regulated. The government keeps an eye on them, and it's easy to track which ones are doing well and which ones aren't. But, when you're managing your own portfolio, it's all on you to keep perspective of what matters and not get sidetracked by the next shiny thing.
This leads us to the next point: accessibility and liquidity of assets don’t necessarily translate to a benefit. For some folks, this could encourage jumping from one investment to another in search of huge and quick returns. Yes, the potential payoff is big, but so are the chances of losing.
Hence, the choice between investing inside or outside super depends on who you are as a person. Are you the type who needs to keep your savings out of sight, out of mind? Or can you trust yourself to invest long-term on your own?
How to decide whether to invest inside or outside superannuation
Aside from the questions above, there are other factors you need to consider if you’re deciding where to invest:
- What are your goals?
Are you looking to retire comfortably, or do you have other plans like buying a house or generating passive income through dividends? Knowing our goals helps us decide where to put our money.
For some, investing directly into super because it's tax-advantaged makes perfect sense, especially if retirement is the main focus. Others might prefer increasing cash flow now through income and dividends.
- What is your timeframe?
If retirement feels like it's ages away, you might not want to lock away extra money into super just yet. However, if you're closer to retirement, it makes more sense to increase your super contributions since you'll be accessing it sooner. For instance, at 26, Tash might only put $50 a week extra into super, while someone nearing retirement might put in $500 a week.
- Are you navigating this decision with a partner?
If one of you is older, they’ll get access to their superannuation funds sooner. So, it makes sense for the older partner to contribute more to their super. That way, your household can start using those funds earlier when needed. This is also one of those strategies where talking to a financial adviser can pay off.
- How much is your taxable income?
Without going into the weeds, if you’re a high earner, the tax benefits of investing in super can be significant. For lower income earners, though, those tax savings might not be as substantial. In the meantime, this article gives a better breakdown: “How is my super taxed in Australia?”.
- Are you going to use your super to buy a home?
We explored the First Home Super Saver Scheme in a previous episode. With this strategy, you need to plan a few years in advance and understand the rules. But, it’s worth considering your super to build up a home deposit if that’s one of your medium-term goals.
- How much do you need to retire?
That’s the million-dollar question, isn’t it? There are plenty of resources out there that give us an idea of how much super we need at different ages to maintain a certain lifestyle. However, while those guidelines can teach you the maths, there’s really no hard and fast rule for how much you’ll need in the future. Only you can imagine how retirement will exactly look like for you.
- When do you need to access that money?
Lastly, think about when you’ll need to access the money. If you’re putting away cash in super, you’re playing the long game, letting compound interest work its magic over decades. Yet, if you suspect you might need that cash earlier, then locking it all away in super might not really be a good option. You have to weigh the benefits of tax savings against the need for liquidity (which is why emergency fund should always come first before investing).
Final thoughts
Should you invest in and out of super? The quick answer is: it really depends on your timeframe, tax rate, and personal goals. But, we get it – it's not always easy to make these decisions.
If you’re feeling stuck or uncertain, why not start small? Even something like $10 or $50 a week can make a difference, and there’s no downside to this incremental strategy.
Finally, if you have any questions or need further clarity, we love receiving voice messages. So, feel free to send one in through any of the links below. We’ll do our best to answer it in upcoming episodes.
Thanks for joining us! If you found this episode helpful, please rate us five stars, write a review, or share it with a friend. And if you're new to investing, make sure to listen to our first ten episodes. Follow us at @getrichslowclub or @tashinvests and @anakresina on Instagram.
Until next time, and happy investing!
Tash & Ana
