Superannuation Handbook 2007-08

I just finished reading The Superannuation Handbook 2007-8 by Koken and Smith. It is a pretty comprehensive coverage of Australia's very complex superannuation or retirement system. I think my understanding of the system improved somewhat after completing the book, though it is still hard to keep all the facts and rules organized in my head.

Australia's superannuation system is complex for a number of reasons. First and foremost, governments have continually changed the rules while trying to grandfather in existing super investors in many cases. And there have been very significant recent changes. In the US, new rules have often meant the creation of new types of retirement account such as the Roth IRA or Roth 401k. In Australia there is only one type of account and all the various rules have been applied to that same account class. So we have pre-tax and post-tax money going into the same accounts, for example. In the US defined benefit pension schemes are an entirely separate beast to defined contribution retirement accounts. Not so in Australia.

Second, while the US does not tax money in retirement accounts Australia does (the US taxes payouts from accounts that had pre-tax contributions like the 401k). This I suppose is why self-managed superannuation accounts in Australia are subject to such a bureaucratic regulatory nightmare compared to IRA accounts in the US.

Third, there are several different age thresholds (55, 60, and 65) at which investors have different rights to access their super and varying taxation obligations if they do. In the US there is a single age threshold of 59 1/2, though you can access your money before then subject to tax and penalties (unless you do a 72t or annuity).

Fourth, eligibility for social security in the US does not depend on assets whether in retirement accounts or not. Access to the age pension and other benefits in Australia does depend on income and assets tests and sometimes it matters if the source is from super or not (but less than in the past).

Fifth, in Australia, how much tax you pay depends on how you take the money out of your super account - whether as a variety of different "income stream" products or as lump sums.

Well, there are probably more reasons that don't immediately come to my confused mind that result in the Australian system seeming more complex to me.

The book does an admirable good job of covering this very confusing topic. There are three points though which are somewhat weak. Not all terms are clearly defined. For example, the entry in the glossary just says that a "complying pension" complies with certain regulations. It'd be nice to spell out some of these more clearly.

Second, the authors often gloss over details and technicalities. Footnotes or appendices to chapters could cover these if they don't want to complicate the text further. For example, there is a rule that a low-income self-employed person cannot get a government co-contribution if their "business income" is less than 10% of their total income. In other words the rest of their income is from investments or superannuation etc. This is the kind of point that was glossed over that I wanted to get a straight picture on.

Third, there are plenty of worked examples in the text, but most of these only cover the first year of any investment program. In some cases they comment that the difference between investing in superannuation or outside superannuation isn't that big. But that's the result after only one year. The results of investing in superannuation or outside superannuation could look quite different in the long-term than in the short-term.

Bottom line, I'd recommend this book as a very solid background to the topic though you might need to consult the ATO website and other resources along the way.

All of Labor's Tax Increases

The Labor party is at the moment likely to win the next federal election in Australia in May. Labor has become increasingly left wing in recent years and has a long list of policies to raise taxes. This is, I think, a comprehensive list:

1. Abolish Liberal plan to raise the top tax threshold to $200k: This was supposed to happen in 2024. The top tax bracket will still cut in at $180k (about USD130k) where it has been for many years. Bracket creep is pushing more and more taxpayers into the top bracket. This will affect us if I am still working then. If I'm not, probably my taxable income will be lower.
   
2. Raise the top tax rate: Add 2% to the top rate to raise it to 47%. With Medicare that is 49%. This will immediately raise our taxes.
   
3. Abolish plan to eliminate 37% tax bracket: This also was supposed to happen in 2024, so may not affect us except to the extent of how many franking credits will get used up offsetting our taxes, if I retire by then.
   
4. Repeal already-legislated tax cuts for companies with turnovers of between $10 million and $50 million: Small businesses pay 27.5% corporation tax and larger companies 30%.  The government wanted to extend the low rate to larger companies. This is unlikely to directly affect us.
5. Reduce the long-term capital gains tax discount to 25%: The discount is now 50%. This will have an immediate impact on us as we have run out of accumulated tax losses. OTOH existing investments will be grandfathered. It makes it more attractive to incorporate and pay CGT of 27.5% instead of 37.5%.
   
6. Abolish refundability of franking credits: Since 2000, if you have excess tax credits from Australian companies beyond those that offset the taxes you need to pay you can get a cash refund. I did benefit from this once or twice soon after we moved to Australia and my income was low. This will have a big impact on superannuation funds in pension phase that have zero tax to pay and possibly even in accumulation phase if they have a lot of franked dividends. It will affect lower income self-funded retirees with money outside superannuation too.  Some listed investment companies (closed end funds) are already paying out special dividends to get franking credits out of the fund and to investors before the end of the financial year. On the other hand, I don't think these funds will radically restructure due to this proposal. I don't think it will have a big impact on us as I've planned to put the least tax advantaged investments like managed futures into our planned SMSF. And I expect we would be in the 32.5% tax bracket when retired. If I retire at 60 say and start a superannuation pension we could use franking credits inside our SMSF to offset Moominmama's superannuation earnings tax liability as she is 10 years younger. And then maybe we could add Moomin to the superannuation fund :)
7. Abolish negative gearing: This is the ability to deduct investment costs beyond the earnings of an investment from other income. This mainly applies to property investors who mostly lose money in Australia in the short run, hoping for a long-run capital gain. We don't negative gear so it shouldn't affect us. Wealthier property investors who also own shares or other investments will be able to offset their losses in property against dividend and other income. So, like many of the Labor measures they mainly hit lower income investors...
   
8. Tax discretionary trusts as companies: These are trusts that have multiple beneficiaries and can alter what earnings they stream to which beneficiary on a year by year basis. Actually, they are proposing to tax trust distributions at a minimum of 30%. So, it's not like a company which pays 27.5% tax in the case of a small business and then distributes franking credits. I don't see any justification for allowing this kind of tax dodging. However, I think they should just require all trusts to be unit trusts with defined shares and everyone sharing in all income. These operate just like unlisted managed funds (mutual funds). I think most discretionary trusts will just do this if it's allowed.
   
9. Reduce annual non-concessional superannuation contributions to $75k: This would mean it would take us more years to make all the non-concessional contributions we want to make and means I probably should already get one in this financial year.
   
