Last week, we saw that there are two ways to accumulate super: contributions and earnings. Over time, we expect that earnings will have more impact on retirement than the money you actually contribute in. Investment earnings are really important to your super.
Now, stop and think about what happens after you retire. Once you do that, there are no more contributions. This means that investment earnings become even more important after you stop working.
Last week, we looked at a 60 year old person who had worked for 40 years and accumulated $1.776 million in inflation adjusted savings. What happens when that person retires?
The first thing to realise is that if you commence an income stream, it becomes easier for you to generate superannuation earnings. This is because earnings on super that is funding an income stream are not taxed. So, everything else being equal, we would expect that the after-tax earnings on your super would actually increase each year once you start drawing on your super. For now, though, we will just note that this is likely and continue to use the numbers we used last week – an average after-tax rate of return of 6%.
If, upon turning 60, the person retires and starts to withdraw 6% of their super as an income stream, then their capital amount should stay about the same. They are basically withdrawing the investment earnings each year.
Do that for 25 years of retirement, and you will still have the same amount in super that you started with (remember, we have adjusted for inflation, so this really is the same amount).
But there’s no fun in that! What if you increased the rate at which you withdraw your super from 6% per year to 9%? Well, if you do that for 25 years, you will withdraw a total of $2,680,000. And you would still have $720,000 remaining in the fund.
That’s not bad for a fund that only had $1.776 million in it when you retired!
The Importance of Earnings Across the Entire Lifespan
You will remember last week we assumed a person who started work at age 20 on $35,000 a year. Their income rose by $5,000 a year until they turned 30, at which point it started rising by just 2% per year plus inflation. They worked until they turned 60, and their super made an average after-tax return of 6% plus inflation.
We saw that 70% of the money they had in super came from earnings. Just 30% came from contributions.
Now, when we add in the fact that your super keeps earning investment returns after you retire, we can see what happens to this person even if they withdraw 9% every year between the ages of 60 and 85. If they do, then the following will have happened;
- Overall, they (or their boss) have contributed just over $525,000 into super.
- Before they retired, they earned investment earnings of $1,250,000.
- After they retired, they earned a further $1,725,000 in investments earnings.
- In the first 25 years of retirement, they withdrew almost $2.7 million.
- By that stage, at age 85, they still had $720,000 in the fund.
Across the whole lifespan of the fund, investment earnings were almost $3 million. Contributions were just over $525,000. This means that 85% of the total value of their super fund came from investment earnings.
In addition, 60% of these investment earnings came after they had retired. Their super kept working long after they stopped!
None of this is to say that super contributions are not important. After all, contributions comprise 15% of the fund’s income across its lifespan. The greater the contributions, the more money this 15% represents – and, of course, the more money the other 85% has to represent as well. That’s how maths works. Contributions will always make your super bigger. But most of us do not need to decide much about our contributions – they happen automatically.
The really important decision about super is how to invest it.
The investment decision is also our forte. So, make a time to come and see us to make sure your super is earning you the best retirement it can.