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When we think about retirement savings most of us think superannuation. Yet super is not the only source of private income in retirement. For many Australians, personal investments outside super are an important part of the retirement income mix.
According to Rice Warner, Australians held close to $2.7 trillion in personal investments outside super as at June 2018, slightly more than the amount held in super at the time.
Rice Warner’s Personal Investments Market Projections 2018 report shows that cash and term deposits represent approximately 43% of the total personal investments market, followed by around 42% in investment property. Shares represented less than 15% of the total while the amount in fixed interest and other investments was negligible.
Of course, these figures include savings for goals other than retirement whereas all monies in super are meant to be for the sole purpose of providing income in retirement. They also include personal investments held by all age groups, those still working as well as retirees. But as real property is typically a long-term investment, we can assume that much of the wealth tied up in this asset class outside super is also destined to provide retirement income.
Why hold retirement savings outside super?
Super is still, without a doubt, the most tax-efficient vehicle for your retirement savings. Even so, there can be sound reasons for having investments outside super both in the lead-up to retirement and after.
Some considerations are:
- Need for cash. It’s a good idea to hold cash in readily accessible bank savings accounts and term deposits for daily living expenses and emergencies. Holding cash in term deposits with staggered maturity dates can also help retirees manage their cash flow. It also helps avoid selling assets in a market downturn, and crystallising short-term market losses, to pay for immediate spending needs.
- Your age. If retirement is still a long way off, you may prefer not to lock your savings up in super where you can’t access them. Even if investments are earmarked for retirement, you may want to hold some outside super in case you need the money earlier than anticipated.
- Early retirement. Investing outside super is also a good idea if you want to retire early. That’s because you can’t access your super until you reach your preservation age (between 55 and 60 depending on your year of birth), or meet another condition of release. Even then, if you access your super before age 60, you may pay tax on some of the income, which is an incentive to ‘preserve’ your super until it becomes tax-free in the hand.
- Tighter super caps and restrictions. In some cases, you may have no choice but to invest outside super if you have reached your annual contribution limits or already have a high super balance. While you are still working there is a $25,000 annual cap on tax-deductible (concessional) super contributions and an annual $100,000 cap on after-tax (non-concessional) contributions. There is also a $1.6 million limit on both how much you can hold in super, referred to as your total superannuation balance, and how much you can transfer into a retirement account, or transfer balance cap.
“If you are capped out, it then comes down to which taxable entity is best for me,” says Russell Lees, financial planner and founder of Kauri Wealth. “(You might consider) a testamentary trust, holding investments in your own name or a company, whichever is best for the types of assets you hold,” he says.
The type of assets you invest in can also have a bearing on whether you choose to hold them outside super.
A preference for property
As the Rice Warner figures above show, Australians have an ongoing love affair with investment property, which represents 42% of non-super investments. According to the most recent Australian Bureau of Statistics (ABS) figures, one in five Aussie households owns investment property and/or a holiday home. The vast majority (71%) of those own just one property other than their home.
The main drivers of investment in real property are low interest rates and negative gearing.
Definition. A property is negatively geared if the rental income is lower than the interest payments on your investment loan and other outgoings. This rental ‘loss’ can be used to offset other income earned, such as your salary, thereby reducing your taxable income and the amount of income tax you pay.
Good reasons for holding property outside super
Investors who wish to own investment property can only do so within super if they have a self-managed superannuation fund (SMSF). Even then, it may be advisable to hold property assets outside your SMSF. For one thing, there are stringent rules for borrowing to buy property with your SMSF, but that’s not the only reason.
“I’ve never been a big fan of leveraged property in super because you don’t get the full tax benefits of negative gearing,” says Lees. That’s because income earned inside super is taxed at the concessional rate of 15% rather than your marginal tax rate, which applies to investments held outside super.
Another consideration is your age. Property is a long-term investment so the popular strategy of negatively gearing an investment property is best done when you are younger and able to fully enjoy the tax benefits of negative gearing and long-term capital appreciation. Taking out a loan to buy investment property when you are close to retirement is high risk, as any increase in interest rates will eat into your retirement savings. Also, time is not on your side if there’s a major market correction that reduces your property’s value and you need to sell.
Diversification may also be an issue with a heavy dependence on property investment in retirement, in or out of super. Because property is a large single investment, you can’t just sell off a room when you need extra cash. Property is best considered alongside investments in other asset classes as part of a diversified portfolio.
Savings invested inside super are likely to produce a better outcome at retirement due to the tax advantages and long-term compounding, all things being equal. That said, considerations such as whether you have reached your super contributions limits, your age, cash requirements and other personal circumstances all come into play.
It’s never a good idea to look at your assets inside or outside super in isolation. In time, both will form part of your retirement income mix along with your eligibility for a full or part Age Pension.