10. Reduce the threshold for 30% superannuation contributions tax to $200k: Currently the threshold is $250k. The threshold includes employer superannuation contributions, so this will definitely affect me.
    
11. Remove the right, already legislated by the government, of superannuants to make catch-up contributions when their super balance is less than $500,000: I don't think this is probably a big deal. It will mean stretching contributions over more years.
    
12. Reduce ability to take tax deductions for additional concessional superannuation contributions: People will need to have 90% of their income or more from sources other than employment to do this. I don't understand why concessional contributions for employees are limited to salary-sacrificed contributions and you can't make more concessional contributions unless you really aren't an employee. The Liberals tried to fix this anomaly.
13. Limit tax free pensions to $75k per year: Currently you can transfer up to $1.6 million into an account to fund a tax free superannuation pension. At a 4% initial withdrawal rate (required rate for under 65s) that is $64k per year. At 5% (65-74 y.o.) it is $80k per year. So, Labor's proposal is not that restrictive. However, if the $1.6 million earns a lot more than that a year, it will be taxed a lot more than at present.
14. Limit deductions for tax advice to $3,000 per year: I am assuming that this won't apply to companies or superannuation funds, just to individuals. In which case, it isn't a big deal.

I think most people are probably aware of one or two of these but don't have a good idea of the extent of the proposed tax increases. A big question is whether Labor will have sufficient control of the Senate to pass all these measures.

Spending 2023-24

For the last seven years I've been putting together reports on our spending over the Australian financial year, which runs from 1 July to 30 June. This makes it easy to do a break down of gross income including taxes that's comparable to many spending reports you'll see online, though all our numbers are in Australian Dollars. At the top level, we can break down total income (as reported in our tax returns plus employer superannuation contributions) into the following expenditure categories:

The gross income for this year (bottom line), and so also "Other Saving", is just an estimate. It is based on the gross income we expect to report in our tax returns (before investment expenses etc.) plus employer superannuation contributions. Tax includes local property tax as well as income tax and tax on superannuation contributions. Investing costs include margin interest. Mortgage interest is included in spending here (though usually I consider them to be an investment cost), while mortgage principal payments are considered as saving. Spending also includes the insurance premia paid through our superannuation. Other saving is then what is left over. This is much bigger than our saving out of salaries because gross income includes investment returns reported in our tax returns. Spending increased by 4% this year in line with inflation. Gross income, especially in real terms, has been slowly declining since the peak in 2020-21. This is partly because I moved high-tax investments into superannuation. Expected other saving is the lowest it has been. The latter includes the AUD 20k concessional contribution we made for Moominmama to our SMSF in each of the last three years. Graphically, it looks like this:

We break down spending into quite detailed categories. Some of these are then aggregated up into broader categories:

Our biggest spending category, if we don't count tax, continues to be childcare and education, which declined slightly this year as the youngest moved out of daycare and the older one changed schools. Both are now in the same private school since the beginning of this calendar year. As mentioned above, the income, tax, and other savings numbers for this year are all estimates. Commentary on each category follows:

Employer superannuation contributions: These include employer contributions (we don't do any salary sacrifice contributions) but not the concessional contributions we paid into the SMSF.

Superannuation contributions tax: The 15% tax on concessional superannuation contributions. This includes tax on our concessional contributions to the SMSF. It does not include taxes on SMSF earnings as the superannuation earnings are not included in income here.

Franking credits: Income reported on our tax returns includes franking credits (tax paid by companies we invest in). We need to deduct this money which we don't receive as cash but is included in gross income in order to get the numbers to add up.* Foreign tax paid is the same story.

Income tax paid is one category that has fallen since 2017-18! Franking credits rose fourfold.

Life and disability insurance: I have been trying to bring this under control and the amount paid has also fallen since 2017-18 as a result.

Health: Includes health insurance and direct spending. Spending peaked with the birth of our second child.

Housing: Includes mortgage interest, maintenance, and body corporate fees (condo association). Rising interest rates have pushed up spending this year again as has replacement of our central air-conditioner, which will cost more than AUD 11k.

Transport: About half is spending on our car and half is my spending on Uber, e-scooters, buses etc. I tried to spend less on Uber this year. I reduced my transport spending by 22% as a result. Also, the value of our car rose, contributing AUD 1,700.

Utilities: This includes water, gas, electricity, telephone, internet, and online storage etc.

Subscriptions: This is spending on all online services that aren't basic infrastructure. After rising strongly during the pandemic we brought it back under control this year with an 8% reduction.

Supermarkets: Includes convenience stores, liquor stores etc as well as supermarkets. Spending has been stable in nominal terms for the last three years.

Restaurants: This was low in 2017-18 because we spent a lot of cash at restaurants. It was low in 2020-22 because of the pandemic. It then jumped as life got more back to normal and rose 11% as prices are climbing I feel particularly in this area. I just paid more than AUD 7 for a large coffee this morning in Queensland, which is a record for me.

Cash spending: This has collapsed to almost zero. I try not to use cash so that I can track spending. Moominmama also gets some cash out at supermarkets that is included in that category.

Department stores: All other stores selling goods that aren't supermarkets. Has been falling since 2019-20.

Mail order: This continued to decline since the pandemic peak in 2020-21. Down another 15% this year.

Childcare and education: We are now paying for private school for both children plus music classes, swimming classes...

Travel: This includes flights, hotels, car rental etc. It was very high in 2017-18 when we went to Europe and Japan. In 2020-21 it was down to zero due to the pandemic and having a small child. This year it almost reached the nominal level of 2017-18. We paid to rent a house in Bondi Beach in Sydney because my brother and his wife were supposed to visit. That was very expensive. In the end, they couldn't visit because of the war in the Middle East. And now we took a second vacation in Winter in Queensland.

Charity: Continues to fluctuate around my goal of AUD 1k. When I think I am really financially independent and my children are grown up I'd plan to increase it.

Other: This is mostly other services. It includes everything from haircuts to fees for tourist attractions. I don't include the latter in travel because we might also pay to go to a museum or paid play place when we are home.

This year's increased spending was mainly driven by increased housing and travel costs, while most other categories declined despite inflation. Both of housing and travel included one-off costs. I paid the second half of the air-conditioner bill a few days ago in the new financial year, so I expect housing costs will remain similar in 2024-25. Travel is hard to predict, but I expect that spending will remain high as we begin to spend more on airfares again. We were still paying for daycare in the first half of the financial year, so I expect education costs to fall a little in 2024-25. 

