A couple of weeks ago i had an interesting experience. I was scrolling through my Facebook feed and a post from an old Uni mate (A Professional Musician) grabbed my attention…
“I’m curious – how many of my self employed friends have some kind of retirement plan in place e.g superannuation, savings, shares, anything else etc”
As a sound engineer, former professional musician, and someone who has many self-employed musician friends this really struck a chord with me (pun intended). It wasn’t so much the question that stopped me, but the amazing variety of ‘financial advice’ that started flowing in from other self-employed musicians and creative professionals.
Here is a quick snapshot of some of the responses:
- I’m planning to make a plan
- I have super with ‘Spaceship’ – I like that they invest in Future Tech.
- Crypto Currency
- Read the Barefoot Investor
- Find a sugar Daddy / Mumma
- Super is for people who can’t save, and spend every cent week to week. If you are smart with your money it is better having it in your own bank saving interest than risking in the stock market that is super.
- Cash – Old School
- I don’t think i’ll make it to retirement age
- The kids will look after me
- Make the kids into a family band ala The Jackson 5 and sell them to the world.
- Gig till i die.
- Play the RSL circuit
- Hoping to win the lottery or get famous and rich as an Instagram influencer… Also crypto
- As a minimum, I work out what amount gets me the government super co-contribution and put that away each year. Additionally as some of my work is as a school employee I get a little extra.
- My own home is my investment.
Whilst there were some very sensible and pragmatic responses, and some were clearly tongue in cheek, it also became clear that there is a lot of misunderstanding about super / retirement, or that it is often an afterthought. (Mind you this is just as true of employees, but they are extremely fortunate in that their employer super guarantee payments just magically happen behind the scenes without any input or action from them – apart from ticking a box or filling in a form at the start of their employment)
My intention here is not to back pat every ‘good’ response, and shoot down every ‘bad’ one, it is merely to raise awareness, dispel some common myths & misunderstandings, and encourage everyone to give some thought to their retirement plans – its important stuff!
So with that said, lets have a look at Super, and more specifically, Super for the Self Employed.
Lets start at the beginning…. how much super do you need to be able to afford to retire?
According to Superguide the amount required for various standards of retirement looks something like the following table. This assumes that you own your own home debt free.
Key Notes:
– Assumes retirement after ‘aged pension age’ – 67 if you’re born after 1957.
– Lump sums provide for 25 years of retirement
Now, before you freak out and think ‘Holy crap, how am i going to save $695k for an average retirement?’, just calm down – you don’t have to.
You see, there is an enormous difference between saving and investing.
By ‘saving’ at $6000 p.a and earning bank interest @ 3% p.a, it would take 50 years to accumulate $595,000! On the other hand, by ‘Investing’ your $6000 each year in a super fund returning 7% p.a net of fees, that time is cut down to around 31.5 years.
Here is what potential super returns look like at various rates of return for a self-employed person who kick-starts their super at age 35 with a $0.00 balance. It assumes a pre-tax wage of $60,000, and yearly contributions of 10% p.a. (similar to the current employer super guarantee rates).
As you can see, a small difference in your % investment returns can have an enormous impact on your retirement super balance. For each of the options above, the investor has contributed exactly the same amount of their own hard earned money (30 years x $6000 = $180,000), but the end results are vastly different due to how their money is invested. It is true that to achieve greater returns, you need to be willing to accept greater risk, but risk of market downturns is mitigated over time – the Australian sharemarket has returned 9% p.a over the long term. You can read more about Risk vs Reward here.
Now, before we get into the nitty gritty, i want to spend a quick moment on the difference between inside super, and outside super investments. Whilst outside super investments are appealing for their flexibility, the tax advantages of superannuation make it the #1 vehicle for long-term wealth building & retirement savings…. hands down.
Outside Superannuation Investments:
- You pay the Tax man 1st based on your gross income, then you invest with whats left over.
- Income from investments (dividends from shares / managed funds or rent from investment properties) is taxed at your Marginal tax rate. (32.5% for taxable incomes between $37K and 87K)
- Capital gains (from shares, managed funds, or property) are taxed at your MTR, with a 50% discount applied if held for >12 months.
Inside Superannuation:
- You pay contributions into your super fund from your pre-tax income, which lowers your taxable income, which in turn lowers your tax payable and enhances your cashflow.
- Your contributions are taxed at 15% (as opposed to being taxed at your MTR of 32.5% and then investing with what is left over)
- Income from investments within super are taxed at 15%
- Capital gains made inside super are taxed at 15%, with a 33.33% discount for assets held > 12 months.
- No tax on withdrawals or a super income stream after age 67 (assuming you were born after 1957)
These differences, when compounded over 30 years can have an extremely large impact on your accumulated retirement savings.
Time is your friend:
When investing for long-term goals (like retirement), time is your best friend. Due to the magic of compounding, small, consistent contributions to an investment or super plan over a longer time will yield better results than higher contributions for a shorter time (as a guiding principal).
As an example, if you decided to add $6000 per year into a super fund that achieved 8% p.a, over 30 years it would turn into ~$683,000. To achieve that same result in 20 years (all other things being equal), your yearly contributions would have to be $13,500… more than double!
That is why its so important to start today – don’t delay!
Change your Mindset:
One of the great challenges for the self-employed is the fact that they receive 100% of their gross revenue in their bank account, and then have to make provisions for tax, super, insurance, illness, and many of the other things that employees benefit from without even giving it so much as a passing thought (its easy to spend it if you’ve got access to it).
On the other hand, employees might only receive 60 – 70% of their inc super salary package in their bank account.
The trick may be to change your mindset, and do a quick ‘ready reckoner’ of what your gross income actually represents. For example, you issue a client an invoice for $1,000 ex GST for services (no material costs like a tradie might incur). Here is how you could break that down:
Gross income: $1,000
- Super payment: $100
- Provision for tax: $200 – $300 (depending on your yearly earnings and tax liability)
- Provision for illness / holiday pay: $100
- After Tax Income: $500 – $600 (Equivalent of an employees pay cheque)
I quizzed a good (self-employed) friend on the matter and how he thinks about super / retirement. Here is what he had to say:
“I decided I have an obligation to continue to contribute every month. I have an SMSF and despite my income being variable I just allocate the same amount each and every month. If things ever get tight I make cut backs else where but never in the super. If I miss a month (very rare) for cash flow reasons I simply pay double the next month”
“The mind set part comes from feeling like you do it tougher because others get their super paid by an employer and yours comes out of your personal / company earnings. You just have to forget about ever having that money and transfer it out. It’s the first transfer I make each month. Like anything it’s discipline and consistency. Understanding the power of compounding has helped with the motivation”.
Joe Doyle – Select Training
In part II we’ll start to look at some of the finer details, alternatives to super along with their pros and cons, and a few other interesting tidbits.
- Is my own home a good investment?
- Government co-contributions to super
- Tax-deductible super contributions
- Isn’t the stock market risky?
- Self Managed Super Funds
If you’re self employed and super is one of those things you keep telling yourself you need to look into, now is the time to get stuck in and do something about it! If you’ve got any burning questions, Please leave your comments below and i’ll try to include them in Part II.
All the best to all the Muso’s, Artists, Tradies, Entrepreneurs, and other self-employed folk out there. You are the masters of your own destiny – and with a little bit of knowledge and some help, you can be the masters of your own retirement too.
Saul.