For many, joining the "Millionaires Club" seems like just a pipe dream – but the magic of compounding interest and the tax-haven that is the Aussie super system could change that perception.
Back to basics: understanding your super
Investing 101 tells us that the magic of compounding interest is your best friend when investing and superannuation is no different. The younger you put money into your tax-sheltered super fund, the more those investments will grow and compound over time until you reach preservation or retirement age.
The biggest risks of pouring money into super are two-fold: illiquidity and regulatory.
Superannuation is locked away (effectively) until the preservation age is reached, which is currently 60 years of age, and only likely to increase as the pension burden increases and Australians live longer.
On the regulatory front, it's very easy to see why governments want to get their hands on super. What better way to fix a budget deficit and score a political win than to tinker with the super system to generate more taxes that go straight to the government purse?
So while investing in your super and maxing out contributions can be tax-effective and a big personal finance step, it may not be the optimal investment for everyone depending on their liquidity needs and investment horizon.
Why becoming a millionaire is simple maths
The key here is that time is your best friend, or your worst enemy, depending on your ability and willingness to invest in your superannuation balance and set yourself up for the long-term.
Superannuation contributions are currently taxed at 15%, which is lower than the lowest Aussie tax bracket of 18% for every dollar earned between $18,200 and $37,000.
Clearly, the value of super from an after-tax returns perspective is most beneficial for those high-income earners who might otherwise be earning in the 37%, 42.% or 47% progressive tax brackets.
My assumptions used for the basic superannuation growth calculation include:
- 2% p.a. annual inflation
- 5% p.a. real rate of return (compared to long-run ASX return of ~9% p.a.)
- Starting portfolio amount = $10,000
- Age 25-35 = $5,000 per year contribution
- Age 36-45 = $10,000 per year contribution
- Age 46-55 = $15,000 per year contribution
- Age 56-65 = $20,000 per year contribution
Based on my assumptions, one would easily exceed the magic $1,000,000 mark by the age of 62 according to my calculations which with a 4% withdrawal rate would net a tidy $40,000 p.a. passive income in return.
In my view, given the numbers involved, becoming a millionaire by leveraging off the tax-efficient superannuation system is very achievable for everyone with a little bit of discipline and forward planning.
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