* Moominmama has negative income tax and gets some of her franking credits paid out as cash. This is accounted for here as a reduction in the net income tax category.

Superannuation Returns in the Long-Run

Following up from my post on how our SMSF is performing compared to our managed superannuation funds, here is how our superannuation in general has done over time:

Note that the y-axis is a log scale! Our superannuation has outperformed the MSCI index in AUD terms in the long-run. The big win was in the couple of years after 2002 when I rolled over my Unisuper fund to Colonial First State and invested in geared funds. Then I got too conservative leading up to the GFC - the flat top you can see on the red line. Superannuation returns crashed in the GFC because I got aggressive again too early. After that, we have followed the market more closely until after 2018 when we have gone into a bit more of a capital preservation mode again. This reduced the volatility in 2022 but returns in 2023 are a bit disappointing so far.

On the other hand, our non-superannuation assets had catastrophic performance up to 2009. After that, I got my act together, which eventually gave me the confidence to set up an SMSF. But you can see the value of handing control to an external manager early on.

Superannuation returns are pre-tax but after fees. My method of imputing tax paid for public superannuation funds probably exaggerates their performance a bit. These time based returns are quite different from dollar based returns. All the early volatility wasn't that important because total assets were small. Performing well now is much more important.

Enough Wealth followed up on my original post by comparing his SMSF over a longer period to a basket of industry funds.

Transition to Retirement

I am thinking of setting up a transition to retirement pension (TTR pension). This allows you to receive regular payouts from your superannuation once you reach the age of 60 even though you are still working. I will be 60 years old in about 6 weeks time! There are lots of strategies this can be used. In my case, I am thinking to continue working full time at least for the next year and to recontribute all the payout to superannuation as non-concessional contributions (post-tax contributions). This has two advantages: 

1. It will convert money that was contributed as concessional contributions (at the 15% or 30% contributions tax rate) and earned as investment returns into non-concessional contributions. If my children inherit some of my superannuation when they are past the age of 18 they then won't need to pay tax on this part of the payout. The "death tax" is only on concessional contributions and fund earnings.
2. Once I hit the transfer balance cap, of currently $1.9 million, I can contribute the money to my wife's superannuation instead. I am currently at $1.7 million and she is at $800k. So, there is still a lot of unused capacity there. 

When you retire or reach age 65 you can transfer money up to the transfer balance cap into a zero taxed pension account. Money over the limit stays in an accumulation account where earnings are taxed at 15% (10% for long term CGT). The TTR pension does not affect the calculation of the transfer balance cap unless you are still holding it at age 65 when it becomes a regular tax free pension account.

My Unisuper account is 100% concessional contributions and earnings. So, I would start with that and transfer $600k to a pension account and pay out 10% of it each year, which is the maximum withdrawal rate. You have to leave some money in the accumulation account to receive new contributions... But actually 60% of my SuperGuardian account is also concessional contributions and earnings, and so it would make sense to transfer $400k from that into a TTR pension account too. So I would be withdrawing $100k per year and recontributing. The reason I wouldn't withdraw the maximum annual non-concessional contribution level of $110k is because my employer contributes more than the allowed cap on concessional contributions each year and the excess becomes non-concessional contributions.

The downside to recontributing to my wife's superannuation is that I could make those contributions from non-superannuation money resulting in getting even more money into super. After all, even if you have more than $1.9 million in super, the amount above the limit is concessionally taxed compared to non-super investments.* But right now I am not making those contributions. Instead, I have been building up a pile of cash offsetting our mortgage. This is partly to reduce our interest bill but also part of a plan to buy a more expensive house in the future. So, as long as I was planning on saving to buy a house, I wouldn't make non-concessional contributions to her account.

Anyway, I sent an email to Unisuper yesterday expressing my interest in TTR pensions and asking what the next step is. 

Originally, I planned on switching to half time work when I reached 60 years old, but I seem to have fallen victim to the one more year syndrome. Seems silly to sacrifice $120k in pre-tax salary and superannuation just to have a bit easier time in the teaching half of my year. Also, my university is enacting a major cost-cutting exercise that likely will see more than 500 jobs cut in total. Academic jobs will not be cut till next year. They are not putting in a voluntary redundancy scheme. But I figure that if I am made redundant then I will get a bigger payout if I am still working full time. I could be wrong about that.

* The government plans to tax superannuation in excess of a $3 million threshold at higher rates that include unrealised capital gains. But I think the senate will not pass that legislation and we are still a long way from the $3 million level.

Spending 2022-23

For the last six years I've been putting together reports on our spending over the Australian financial year, which runs from 1 July to 30 June. This makes it easy to do a break down of gross income including taxes that's comparable to many you'll see online, though all our numbers are in Australian Dollars. At the top level we can break down total income (as reported in our tax returns plus superannuation contributions) into the following categories of spending:

The gross income for this year (bottom line) is just an estimate. It is based on the gross income we expect to report in our tax returns (before investment expenses etc) plus employer superannuation contributions. Tax includes local property tax as well as income tax and tax on superannuation contributions. Investing costs include margin interest. Mortgage interest is included in spending, while mortgage principal payments are considered as saving. Spending also includes the insurance premia paid through our superannuation. Current saving is then what is left over. This is much bigger than saving out of salaries because gross income includes investment returns reported in our tax returns. The latter number depends on capital gains reported for tax purposes, so is fairly arbitrary. Spending increased substantially, though we also expect income to hit a high though it's been fairly constant over the last five years. Graphically, it looks like this:

We break down spending into quite detailed categories. Some of these are then aggregated up into broader categories:

Our biggest spending category, if we don't count tax, is now childcare and education, which continues to trend upwards. As mentioned above, the income and tax numbers are all estimates. Commentary on each category follows:

Employer superannuation contributions: These include employer contributions (we don't do any salary sacrifice contributions) but not concessional contributions we paid to the SMSF this year.

Superannuation contributions tax: The 15% tax on concessional superannuation contributions. This includes tax on our concessional contributions to the SMSF.

Franking credits: Income reported on our tax returns includes franking credits (tax paid by companies we invest in). We need to deduct this money which we don't receive as cash but is included in gross income. Foreign tax paid is the same story.

