How to make the most out of your super increase

Super increase

After 1 July this year, your employer must increase your super contributions from 9.5% to 10% of your salary. This contribution rate will then increase by 0.5% p.a. for the subsequent 4 years until it reaches 12%. This could boost your retirement savings but only if you optimise two things.

The government was tempted to delay this increase

It has been reported that the government was contemplating delaying increasing the Superannuation Guarantee Charge (SGC). The increase in SGC was proposed by the Gillard government back in 2012 but it was subsequently delayed until 1 July 2021. The Morrison government was probably concerned about whether businesses could afford higher employment costs during a pandemic. In addition, some commentators have suggested it would deter higher wage growth because any possibility for wage increases would be thwarted by higher superannuation costs.

In my opinion, not delaying the super increase is the right decision. The underlying economy is recovering better than expected. And an increase in wage inflation in the short term is probably unlikely anyway for a variety of reasons. Forcing people to increase the amount they save for their future retirement is a good thing for them personally and the country as a whole.

What effect will this have on your future super balance?  

The table below sets out the projected increase in super balance depending on your income and your super balance today. There are three numbers in each corresponding cell. The first number represents the percentage increase over a 10 year period, the second over 20 years and the third over 30 years. For example, if your super balance is $200k and your income is $150k, then this increased SGC rate over the next 5 years is projected to increase your super balance by 6.1% in 10 years, 9.1% in 20 years and 10.3% in 30 years.

Impact of super increase

As we can see, the increase in SGC really helps people with lower super balances the most.

However, if you already have a healthy super balance, the increase in contributions probably isn’t going to have a material impact on your retirement. Instead, fees and returns will have a greater impact on your future balance.

It is important to highlight that most people will need to invest in assets in addition to super to be able to enjoy a very comfortable retirement. That is, super alone is rarely sufficient.

There are two factors you must optimise:

Factor one: Minimise fees

Fees are guaranteed. Investment returns are not.

It is important to minimise investment and administration fees as much as possible. Unlike many things in life, paying higher fees does not generate higher returns. In fact, many studies have shown that there is an inverse relationship between investment fees and investment returns. That is, typically, the lower the fees, the higher the returns. With investments, when you pay more, you receive less.

If your super is with an industry super fund, you should aim to pay no more than 0.70% p.a. in investment and admin fees plus a fixed dollar fee of around $100-140 p.a. If your fees are materially more than this, you should review alternative options.

Factor two: Maximise returns

This is an obvious second factor. Of course, you must maximise your investment returns.

One of the commonly espoused benefits of industry super funds is that they are non-for-profit, unlike the banks (retail super funds). Of course, all things being equal, that should serve you well. Almost always, retail funds are inferior.

However, I would make two important points about industry super funds.

Firstly, not aiming to derive a profit is useless, unless you have a fanatical focus on productivity and reducing costs. For example, some charities raise a lot of money for their causes. However, unfortunately, some charities spend more than 40% of that revenue on administration costs. For example, 44% of revenue donated to Make-A-Wish Foundation is spent on administration and advertising. Therefore, being “run only to benefit members” means nothing if there is no accountability to reduce costs. The Productivity Commission in 2019 highlighted that Australian industry super funds have failed to deliver lower fees despite achieving massive scale.

Secondly, just because your fund is an industry super fund, doesn’t mean it’s automatically a good option. Industry super fund returns vary greatly. The table below compares the investment returns from the top 8 largest and most well-known industry super funds. I have selected two of the top performers (over 5 and 10 years ended March 2021) and compared those to the two bottom performers. As you can see, the returns vary by circa 1% p.a., on average. Over 20 years, that could result in a 13%[1] lower super balance, which is generally going to have a more substantial impact on one’s super balance than the SGC increase. Of course, there are plenty of super funds that have generated even lower returns.

Comparing investment returns

The government has proposed to publish returns on an easy-to-understand website to help people compare options. In addition, it will force poor-performing funds to consolidate with larger players. Of course, the success of this lies in its implementation, but any improvement in transparency and accountability is positive.

Fees charged by the industry super funds should reduce – but will they?

If you operate a super fund, it might cost you say $7 to administer every $1,000 of super you receive (equating to a fee of 0.70% p.a.). When the SGC increases from 9.5% to 12% p.a., instead of receiving $1,000 of contributions, the fund will receive $1,260 of contributions. However, the cost to manage $1,000 or $1,260 should be very similar. Therefore, it should still cost circa $7 or 0.55% p.a.

In short, increasing the SGC from 9.5% to 12% should deliver the super industry significant economies of scale. As such, we should expect fees to reduce by 15% to 20% p.a. over the next 5 years. Watch this space.  

Soon there will be a much better option for Australian’s

Historically, there have been four options available to Australians for their super:

  1. Retail funds owned by the banks – typically these are characterised by high fees and low returns and are almost always never a good option.
  2. Wrap accounts which I discuss here. The main disadvantage is that to run it properly, you should engage a financial advisor, which may be economic if you have advice needs beyond super.
  3. Self Managed Super Funds – because of their high fixed costs, they are typically only worthwhile if you (1) want to invest in direct property and/or (2) have a high balance.
  4. Industry super funds – which tends to be the best option for those that don’t need a financial advisor and/or don’t have a high balance.

However, within the next year a new entrant will appear. It is Vanguard. Vanguard is a US firm founded in 1975 and is the first and largest index fund provider (it manages over $9 trillion globally). It is a mutual organisation meaning it’s not-for-profit, like industry super funds. However, unlike industry super funds, it has a long (almost 5 decades) history of reducing investment fees.

Whilst Vanguard has not released any details, I expect this will be a very exciting option for Australians. It’s offering will likely be low-cost, offer absolute transparency (what your money is invested in) which invites more accountability and its investment track record (returns wise) is excellent. When the product arrives, no doubt, I’ll be writing about it here.

Vanguard will generate some much needed competition for industry super funds.

Good reasons to not switch your super

Whilst generally I encourage you to proactively compare your super fund’s fees and returns and switch if they are not suitable, there are some matters to consider before you do that.

Firstly, some employer-related funds offer subsidies such as lower fees and free insurance benefits. It’s important to take these into account.

Secondly, if you have insurance cover, you should aim to replicate that cover in your new fund, if appropriate. You should do that prior to rolling all your monies over. If the new fund does not agree to providing you with economical insurance cover, you could consider leaving a minimum balance in your old fund just to preserve the insurance.

Super may be boring but it’s important

I appreciate that the vast majority of Australian’s are disinterested in super. However, the biggest advantage of super is that it forces us to make long term decisions and enjoy the power of compounding returns. Invest money today and leave it there for 20, 30 or more years. That is powerful.

However, it is also incredibly wasteful to not check-in every couple of years to ensure your super fund is still performing well i.e. high returns and low fees. Doing so could dramatically increase your retirement savings.

[1] Based on super balance of $350k and income of $200k p.a.