Is playing it safe costing you money?

22 Aug 2017

When looking to invest money, there are a few options: term deposits, savings accounts and shares being the main three. However, while many Australians believe investing in shares is risky, when retired or nearing retirement, they could be your best option.

This is the case when considering the $1.6 million superannuation pension cap that went into effect last month.

What is the superannuation pension cap?

The current government has placed a cap on funds moved into the tax-free retirement phase of superannuation. According to the Government, there are a couple of reasons for this.

First, the loss of tax revenue from the uncapped system is believed to be too high. And second, there is the belief that some people were using the existing scheme as estate planning; accumulating assets in a tax-free environment to pass on to beneficiaries. The cap places a limit of $1.6 million that can be transferred into the tax-free retirement phase, limiting the amount of money that is sitting in the tax-free environment.

Importantly, for people with superannuation balances under $1.6 million, there are no major changes. However, if there is more than $1.6 million in your superannuation fund when you transition the funds into the pension phase, something needs to be done with the excess capital.

Where to put the excess funds

There are options on how to manage the excess funds.

Of course, excess amounts can be maintained in an accumulation account, which is taxed at 15 per cent.

However, many retirees are being advised to put the money into term deposits. But, at the end of the day, this decision could actually be costing you money.

According to Investfit director James Claridge, putting excess funds into diversified shares is probably a better strategy than term deposits. “The difference in effective tax rates is quite significant, with the earnings from investments in Australian shares in super being taxed at only one per cent on average [compared with 15 per cent for term deposits],” he explains. “This could have a substantial impact on retirement income or legacy.”

The problem lies in the perception that shares are a risky investment. Claridge says this isn’t the case. “In certain scenarios, it’s actually lower risk than putting your money into term deposits.”

The main problem is that financial advisers talk about annual risk, whereas, in retirement, the savings goal is actually longer than a year. “While investment return on shares is much more variable than interest on deposits in the short-term, this evens out quite significantly when you plot it out over a 10-year period,” Claridge says.

What to do

When in doubt, always talk to the experts. According to Claridge, a proper assessment of your assets and goals is the only way to ensure your risks. “The only way to accurately determine the risks when investing for retirement is to properly model all of your assets, liabilities, cash flows, and of course, goals. Modelling also needs to take into account the variability in returns for different types of investments,” he says.

At the end of the day, it’s definitely worth doing your own research so you fully understand what the cap is all about and how it may affect your superannuation plans.