Income tax is one category that has fallen since 2017-18!

Life and disability insurance: I have been trying to bring this under control and the amount paid has also fallen since 2017-18 a result.

Health: Includes health insurance and direct spending. Spending peaked with the birth of our second child. It is up this year because I had an operation early this calendar year.

Housing: Includes mortgage interest, maintenance, and body corporate fees (condo association). Rising interest rates have pushed up spending this year.

Transport: About half is spending on our car and half is my spending on Uber, e-scooters, buses etc.

Utilities: This includes water, gas, electricity, telephone, internet, and online storage etc.

Subscriptions: This is a new category this year, split out from utilities. It's been trending up strongly.

Supermarkets: Includes convenience stores, liquor stores etc as well as supermarkets. Seems crazy that it has almost doubled in five years and is now our third biggest spending category.

Restaurants: This was low in 2017-18 because we spent a lot of cash at restaurants. It was low in the last two years because of the pandemic but doubled this year as life got more back to normal and prices are climbing I feel particularly in this area.

Cash spending: This has collapsed to almost zero. I try not to use cash so that I can track spending. Moominmama also gets some cash out at supermarkets that is included in that category.

Department stores: All other stores selling goods that aren't supermarkets. No real trend here.

Mail order: This seems to have leveled out in the last three years and actually came down this year,

Childcare and education: We are paying for private school for one child, full time daycare for the other, plus music classes, swimming classes...

Travel: This includes flights, hotels etc. It was very high in 2017-18 when we went to Europe and Japan. In 2020-21 it was down to zero due to the pandemic and having a small child. This year we went to Sydney for a week and this is mostly how much the accommodation cost.

Charity: Not sure why this is trending down.

Other: This is mostly other services. It includes everything from haircuts to professional photography.

This year's increased spending was mainly driven by increased childcare and education costs and higher mortgage interest. I expect education to fall a little next year as private primary school is cheaper than daycare.

Changes to Health Insurance and Superannuation

The recent Australian federal budget announced changes to arrangements for health insurance and superannuation. The former surprised me because it made me aware of a tax concession I didn't even know existed. I'll also comment on how easy it is to exceed the new superannuation contribution limits for some middle income people.

Health Insurance Australia has more or less free government health care under Medicare (with very hefty copays effectively) but also since the late 1990s has tax incentives to encourage people to take out private insurance. When the Howard government introduced the current tax incentives (I lived in Australia at the time) I was under the impression that people earning less than $A30k a year would get a 30% rebate on the cost of their health insurance while people earning more than $A50k a year (which was the top tax bracket when the Howard government came to power!) would be taxed 1% extra a year - the Medicare Surcharge - if they didn't have private health insurance. This 1% wasn't marginal but applied to your entire income. Earn $A1 over $A50k and you got hit by a $A500 charge. The surcharge was also raised higher for a while. I knew that the threshold for the surcharge had been raised to $A75k a year, but what I didn't know was that rebates for private health insurance appear to apply at every income level. I found this out only because of the Rudd government's decision to means test them. Did I misunderstand the original structure of the Howard scheme? Or were the rebates extended to higher incomes at some point?

Back when I lived in Australia in 1996-2002 I never found it worthwhile to get private insurance as mostly I got my income below $A50k and even if I hadn't the insurance seemed to cost about as much as the charge and I like to avoid this kind of hassle. And I had no idea what benefits private insurance might give me. Now both Snork Maiden and I will probably earn less than the $A75k threshold for the 2008-9 and 2009-2010 tax years. When we had to take out private cover for Snork Maiden it cost around $A1,000 per year. Australian Unity quote a rate of $110 per month for the most minimal coverage for the two of us together and I think that is after the rebate of 30%. So it would make sense if both of us earned more than $A75k per year but not before we hit that level...

Superannuation The government lowered the maximum limit for concessional contributions to superannuation (taxed at 15% instead of your marginal rate) from $A50k per year to $A25k per year. It's important to note that required employer contributions are included in this limit. If you exceed the limit you are hit by an extra 31.5% tax on the contributions. The Unisuper superannuation scheme in the higher education sector has extremely high contribution rates. Employers contribute 17% of salary to the fund (instead of the legally required 9%) and employees contribute 8.25% from pre-tax salary. Any academic earning more than $99k per year - i.e. the Associate and Full Professor levels at most universities - will exceed the new limit. You can instead pay the employee contribution post-tax. Then you'll need to earn $A147k to exceed the limit which covers all regular full professors. But anyone in those ranks needs to switch to post-tax contributions.

I'm sure most senior administrators come in above that level - e.g. a department head who is a professor will probably earn an administrative supplement on top of the professor's salary and deans must earn more than that. Also some professors earn more than this due to supplements for people in some areas like law or additional fellowships like the Federation Fellowships. John Quiggin, for example, has one of these and, therefore, has a salary close to $A 1/4 million. These people will need to get their employer contributions lowered and their salary raised (with larger post-tax contributions) to reduce tax. I don't know if that flexibility is available.

Spending 2021-22

For the last five years I've been putting together reports on our spending over the Australian financial year, which runs from 1 July to 30 June. This makes it easy to do a break down of gross income including taxes that's comparable to many you'll see online, though all our numbers are in Australian Dollars. At the top level we can break down total income (as reported in our tax returns plus superannuation contributions):

The gross income for this year (bottom line) is just an estimate. It looks like falling quite significantly. Tax includes local property tax as well as income tax and tax on superannuation contributions. Investing costs include margin interest. Mortgage interest is included in spending, while mortgage principal payments are considered as saving. Spending also includes the insurance premia paid through our superannuation. Current saving is then what is left over. This is much bigger than saving out of salaries because gross income includes investment returns reported in our tax returns. The latter number depends on capital gains reported for tax purposes, so is fairly arbitrary. Spending also recommenced its increase this year. Graphically, it looks like this:

We break down spending into quite detailed categories. Some of these are then aggregated up into broader categories:

Our biggest spending category, if we don't count tax, is now childcare and education, which has again risen steeply. As mentioned above, the income and tax numbers are all estimates. Commentary on each category follows:

Employer superannuation contributions: These include employer contributions and salary sacrificed contributions but not concessional contributions we paid to the SMSF this year.

