Why it can pay to put as much as possible into super

As the retirement day of reckoning looms, it’s common for Australians of a certain age to regret not putting more into their super earlier on.

While recent changes to the super rules make it easier for older Australians to continue contributing to their super account until they turn 75, that doesn’t alter the fact that the sooner you start the better. Why?

Tax efficiency and compound interest, it’s that simple.

The power of compound interest

You have probably heard that Albert Einstein described compound interest as the eighth wonder of the world. Thankfully, you don’t have to be a genius to take advantage of it.

Compound interest means you earn interest on your interest. The longer this compounding continues, the bigger your savings will be.

In the context of super, your money is locked away for upwards of four decades until you retire. During that time, all investment earnings on your savings are reinvested.

And it doesn’t stop there. If you transfer some or all of your retirement savings into a super pension account when you retire, the underlying investments will continue to generate returns even as you withdraw income. What’s more, investment earnings are generally tax free in retirement phase.

Tax-efficient savings vehicle

Concessional (tax-deductible) contributions into super are taxed at just 15% on the way in. That includes your employer’s Super Guarantee (SG) payments, salary-sacrifice arrangements and tax-deductible personal contributions, up to an annual cap. In 2024-25, the concessional cap is $30,000. If you have unused cap amounts from previous years you may be able to contribute more than the usual limit under the carry-forward rule.

Because concessional contributions are made before tax (or provide a tax deduction for personal contributions you make from your after-tax earnings), they offer significant tax savings for higher income earners. Instead of paying income tax at a marginal rate of up to 45% you pay contributions tax of just 15%, or 30% if your income and concessional contributions total more than $250,000 a year. 

However, making extra super contributions is generally very tax effective if you earn more than $45,000 a year, which is when the 30% marginal tax rate kicks in.

If you have reached your annual concessional contributions limit, you can also make a non-concessional (after-tax) contribution. You won’t pay the 15% contributions tax, but there is an annual non-concessional contribution cap. The cap for 2024-25 is $120,000 and most people can contribute more under the bring-forward rule.

Why would you bother adding to your employer’s super guarantee contributions when you could simply invest your surplus cash outside super?

You guessed it, tax and compounding. Once your money is inside your super fund you pay tax on investment earnings at a rate of up to 15%. If you bought the same investments outside super, you would pay tax on investment earnings at your marginal income tax rate. This leaves more money in your super fund to go on compounding.

But wait, there’s more. The biggest tax savings are left till last.

Tax-free retirement income

When you retire and start a super pension, you generally pay no tax on pension income or investment earnings inside your pension account from age 60. This is known as the ‘retirement phase’ of super.

If you’re receiving your retirement income from an untaxed fund, then it will be taxable but all your contributions and earnings along the way were tax-free.

As with everything to do with super, there are rules. To move from the accumulation phase of super to retirement phase, you must retire and satisfy a condition of release or turn 65. And many super pensions require you to make minimum annual withdrawals. 

There are also limits to the government’s generosity.

Keeping a lid on super savings

It’s important to recognise that the sole purpose of super is to provide retirement benefits for members, not to act as a tax-efficient store of intergenerational wealth.

With this purpose in mind, the government conducts a fine balancing act. While encouraging us to save for our retirement with generous tax concessions, it also caps the amount we can have in super and still enjoy those tax benefits.

Your total superannuation balance (accumulation and pension accounts combined) must be less than permitted thresholds to participate in some arrangements such as the bring forward and carry forward rules.

There is also a transfer balance cap on the amount of money you can shift from accumulation phase to retirement phase. In 2024-25 this cap is $1.9 million for people investing in the retirement phase for the first time.

What about lower earners?

While super tax concessions undoubtedly favour wealthier individuals, there are also incentives for lower income earners to add to their retirement savings.

If you earn $45,400 or less in 2024-25, the government will contribute 50c for every dollar of personal contributions you make into your super account, up to a maximum of $500. That’s a return of 50% on your investment, which is close to impossible to match, legally at least.

The government co-contribution phases out once your income reaches the upper threshold of $60,400 in 2024-25.

While an additional super contribution of a thousand or two a year might seem like small beer, it can make an enormous difference to your retirement super balance.

Go early, go super

To paraphrase then treasury secretary Ken Henry’s advice to government during the GFC, to maximise your retirement savings while allowing tax and compound interest to do the heavy lifting, the best approach is to go early, go super.

Not only does adding to your super earlier in your working life make the most of compounding, but it also means you won’t run up against contribution limits later in life as you scramble to give your super a last-minute boost.

Case study 1: Getting rich slowly