Lower contribution limits may force SMSF re-think

Australian Financial Review

20 February 2017

Ben Smythe

Now that the government’s superannuation changes have become law, much attention has turned to the various opportunities that are available to maximise contributions before July 1, when the new legislation kicks off.

One significant change that may not necessarily hurt too many people on the cusp of retirement but will affect the “wealth accumulators”, is the reduction in the concessional super contribution cap to $25,000 a year. This cap currently sits at $30,000 if you are under age 50, and $35,000 if you are over age 50.

With the reduction in the contribution limit, there is definitely a question mark as to how much you will be able to accumulate within super without the need to top-up your balance with after-tax contributions so you have a meaningful balance at retirement.

The lower limit might also curtail some people’s ability or willingness to set up a self-managed super fund (SMSF). Commentators often cite the figure of $200,000 as a minimum amount required to make an SMSF worthwhile. The lower contribution caps may mean it will take much longer for people to reach this target.

I have run some numbers around what is now possible to accumulate in super with the lower pre-tax contribution ceiling. Assuming someone is employed consistently between the ages of 25 and 60, their starting salary is $75,000, they rely on the 9.5 per cent super guarantee until they are 45 and then start to contribute $25,000 a year, the individual will accumulate approximately $1.5 million by the age of 60.

If you retired today with $1.5 million and your living expenses were $100,000, your super balance would last approximately 20 years, and then you would fall back on to the age pension (not something that I would be recommending clients work towards!).
There are obviously a number of assumptions with this modelling, and it is also only based on one person, no changes to legislation and 3 per cent inflation. However, with a growing majority of people now living beyond age 80, $1.5 million doesn’t go too far these days.

So what are the other implications of this reduced cap? Firstly, the reality is that most people will need to give consideration to making non-concessional, or after-tax, contributions, although given that this money will be locked up for a long time, you would probably not the strategy until you are closer to retirement age.

A bigger issue will be costs. If your super is only growing by way of contributions and earnings, and the contribution multiplier is now going to be smaller, then you need to be very cognisant of the fees you pay because they will detract from returns. This includes administration fees and investment management fees. This may well be a driver for people to take a much closer look at their super and perhaps choose a SMSF for its transparency when it comes to fees.

The administration fee is charged by your fund should really be a fixed dollar amount, as is the case typically with an SMSF. The investment management fee is the fee your fund pays an investment manager, which in a lot of cases is a percentage of your balance. This fee is sometimes hidden and can be quite expensive (more than 1 per cent).

The other typical cost you incur is an insurance premium, with most people having some level of insurance inside super. Premiums for life and total and permanent disability cover are tax deductible when held inside super. But premiums rise with age and after 50 your insurance premiums can really take off and potentially erode a large chuck of your contributions. In other words, you need to assess the merits of insurances inside super as you get older. It can be a good idea to reduce cover, as the risk you are trying to protect reduces over time.

Change definitely presents opportunities. For those building their savings there is a new set of parameters to consider when deciding whether to stay in a pooled fund or go the self-managed route.
Ben Smythe is the Managing Director of Smythe Financial Management.

AFR Contributor