Future Focus: The fatal error with super
Don’t fall for predatory companies encouraging you to pillage your retirement savings.
More Australians are disengaged with their super. And more companies are taking advantage of this.
Data from the Australian Tax Office (ATO) show that the number of individuals applying for compassionate release of super has increased from 39,000 in 2019-20 to nearly 69,000 in 2023-24.
The ways you can access your super before preservation age are limited. Most applications for early release of super are for medical expenses. 71,900 of the 90,700 applications submitted in the 2024 financial year were submitted for medical treatment or travel to obtain medical treatment. Why is there such a large increase in compassionate release for medical treatment? It is complicated.
Has the mindset about super shifted?
Super is designed for retirement. Yet government policy keeps sending mixed messages on the purpose of super. There are policies to help first-time homeowners. More widely adopted were two tranches of early release of superannuation during the pandemic.
More than 2.5 million Australians took the Morrison government up on this offer. Over $38 billion was drained from superannuation accounts. And those that did access their super reduced their balances by 51%.
The limits on withdrawals and percent decrease in balances indicates that it was mostly younger Australians or those that were self-employed who took part in the early release program. Participants took what they could as 75% withdrew the maximum amount available.
This policy was colloquially known as the $120,000 pizza, referring to the fact that a large amount of the money was spent on takeaway food. The amount spent on takeaway food and gambling – another popular use for the money - will result on average of $120,000 less in individuals’ accounts at retirement.
Since these early release schemes there’s been increased visibility that money can be taken out of super. Most people are disengaged with their super, and according to research from Australian Retirement Trust nearly a quarter of Australians haven’t checked their balance in the last 12 months. More Australians learned from the early release scheme that super can improve their lives – not in the future, but today.
Predatory practices are keeping early release front of mind
I’ve been served advertisements on social media multiple times from companies promoting early release. The message is that early release is possible, and guidance and assistance are offered to obtain it. The ads stop just short of encouraging Aussies, but the implication is clear.
The line that needs to be crossed to consider these practices predatory is arbitrary. I believe they’ve met the standard. The incentive is there as the companies benefit from the services individuals spend the money on. For example, a hair loss treatment centre gains a client from someone who can only afford the treatment if they use funds from super. There are also third-party companies affiliated with medical services that facilitate release and promise a ‘100% success rate’ for applicants.
I’m not the only one concerned with what is happening. In a press release The Super Members Council (SMC) stated ‘(we are) alarmed by a growing trend of Australians withdrawing retirement savings early to fund treatments beyond the original intent of compassionate access provisions — which were envisaged only for rare, life-saving circumstances.’ They called for the government and regulators to shut down the companies offering non-essential medical or dental treatments.
The SMC also notes their concern with the methods used by these companies. Not only are they targeting consumers but also preparing inaccurate medical reports to increase the chance of release on compassionate grounds.
Analysis from the SMC shows that an individual who withdraws $20,000 from their super at 30 will have $93,000 less in retirement.
Eligibility criteria for early release of super
There are several legitimate reasons which allow early release of superannuation. The provisions are designed to help people that are in dire need. My intention is not to vilify people in legitimate need. It is to educate people on the implications of early release to fund non-essential spending.
The companies preying on people who don’t understand the impact of withdrawals are focusing on release through compassionate grounds.
Below is a list of the grounds for early access:
- Access on compassionate grounds
- This includes medical treatment for you or your dependent, preventing foreclosure or forced sale of your home, modifications to your home or a vehicle to accommodate your or your dependant’s special needs arising from a severe disability.
- Access due to a terminal medical condition
- Access due to severe financial hardship
- Access due to temporary or permanent incapacity
- Super balance is less than $200.
The impacts of withdrawing your superannuation early
Individuals who are considering withdrawing funds from their superannuation for non-essential spending should go into the decision with both eyes open. These are the implications of the decision.
- The magic of compounding over decades
Withdrawing funds means you miss out on the opportunity cost of compounding over the decades. This can dramatically alter your retirement outcomes. As mentioned, the SMC calculates a $20,000 withdrawal will result in $93,000 less in retirement. When the average balance of a retiree is $435,900 for men and $381,700 for women, this is significant.
The marginal tax rate of the median Australian salary is 30% (+2% Medicare Levy). This is more than double the tax within super. Over time, the tax savings on contributions and earnings compound, meaning it is difficult to match the long-run compounding benefits of the superannuation structure. Investing in super is very attractive.
You also have a reduced buffer in retirement. Market volatility doesn’t really matter at year 1, 5 or 20 of a 40-year holding period. If you deplete your super too soon or too heavily, you have less buffer to ride out investment volatility or economic downturns in later years.
- Higher risk of outliving your savings and a lower quality of life
We all want a good quality of life in retirement. It is hard to know what the age pension will be in 40 years. We do know that having a lower balance will mean a higher risk of outliving your savings through sequencing and longevity risk and having to rely on welfare.