Superannuation contributions tax: The 15% tax on concessional superannuation contributions. This year it includes tax on our concessional contributions to the SMSF.

Franking credits: Income reported on our tax returns includes franking credits (tax paid by companies we invest in). We need to deduct this money which we don't receive as cash but is included in gross income. Foreign tax paid is the same story.

Life and disability insurance: I have been trying to bring this under control and the amount paid has fallen as a result.

Health: Includes health insurance and direct spending. Spending peaked with the birth of our second child and continues to decline.

Housing: Includes mortgage interest, maintenance, and body corporate fees (condo association). We haven't spent much on maintenance this year, so spending is down.

Transport: About 2/3 is spending on our car and 1/3 my spending on Uber, e-scooters, buses etc.

Utilities: This includes spending on online subscriptions etc as well as more conventional utilities. I need to cut back on spending on video games as this category continued to climb strongly.

Supermarkets: Includes convenience stores, liquor stores etc as well as supermarkets. Seems crazy that it has almost doubled in five years and become our second biggest spending category.

Restaurants: This was low in 2017-18 because we spent a lot of cash at restaurants. It was low last year because of the pandemic and this year because of a seeming permanent behavior change.

Cash spending: This has collapsed to zero. I mainly use cash to pay Moomin pocket money and he pays me back if we buy stuff online for him. That's how it ended up negative for the year. Moominmama also gets some cash out at supermarkets that is included in that category.

Department stores: All other stores selling goods that aren't supermarkets. No real trend here.

Mail order: This seems to have leveled out in the last three years/

Childcare and education: We are paying for private school for one child, full time daycare for the other, plus music classes, swimming classes...

Travel: This includes flights, hotels etc. It was very high in 2017-18 when we went to Europe and Japan. Last year it was down to zero due to the pandemic and having a small child. This year we went to the nearby coast for a week and this is mostly how much the accommodation, booked at the last minute, cost.

Charity: Not sure why it's down this year.

Other: This is mostly other services. It includes everything from haircuts to professional photography.

This year's increased spending was mainly driven by increased childcare and education costs. I expect these to be about the same next year and then fall for a while in subsequent years - private primary school is cheaper than daycare with the low level of subsidy we get - before beginning to rise again.

Investments Review: Part 1, Diversified Funds

After noting that we had at a conservative count, 40 different investments, I thought it'd be a good idea to do a review of all of them to see what makes sense and what doesn't. Maybe my readers will learn about some interesting investments too. Or about what not to invest in. Each post will look at one type of investment starting with diversified funds. Shares of net worth don't include our house in net worth.

Unisuper Balanced Fund. Share of net worth: 10.02%. IRR: 10.64%. This is my employer superannuation fund. I think in theory we could have contributions made to another fund instead but then they would only pay the 9.5% (of salary p.a.) superannuation guarantee instead of 17%! What I do have an option to do is to switch to other investment options within Unisuper. I also think I could rollover the investment into another fund such as our SMSF. The balanced fund is diversified across Australian stocks (33%), international equities (27%), bonds (30%), property (5%), and infrastructure and private equity (5%). It is one of the better performing balanced super funds in Australia. I used to invest more aggressively by investing in the growth option instead. Unless our SMSF outperforms strongly, I'm inclined to leave this as it is.

PSS(AP) Balanced Fund. Share of net worth: 9.16%. IRR: 9.41%. This is Moominmama's employer superanniation fund. It's not quite as well-performing as Unisuper. They only offer four investment options now. There used to be more. They provide even less information about their investments than Unisuper do. Generally, it's amazing how little information most Australian fund managers provide compared to U.S. fund managers. The fund is allocated across equities (56%), bonds (18%), hedge funds (15%), and real assets (11%). I think there is a similar condition on fund choice.

Colonial First State Diversified Fund. Share of net worth: 3.12%. IRR: 10.31%. I contribute automatically AUD 500 into this fund each month. Before rolling over my CFS superannuation account into our SMSF we had a lot of superannuation invested in this fund too. There isn't really a strong justification for holding this fund, especially given the 20% of net worth that we have invested in the two superannuation funds above. Selling would mean a capital gains tax bill, but I'm really not sure why I am continuing to put money into the fund. The CGT bill would actually not be that big as the distributions have been taxed all along the way. The fund is allocated 30% to Australia shares, 20% to global shares, 30% to bonds, 5% to property securities, 5% to infrastructure securities, and 10% to "real return". It has returned 7.78% p.a. in the last ten years to March, which is less than our portfolio return.

CREF Social Choice. Share of net worth: 1.66%. IRR: 13.33%. This fund is 40% U.S. stocks, 20% rest of the world stocks, and 40% bonds with an ESG overlay. I use this as the core fund in my former U.S. employer retirement fund (403b account). Apparently, my market timing since 2002 when I first invested in this fund has paid off to boost the IRR. I have been both more aggressive and more conservative in the allocation in this account. It has returned 8.33% in the last ten years and outpaced the relevant Morningstar benchmarks. The question is whether to be more aggressive in this account and shift to the Global Equities option instead.

Ruffer Investment Company (RICA.L). Share of net worth: 0.97%. IRR: Too new. This is an extremely new investment that plays more of the role of a hedge fund in the portfolio. But as it doesn't use shorting or charge a performance fee I've classified it as a diversified fund. The allocation is 9% U.S. stocks, 31% rest of the world equities, 39% bonds (mostly index linked), 8% gold, and 13% in what they describe as "illiquid strategies" and options. The illiquid strategies seem to be hedge funds specialising in mitigating tail risk. I'm counting this part of the fund towards our hedge fund allocation.

How Much Investment Income Do We Need to Compensate for Inflation?

 

This chart compares the fitted investment income curve from my previous post about the "boiling point" with the monthly loss of value of our portfolio (including our house) due to inflation. I just took the monthly percentage change in Australia's consumer price index and multiplied by the value of our portfolio that month. The gap between the blue and orange curves is a naive estimate of how much can be spent each month in retirement mode.

Currently, projected investment income is only just enough to cover the loss from inflation. Smoothing inflation over twelve months tells a similar story:

Here I divide the CPI by its value twelve months earlier, take the twelfth root and subtract one before multiplying by the value of the portfolio. This shows that inflation is coming down a little but is still high. We really need to boost our rate of return relative to inflation in order to retire and maintain the real value of the portfolio. It is hard to think about retiring until in inflation is more under control.

