2 May 2017
Over the past week Australian shares were 1.2% higher. Shares in developed countries were 2.0% higher and the US market was 1.5% higher. Shares in emerging markets gained 1.7%. The Australian dollar was 0.7% lower at 0.7488 US cents. The 10 year bond yield in Australia was 0.04 higher at 2.58% while in the US, the 10 year bond yield closed 0.03 higher at 2.28%. The oil price lost 0.6% to 49.33 US dollars per barrel.
The broad message when accumulating super is simple. Contribute regularly to your super, we invest well and your savings will grow, which can then be used to provide income in retirement. We showed a simple example in our update 31 October 2016 to illustrate the important role that investment earnings play in growing your super. Today we’re going to explore the power of contributing more to your super and committing to this decision as soon as possible.
To explore this we present the same simple example of a 22 year old, Jim, who recently started working with a salary of $65,000. He has 45 years to contribute to his superannuation before he reaches retirement. Jim’s salary is expected to grow at the rate of wage inflation. His contributions come from his employer which is currently 9.5% of his salary. He invests in the Mine Wealth + Wellbeing default Lifecycle Strategy. For this simple model we assume that the investment objectives are achieved each year. This is an unlikely scenario as returns bounce around year to year, but we do expect to achieve the stated investment objectives over the long term.
The purpose of this example is to see how much impact it would make to Jim’s retirement if he decides to contribute a little bit more to his super. Note that these calculations incorporate Age Pension entitlements as well. We assume that Jim retires with a spouse and they jointly own a home property for the purpose of estimating his Age Pension entitlements. Figure 1 illustrates the outcomes from contributing more to super than simply the Superannuation Guarantee rate. If Jim doesn’t do anything to his super he’ll expect to receive $510,600 in today’s dollar at retirement. This translates to an income stream of $31,400 pa taking into account his Age Pension entitlements until he reaches his life expectancy at age 93. In our simple modelling we assume Jim lives to his life expectancy. If Jim lives past his life expectancy we assume he’ll be relying on the Age Pension as his sole source of income.
If he contributes an additional 2% of his salary to superannuation every year starting now, at retirement his balance will be $90,500 higher. This translates to an income stream of $34,400 pa which is an extra $3,000 pa. If he doubles his additional contribution to 4%, the increase in his retirement balance will equal $181,000 which is an extra $6,100 pa increase, compared to the case of no additional contribution. This is the power of contributing more to your super.
To maximise the benefits of contributing more to your super one needs to start saving more as soon as possible. This is illustrated in our next example.If Jim decides to contribute more to super but decides to start later on in his life this will reduce the compounding effect of the extra savings. Figure 2 shows the comparison between starting to contribute an extra 2% pa now versus 10 years and 20 years later.
If Jim waits for 10 years, he’ll have $63,700 more in retirement savings and $2,100 more in retirement income pa. However, this is lower than if he’d started additional contributions straight away. His balance would have been $26,800 higher and he’d have an additional $900 pa in retirement income.
If he waits for 20 years to start contributing more, then he’ll of course be better off compared to not salary sacrificing at all. His balance would be $39,000 higher and his retirement income $1,300 pa more. However, if Jim started contributing now, his balance would have been $51,500 higher and he’d have an additional $1,700 pa in retirement income.
Simply, contributing more to super increases your balance and that higher account balance will compound through time. Contributing more will improve your retirement outcome. Making that commitment to contribute sooner rather than later will also help.
David Bell, Estelle Liu and Adam Shao
Past performance isn't necessarily an indicator of future performance.
All data sourced from Bloomberg.