- Reduced access to a tax advantaged account
Replacing funds that you’ve pulled out of super isn’t as easy as saving more and putting it back in. The tax that you pay in super and your retirement accounts is lower than most marginal tax rates. It isn’t just about contributions but the lower taxes on returns.
- You’ve got to pay tax
You don’t just get to pull funds out of super without penalty. You will likely have to pay tax on the withdrawal. The tax that you pay from your superannuation withdrawal depends on whether you meet a condition of release and your age.
Source: Finpeak Advisers
It is worth noting that you can’t elect to receive the amount solely from the tax-free component. It is taken proportionately from each account.
Super isn’t safe, so why should I bother?
It isn’t just financial hardship claims. Mark and I recently recorded an episode of our podcast Investing Compass on investing outside of super. We received several responses, and the common theme was diminishing trust in the super system. People are unsure about future returns and changing regulations and tax and therefore wary of locking up their savings for decades.
Consequently, more investors are considering investing outside of superannuation to minimise the funds going into the system. However, there’s a difference between not maximising your contributions into superannuation and taking funds out.
Regardless, it is not hard to make the connection between recent amendments to superannuation regulation and an increased distrust in the system.
Why I still have faith in super
I haven’t lost faith in super. I believe it is the best interest of the country and governing bodies as it lowers the number of Australians reliant on the age pension. I believe it is in the best interests of people as it offers incentives to save for retirement.
As a result, super will remain a more attractive way to save for retirement regardless of future legislative changes. It is in the best interest of too many stakeholders to change that fundamental truth of the system. The primary beneficiaries will continue to be investors who have the most money and spend the longest time in super.
It is worth a reminder of why it is so attractive to invest in super.
Why super is so attractive
Tax concessions
Contributions to superannuation are typically taxed at 15% up to a certain threshold. This is a lower tax rate than the marginal tax rate outside of superannuation on the median salary. The earnings within superannuation are then taxed at 15%.
In retirement, earnings are taxed at 0%, up to $2 million. This is indexed and increases each financial year.
The risk in the future is that these concessions are lowered. Changes may make super less attractive but - as previously stated - I don’t believe it will be less attractive than saving and investing outside of super.
Conditions of release
Many see the strict conditions for release from superannuation as a negative. Yet they also create forced discipline to save which many people struggle to do.
Even with proposals to allow more flexible access (e.g. for housing deposits), the fundamental compulsory nature of super and stringent conditions of release is likely to remain a key feature.
Super makes for better investors
Morningstar conducts the Mind the Gap study which illustrates the power of your behaviour on your total returns. It looks at the difference between investor and investment returns.
The latest edition of the Mind the Gap study estimates that the average dollar invested in managed funds and Exchange Traded Funds (ETFs) earned 7% per year over the 10 years ended December 31, 2024 (‘investor return’). That’s about 1.2% per year less than the funds’ 8.2% aggregate annual total return (’total return’) over the span assuming an initial lump-sum purchase.
That 1.2% ‘investor return gap’, which is explained by the timing and magnitude of investors’ purchases and sales of fund shares during the 10-year period, is equivalent to around 15% of the funds’ aggregate return.
Behavioural risks reflect our tendency as humans to act emotionally during volatility. We are driven by fear and greed, which is a formula for buying at the top of the market and selling at the bottom. It makes it more likely we will chase performance.
These actions driven by emotions have lowered the returns investors receive. This is the ‘behaviour gap’ that’s displayed in the study - the gap between an investment return and the return an investor gets in the same period.
This study is conducted across regions. Australian investors fare better than most other regions. This difference can be explained by the forced savings and discipline imposed by superannuation. Forced to think long-term Australians exhibit less of the short-term behaviour that plagues most investors.
Time
Younger people have the advantage of time. They have decades to accumulate returns, smooth volatility, and exploit compounding. Even if non-super vehicles earn the same returns the cumulative advantage of super’s tax structure over many decades is hard to beat.
Final thoughts
As more Australians loss faith in super and withdraw money they undermine their retirement security. The impact is especially high for younger people who have the most to lose from compounding and tax advantages. It is hard to reconcile the benefits of short-term spending against this backdrop.
While policy changes shifting the attractiveness of superannuation is front of mind for many Aussies, the structural tax advantages, preservation rules, and compounding benefits suggest that super will remain, on balance, a more attractive vehicle for retirement accumulation than ordinary saving. This is especially true for those on higher incomes and with many years ahead of them until retirement.
Please be careful with your retirement savings. Encouraged by self-interested companies, it may seem like a ripe opportunity to use funds. Carefully consider making this choice for non-essential spending, as it is your quality of life that you are handing over - with extra tax to the ATO to boot.
Invest Your Way
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