Investment income accounts for superannuation taxes, but assumes that the only tax on investments outside superannuation is exactly equal to the franking credits paid.* In retirement, the superannuation tax would go away, but there would be capital gains and other taxes on investments outside superannuation. So, probably it is in the ballpark.

* This is because the series is computed as the change in net worth minus saving and inheritances. Saving is computed after tax including superannuation contribution taxes and income tax.

Target Portfolio

Following up on my previous post where I tested the performance of an idealized portfolio, here are some more ideas about an actual implementation. In total, 50% would be allocated to stocks, half of that Australian and half of that international. A fifth (maybe more) of the Australian category would be allocated to small cap stocks. Of the remaining 20% portfolio allocation half would go into unhedged funds/stocks and 10% into hedge fund type funds, probably mostly listed hedge funds, such as Cadence Capital (CDM.AX). Of the 25% in international stocks, half would go into hedge funds, primarily Platinum Capital (PMC.AX), which pays franked dividends. Then 25% is allocated to managed futures, probably mostly Winton Global Alpha Fund. This should mostly be held in a superannuation account for tax reasons – pay 15% tax on distributions instead of 47%. That means I am going to need a self-managed superannuation fund.

5% is allocated to gold. This would be held in a taxable account as it doesn't pay dividends. On the other hand, the long-term capital gains rate in superannuation accounts is 10% (and zero after going into pension mode) and my current long-term capital gains rate is 23.5%. If Labor get into power, which is likely, and implement their program, which is less likely, that will rise, though in retirement I expect my marginal tax rate will fall back into the 32.5% bracket but with Medicare tax and Labor's proposal, I would still be paying more than 25% for long-term capital gains. So it makes sense to get more money into superannuation, which is zero taxed in pension mode for the first $1.6 million for each partner. I plan to initially invest about $900k in the SMSF. This will come from rolling over my superannuation fund now at Colonial First State and adding $300k - you can invest 3 years of contributions at once - for each of Moominmama and myself.

The remaining 20% is allocated roughly equally to (mostly direct - i.e. not listed) real estate, bonds, private equity, and cash. Then the whole thing is levered up a bit, with the overall exposure adjusted for market conditions. I expect that debt will be roughly equal to the value of our house ($840k).

To summarize, this is the asset allocation (not including our house):

We are quite a long way from that - in particular very overweight long Australian shares and underweight hedge funds, managed futures, and gold.

Self Managed Superannuation

I am exploring setting up a self managed superannuation fund (SMSF). I want to do this so that I can implement our target portfolio investment strategy and so I can put higher tax investments into the lower tax superannuation environment. Managed futures are a tax ineffective investment outside super when your marginal tax rate is 47%. Inside superannuation they will be taxed at 15%.

Setting up an SMSF is very complicated in Australia compared to the US where you can just open an IRA account with a broker like any other brokerage account and the only issue is limits on contributions and later on minimum withdrawals. For standard IRAs you pay tax on withdrawals only, on your regular tax return. The main reason Australian SMSFs are complex is taxation but some of the bureaucracy just seems to be for the sake of it... In Australia, pretax or concessional contributions are taxed at 15% (or 30% for high income levels) going in, and you can also make after tax contributions. Its necessary to keep track of which were taxed how. Then earnings are taxed at 15% (10% for capital gains) and can be offset by franking credits and foreign tax paid. When you finally withdraw your money, no tax is due and earnings of the account are untaxed if you set up a pension, though now there is a cap of $1.6 million on the amount of assets whose earnings are untaxed. So funds need to submit tax returns separate from their members. And they need to be audited annually and there are lots of ways they could become non-compliant with the rules. And an SMSF is a trust which is set up as a separate legal entity. You might also want to set up a company to act as trustee!

You could go to a lawyer to set up the trust and to a local accountant to help audit the fund and do everything else yourself. But there are many providers who streamline the set up and administration of SMSFs. You can get "year-end" administration which just helps get everything in order for the tax return and audit, or you can get a full daily service. Though I do our own tax returns, I have decided to go for the full daily service as I want to outsource this as much as possible (looks like I am going to have to do tax returns for my son too and am also looking at setting up a company...) and want to be confident that I am compliant with the rules, because the penalties for non-compliance are very severe.

This is a great site with information about different providers of services for self-managed superannuation funds. I visited the websites of all the providers that offer a daily service. Some sites have a lot information and some have next to none. The latter want you to phone them to give you the details. I have a strong preference for financial services that are as transparent as possible. I also investigated Commonwealth Securities and Dixon Advisory, which are not on this list.

Dixon are based in Canberra and I often go past their offices on Northbourne Avenue. Years ago, I used to read Daryl Dixon's column in the Canberra Times. Their service combines admin and investment advice and costs from $3,000 for a $333k account to a maximum of $6,000 for accounts above $666k. To make investments, you have to call their broker and the commissions for shares are 1.1%, which is capped at $400 for Australian shares and uncapped for foreign shares. I don't need investment advice and trading is way too expensive.

Commonwealth Securities is a more realistic option. Including audit fees, they charge a flat $3,000 a year. On a $900k account that is 1/3%, which is reasonable. Trading fees are 0.12% for Australian stocks, which is good though not the lowest, and 0.31% for US stocks and 0.41% for shares in the UK and many other countries, which is expensive but not as outrageous as Dixon. You can't trade CfDs (which are offered by CommSec for other accounts) or futures (which aren't offered by CommSec).

You can set up a trading account for an SMSF with Interactive Brokers, which can trade anything you like for low fees, and then find an administration provider who is prepared to work with them. Determining who can work with IB is what I need to do next. You can trade futures in an SMSF as long as it fits within the written investment strategy (yes, you are required to write one) and other risk related rules.

Two providers on my list, who have won awards and who I am going to investigate next, are Heffron and Super Guardian. I am impressed with the transparent information on Super Guardian's site. They also have an endorsement from Chris Cuffe. Super Guardian charge more the more investments you have. If we have up to 20 investments then they are a similar price to CommSec. Heffron charge a flat fee of $3,300 for their top level service.

