Whether you’re an entrepreneur, self-employed or a contract employee, it’s important to consider which retirement investment strategies are best for you, particularly when you’re not obligated to participate in superannuation.
If you fall into any self-employed category, you are certainly eligible to open a super account, or to continue contributing to an existing account, but it’s not required—there are no penalties if you choose not to participate. However, if you don’t create any retirement strategy, you’re effectively penalising yourself against a comfortable retirement.
Super as a compulsory contribution is the government’s response to meeting the financial needs of a population that is living longer than ever before; recognising that the age pension would soon be unable to meet demand. The idea was that workers would contribute to their retirement through salary withholding, and their employers could match those contributions (there are corporate tax advantages to this).
Any Australian who has ever had a job has likely paid into a super. It’s not uncommon for people to have several supers by the time they settle into a career—all those summer jobs and college gigs add up to more supers than you think. If you’ve already had some years in the workforce, you’ve already invested in a super, so whether you’re going out on your own, or have been moved to a contract rather than a permanent position, those contributions cease—but you keep the super.
Superannuation and the entrepreneur
So what about the entrepreneur, whose income is likely to fluctuate, or the contract worker, whose income may be high, but unpredictable? Is investing in a super the best way to save for retirement? You should speak with your financial advisor before you make any financial decisions, but broadly speaking, there are alternative options for the self-employed.
Is super the best strategy for retirement saving?
Super was created as a way for average workers to build a retirement nest egg, so the regulations regarding contributions fall along those middle-income lines. It’s a basic plan for basic investing—the tax penalties for exceeding the $27,500 annual cap speak to that. In reality, a wage earning employee with a family would find it difficult to meet that contribution level—but an entrepreneur coming off a really good year can easily surpass that amount, so there are considerations when putting that money into a super.
First, there’s the tax burden. If you have an extra $70,000 to put into your retirement at the end of the year, you can certainly put it into a super. That first $27,500 is taxed at 15%—not too bad. But here’s the bad news; that extra $42,500 will be taxed at 46.5%. This is Econ 101—a 46.5% tax rate is not the highest and best use of your resources.
Second, any money you put into your super is out of your hands until you retire. It is true that you can withdraw some funds—up to $10,000 for emergencies—and pay a 10% early withdrawal penalty.
In short, super is a simple investment tool for retirement that works well for simple financial situations—as a component of a retirement strategy, but not as the primary investment vehicle. If you’re self-employed, your financial picture is typically more complicated, so you need a more tailored investing and retirement plan.
Alternative retirement strategies to super funds
There are several viable alternatives to investing in a super. Keeping in mind that you probably already have some super funds that are invested on your behalf and will provide some income when you retire, consider these types of investments that are more sophisticated than garden-variety super funds.
Passive income
You have an active role in your business—you’re making the decisions that grow the company. But when you buy bonds or shares, or invest in real estate, you’re a passive investor—the company gets your money, but you have no say in how the business is run. When you invest in these instruments, there are two goals: growing your net worth through increased value of the assets, and generating an income stream when you retire.
Take a good look at investment bonds
If the major shortcomings of investing in your super are the tax implications and contribution limits, investment bonds are really worth a hard look.
What are investment bonds?
Large institutional investors—insurance companies or friendly societies—pool their investor’s money and invest in a wide range of instruments. These include fixed interest bonds, cash, real estate, or shares. The value of the bond fluctuates with the value of the underlying investments. Unlike buying shares that can be sold at any time, you buy bonds for a certain period of time, and are paid interim interest as well as a premium when the bond matures.
Why are bonds a good investment option for retirement?
Investment bonds are a good strategy for self employed retirement options for these reasons, all of which circle back to this: they can be an effective strategy for building wealth.
- Tax on investment earnings is capped at 30%, which can be reduced after tax deductions and franking credits.
- You can contribute any amount in a given year; so when you have a really extraordinary year, you’re not penalised with higher taxes.
- You can withdraw (sell) your bonds at any time, regardless of age or years until retirement.
- If you hold an investment bond for 10 years, the investor (the company managing the funds) pays your personal taxes, After that, no taxes are due on further withdrawals,
Additional benefits of investment bonds
Clearly, this 10-year window for tax-free withdrawals is a huge advantage, but there’s actually a greater benefit. Every year, you can increase the previous year’s contributions by 125% without re-starting that 10-year clock. So once you make that initial investment, every ensuing year’s contributions grow so that after the first decade, you’re getting tax-free income going forward, even as you continue to add money to the funds.
From an estate planning standpoint, these bonds are attractive in that they can be paid independently of your estate, with the tax-free advantages that you had during your lifetime.
Consult with a financial advisor before you make any major retirement planning decisions, but be sure that you’re making the right portfolio decisions for your long-term goals.
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