Superannuation funds pay 15% tax on earnings and similar to how individuals receive a 50% discount on capital gains, superannuation funds receive a 33% discount on capital gains, so they effectively pay 10% capital gains tax. It is important to also understand that once you start a pension with your superannuation, no tax is payable at all on any earnings.
We know that as individuals, it is best not to keep incurring capital gains tax buy continuously selling and buying assets as handing over big cheques to the ATO isn't great for your wealth. But what is happening inside your superannuation fund? Most people would be completely unaware of the ongoing realisation of capital gains tax inside pooled superannuation funds, which are typically how industry funds work. There is investment trading going on, other people rolling money in and out of the fund etc which is hindrance on returns.
Let take a look at Sunsuper, one of Queenslands largest superannuation funds. Their 5 year return on their balanced fund returned 9.0%* and the same balanced fund inside pension (i.e so it paid no tax) was 10.0%. So effectively the tax that is being paid within the fund on the income and all the capital gains being realised cost investors 1.0% per annum. If you think that doesn't seem like much, let me just demonstrate the power of compounding interest and the fact that superannuation is a long term investment. Lets say a 30 year old has $100,000 in superannuation and their net contributions each year is $10,000 (so effectively someone earning about $120,000) and that increases each year by 3% and we compare the difference between getting an 8% per annum return and 1.0% less (ie 7%).
The difference is over $375,000!
But, there is tax on superannuation earnings and it isn't completely avoidable, but it is possible to minimise this to maximise your net returns?
Vanguard is a major index fund manager both globally and in Australia and they release after tax returns. An index fund manager just buys the index so they aren't trying to continually buy and sell to outperform which results in a much more efficient portfolio. They publish both the after tax returns on distributions only (i.e the after tax returns after you pay tax on the income only) and after tax returns if you fully redeem (i.e the after tax returns if you sell the investment and incur the capital gains tax). Their 7 year gross of tax return (i.e the equivalent of the sunsuper pension returns) on the Vanguard High Growth Fund# was 11.43%, however the after tax return on the distributions is 11.48%.
What? Is that a typo? How did it go up? Well the cost of tax on the income is very small, then when you add in a refund of franking credits, the after tax return on distributions is actually higher than the published gross returns of the fund (as they don't include the franking credits in the gross return.
So, instead of losing 1.0% per annum return to tax like the Sunsuper returns, you gain 0.05% return by investing in a superannuation where you control the capital gains tax and not at the mercy of the transactions of thousands/millions of other members and also constant buying and selling trying to outperform. Then you might say, but at some point you will have to pay the capital gains tax? Well, no. When you invest your superannuation in a wrap or investor directed superannuation fund, you are able to transfer the assets to pension without selling them, because it isn't selling the asset and isn't a change in beneficial ownership or trustee, so it isn't a capital gains tax event. Then once it is in pension, it is all tax free so you can sell down without any capital gains tax.
It is important to point out though that although the Vanguard fund is net of their fees, you will need to pay administration fees on a wrap, investor directed (or even SMSF) superannuation fund if you want to invest like this, however most of Precision Wealth Management clients pay very attractive administration fees as everything is rebated back to the client. Generally our clients pay about 0.20% - .0.05% administration fee (depending on the size of the account) so really, the net returns would have been about about 11.28% - 11.43% per annum, compared with Sunsuper's net returns of 9.0% on their superannuation. You saw the difference above of 1% per annum, I don't think I need to show you the difference 2%+ can make over the long term.
Industry funds don't like financial advisers and don't like it when they recommend people move their superannuation to another provider and they have put a lot of marketing into convincing you it is a bad move as financial advisers charge fees. But, perhaps, just perhaps, financial advisers fees actually add a lot of value to clients both with financial benefits and also peace of mind, and also perhaps, the industry fund product offerings aren't actually that great.
*All returns are 5 year returns to 31 August 2015.
#I am using the Vanguard High Growth fund as it has 90% growth assets and 10% defensive assets and the Sunsuper balanced fund has 81% growth assets and 19% defensive assets - if you call 'diversified strategies' defensive assets. I'm not sure. So even though the name suggests they aren't a similar fund in terms of allocation to growth and defensive assets, the asset allocation says they are.