Potential Changes (Yet Again) to Superannuation

Gottliebson has some interesting insights on the upcoming Australian tax review. I think it makes sense that "salary sacrificing" of superannuation contributions will be ended. What does this mean? At the moment contributions to super (=retirement account) are taxed at 15% up to a limit of $A50k per year. Above that you can make "undeducted contributions". Earnings in the fund are taxed at 15% (10% for capital gains). Payouts are tax free (and this is out of bounds for the review) and if you convert your account to a pension then the earnings of the fund from then on are tax free too. Eliminating the concessional rate of tax on contributions has two effects (apart from raising revenue for tax cuts elsewhere):

1. It makes the super system simpler by abolishing concessional and non-concessional contributions.

2. Currently people in the 15% tax band get no gain from this concession. Labor will eliminate another middle class welfare expenditure.

By carrying out this reform Australia will have gone from a system several years ago that gave concessions on contributions and superannuation earnings and taxed payouts heavily, to one that taxes payouts lightly if at all and gives no concessions on contributions and only some on earnings. In other words, from an approximation of a 401k to an approximation to a Roth IRA. The US Congress likes Roth IRAs because they bring tax revenue forward to the present. The Australian Treasury, whose head is heading the enquiry, likely feels the same way.

Even so, I'm not inclined to add any extra money to Snork Maiden's superannuation and lock it up for the next few decades!

IWT Conscious Spending Plan

I like to watch Ramit Sethi's podcasts where he has an in depth discussion with a couple about their finances. These sessions usually involve the "Conscious Spending Plan", which is basically a type of budget. You can get a copy of the spreadsheet here. I was curious how our numbers compared to the guests on the show and so filled in the template myself.

My main issue was deciding what income number to use. At first, I tried using our income as reported in our tax returns plus employer superannuation contributions. That includes net investment income outside of superannuation. But then it was pretty tricky working out what amounts to put in for investment flows. I switched to using just our salaries plus employer superannuation contributions and it all made much more sense. I added a childcare and education category as that is our largest expense. For the "clothes" category I used our spending on mail order and groceries is what we spend in the supermarkets category. Transportation includes all our transportation spending including petrol, car repair, buses, taxis, e-scooters etc. Saving is our employer superannuation contribution plus the concessional contributions we make for Moominmama to our SMSF. All the numbers in the following are in Australian Dollars:

What do I notice in the results? One is that we don't really do "savings" both in terms of saving towards goals and having savings. Our savings are basically money in "checking" accounts. If we need more money we take it out of an investment account or borrow money. I am thinking I probably should get the savings buffer up more in case something happens to me. Otherwise, the family will quickly have payments bouncing without someone to make sure there is always enough money to cover bills. We used to keep about 1% of net worth in our offset account.

Our total "fixed costs" are at 76%, which Ramit considers too high. On the other hand, our investment contributions are at double the recommended level and I think they are now very low.

The amount left over in the "guilt-free spending" category is only 4%, which Ramit considers to be very low. There is a lot of flexibility here in what should fall into the fixed cost and this category. Is subscribing to e-scooters, which saves me a lot of time and is fun, something I should consider a fixed cost or "guilt-free spending"? Should private school and music lessons be considered a "fixed cost"? I have included some hobby-related subscriptions in the subscription fixed cost...  But moving those would only change things by $100 a month at most.

What is in the guilt-free spending is in practice spending on eating out (mostly lunch these days) and travel - mostly the money we spent on renting a house for our vacation. The recommended 20-35% of spending is really a lot!

Accounting for the Effect of Australian Superannuation Taxes on My Rate of Return

The earnings of Australian retirement accounts, known as superannuation accounts, are taxed by the Australian government at 15%. Contributions are also taxed at 15%. This is in contrast to the US approach of either taxing the contributions at the regular income tax rate (e.g. Roth IRA) but not taxing the earnings or not taxing the contributions and deferring the regular income tax on the contributions and earnings till the money is withdrawn (e.g. 401k, 403b, traditional IRA). The superannuation earnings tax is deducted at source from managed funds and the amount is not reported to the account-holder/taxpayer. Up till now I have been using the after tax returns on these accounts in my performance calculations combined with pre-tax returns on all other accounts. The correct way to compare returns to a market index is, however, on a purely pre-tax basis. I've now added back in the superannuation tax paid to each month's returns:



Obviously the result boosts my rate of return and I now almost match the MSCI World Index over 10 years and beat the S&P 500 total return index on all time horizons. The change has the effect of increasing alpha very slightly but boosting beta by about 5 percentage points.

I've been fascinated by the concept of "portable alpha" or "alpha-beta separation". This concept is based on the idea that any mutual or hedge fund can be broken down into a market neutral fund and a market index fund. The former is the "alpha" and the latter the "beta". I did a decomposition of my total returns into the portion attributable to the market (estimated beta*MSCI total return) and the residual or market neutral portion:



The total return index is the product of the market neutral and market related indices. This is natural as current returns multiply the capital built up from past returns.

Superannuation and Life and Disablement Insurance

I finally got my job contract and have signed and returned it, so now I have a permanent job. As I discussed, I decided to make no additional contributions to superannuation (retirement) beyond the 17% my employer is contributing. Additional contributions have to come from after tax income as the employer contribution already almost hits the annual $A25k ($US26k) ceiling on pre-tax contributions. As I won't be paying any capital gains tax for a while and franking credits help reduce my tax bill it seems to make sense to invest outside super for the moment. There will be plenty of opportunity to invest extra in super nearer retirement (assuming the laws don't change). The cap on after-tax contributions is $A150k per year and at the moment for over 50s there is a $A50k cap on pre-tax contributions. I'm 46. So from age 50 to 65 I could in theory put $A3 million into super! I don't think I need to make extra contributions now.

I think we will instead increase Snork Maiden's superannuation contributions to the maximum pre-tax level. Currently her employer pays 15.4% on top of her salary. We contribute $A225 every two weeks from pre-tax salary. We could double that to $A450 and stay within the $A25k cap.

I did opt for the maximum life and disability insurance that is allowed by my superannuation provider without providing health information. This would be a lump sum payout of $A255k currently. That declines to $A231k next year and so forth. It makes sense that the number goes down as there are less years of salary to replace and savings will increase at the same time. The premium is $A218 a year for that amount. I'm not a big fan of paying premiums to insurance companies given the insurance company failures I've seen. But this amount made Snork Maiden feel more comfortable.

More Changes to Superannuation?

The Australian Labor government is floating the idea of taxing distributions from superannuation accounts (retirement accounts) if the balance is above $800k. Currently distributions are tax free but there are taxes on contributions and earnings though these are below the usual income tax rates. The tax free distributions were introduced by the Liberal government in 2006. That was a step towards moving the Australian system towards the Roth IRA model. The US Roth IRA taxes contributions at normal rates and then has no tax on earnings or distributions. The Australian government recently made changes to increase the contributions tax for earners above $300k and reduce it for those under $30k that seemed a further step towards the Roth IRA model. But this new move would just complicate things. It is the fact that earnings in the fund are taxed and that there have been so many changes to the system that has resulted in superannuation being so complicated in Australia. The US system is much simpler. There is a variety of different account types but none of them have earnings taxed - only contributions or distributions. Therefore, no tax return or audit is needed for a retirement account. As a result it is easy to set up an IRA, the US equivalent of a self managed superannuation fund, while it is complex in Australia and only worthwhile for large amounts of money because of the costs.

If the Australian government really wants to tax distributions I recommend they just move to the US 401k model where only distributions are taxed and contributions and earnings are not. I doubt they will do that. The Labor Party and the Treasury see any "tax concession" as equivalent to a government expenditure and they want to eliminate all of them if possible.

This has implications about whether to make "nonconcessional contributions" i.e. after tax contributions in the next decade. If distributions will be taxed there is little point in making after tax contributions of course, given that I don't pay tax on the earnings of my investments outside super at the moment (due to accumulated capital losses and deductions which result in surplus franking credits). Currently, I have $215k in my super accounts. In the next 12 years until I am 60 my contributions will be $300k assuming the current limit remains what it is. A 5% rate of return keeps me under $800. Assuming that the limit would be adjusted for inflation that's a reasonable rate of return. Of course, if I keep working and contributing past 60 then I will go over the limit. Snork Maiden would hit the limit in 2028 when she would be 53 me in 2024 when I'm 60.

Was Snork Maiden's Superannuation Grabbed Already?

No contributions were paid into Snork Maiden's superannuation (retirement) account during July. We checked her payslip online and contributions were made, but they're not in the account. It might just be to do with her employer's transfer to a new computer system. Or is it the result of the implementation of the outrageous policy that was supposed to be implemented from the beginning of this tax year, where temporary residents' superannuation contributions will be paid to the ATO (tax office) and held until the worker either becomes a permanent resident or leaves the Australia permanently?

We're checking with the human resources/payroll department to eliminate the computer/bureaucracy slipup option. As I just discovered, Snork Maiden isn't a temporary resident for tax purposes as she is married to me, an Australian citizen. If it turns out that her contributions have been sent to the ATO we will be making the case that she isn't a temporary resident and this should not have happened.

If this is what happened, it hasn't solved any supposed bureaucratic problems as her previous superannuation savings are still in her account. So there isn't one less account for the authorities to track. It's just caused more bureaucratic chaos.

Delevering

I just made a big switch in my Colonial First State superannuation account to reduce risk. Stock markets still look bullish but the Fed shows no sign of stopping raising interest rates, risking an inversion of the yield curve. They have been saying that this time is different and that an inverted yield curve doesn't mean that there will be a recession. But though the sample size is very small, it has been a good predictor in the past. We are not yet at yield curve inversion but it still could make sense to reduce risk. My CFS superannuation account has been invested very aggressively. At the end of September this was the allocation:

CFS Geared Share Fund: 48.9%
CFS Geared Growth Plus: 20.2%
CFS Conservative: 10.2%
Platinum International: 10.2%
CFS Developing Companies: 10.5%

So about 70% was in geared (leveraged) funds. Geared Share Fund is large cap Australian shares. Geared Growth is diversified. The new allocation, which is much closer to our new long-term allocation is:

CFS Geared Share Fund: 15%
CFS Geared Growth Plus: 18%
CFS Conservative: 4%
Platinum International: 23%
CFS Developing Companies: 20%
Generation Global Share: 20%

Both Platinum, which is a hedge fund (long and short global equities) and Generation performed well in the Great Recession. Doing this transaction in a superannuation account is tax free - capital gains tax of 10% is paid on unrealised gains on a continuous basis. There is just the cost of the entry/exit spreads.

I changed the allocation for new investments in Moominmama's CFS account, which is not a superannuation account to only buy the non-geared funds going forward. If things look more bearish, we may yet do a switch there too.

Should You Keep Your Superannuation in Accumulation Mode?

The accepted wisdom is that as soon as you retire in Australia and are over 60 years old, or as soon as you hit 65 years old even if you are still working you should shift your superannuation from accumulation to pension mode. You can transfer up to $1.9 million per fund member into pension mode currently. Investments in pension mode have zero tax. This is in comparison to 15% tax in accumulation mode with a 1/3 reduction for long-term capital gains.

But what if you have a lot of investments outside of superannuation? These are highly taxed and so doesn't it make sense to run these investments down first to reduce your overall tax? In pension mode there are required minimum withdrawals each year. If you don't spend that money it is simply added to your highly taxed non-super investments. So, despite not having to pay tax on your money in super, you are transferring more and more money out of super into your taxable accounts. Does it make sense to wait till you have spent your non-super investments?

I ran a simulation in my long-term projection spreadsheet. This isn't a Monte Carlo simulation. I just assume my historical average rate of return over the last 20 years applies into the future. I assume that I retire at age 65 and convert my super to a pension and Moominmama converts her super to a pension at age 60. She stops working when I do. I also assume that the tax rate on investments outside super is 20% of returns (without any attempt to define realised and unrealised gains) and in super in accumulation mode is 12.5%. Both are probably at the high end of what might actually happen. But the contrast with zero tax in pension mode, makes pension mode more attractive relative to accumulation mode. The simulation runs to 2050.

I also run a simulation where all our super stays in accumulation mode. This no pension scenario has 8% more assets in 2050 than the pension scenario.

This modelling is still not that realistic. I assume that all our superannuation can be moved to pension mode, even if we exceed the $1.9 million threshold. Also, we are likely to make more non-concessional contributions to Moominmama's account before 2029 and I assume we don't. I'm think that these tweaks won't change the fundamental result. We would have to have a lot less non-super investments to change the conclusions.