In this listener-requested episode, Mark and Shani break down the pros and cons of Australia’s super system vs America’s 401(k)s and IRAs. From tax benefits and compulsory contributions to fee structures and investor outcomes.

Mark LaMonica: All right, Shani, we have a listener requested episode today, which are always fun because we don’t have to think of…

Shani Jayamanne: The topic.

LaMonica: And we have, we, -- Shani has this spreadsheet that has all of the topics and there’s a lot of blank in there.

Jayamanne: There is. But I put them in a very specific order and I always ask Mark, are you all right to write these episodes? And then it comes to it and he just completely changes the topic. But it’s always good. It’s always a good change.

LaMonica: Well, thank you for that. She also has a color coding system, which I updated yesterday.

Jayamanne: I was very proud of you.

LaMonica: She was, yeah, very impressed. It’s a very low bar for Shani and me. But let’s talk about today’s episode. So we are going to compare the U.S. and the Australian retirement system.

Jayamanne: A battle between two retirement systems. What could be better.

LaMonica: I know, but we’re not going to declare a winner.

Jayamanne: I really wanted to declare a winner. Mark.

LaMonica: Okay. Well, we can...

Jayamanne: I’ll ask you at the end of this.

LaMonica: We can declare a winner. I was going to say the point is to understand how different policies impact what investors should do.

Jayamanne: All right. That’s a good outcome of an episode.

LaMonica: Yeah. But anyway, Shani wants a winner. So I guess we will declare a winner at the end or maybe during it. So it would seem that right now, obviously, we’re putting down a lot of countries. That seems to be the general geopolitical vibe. Well, you can imagine who we is. But I want to add a couple of caveats before we get into this. So we’re not going to spend time on the non-investment-related sides of things. So that would be the age pension in Australia and social security in the U.S. So we’re just going to ignore these. This is an investing podcast. So we’re going to talk about the accounts that people have that they can invest in.

Jayamanne: And since we think that most of the listeners will be familiar with the Australian system, we’re going to use that as a baseline to make comparisons. So let’s start with the basis for the Australian system, which is the compulsory aspect of super. So how does that compare to the U.S. Mark?

LaMonica: Well, simply there is no compulsory aspect to it. So in the U.S., saving for retirement is up to the individuals. There are some incentives for saving for retirement, which I will go through. But the biggest one is the tax breaks. And we will go through a whole section where we compare the tax benefits in each country. And really the incentive in the U.S. outside of tax breaks is the employer matches. And so this is where we need to get into the various flavors of U.S. retirement accounts. So the first one we’ll talk about is the 401(k), which was introduced in 1978.

Jayamanne: And that compares to the compulsory aspect of super that we have here in Australia that was introduced in 1992.

LaMonica: Okay, so much like me and you, the U.S. is slightly older here in terms of introducing that.

Jayamanne: Well, it was introduced one year before you were born and one year before I was born in Australia and the U.S.

LaMonica: Well, if only we would have been born earlier, it would have made this whole episode more interesting. So let’s talk about the 401(k). So the 401(k) is offered through your employer. So about 68% of all private sector workers in the U.S. get offered a retirement plan. And many small businesses don’t offer a retirement plan. And that’s because it does cost money to administer that plan. And so obviously this skews towards larger companies and about a third of small businesses in the U.S. right now offer a 401(k) plan. So in some cases, an employer may offer an incentive to participate. And these come in the form of matches. So for instance, employer may say that they will match your contributions dollar for dollar, up to 3% of your salary. So this is really just another employment benefit. And companies use these to compete for employees, having better benefits. And the matches and the level of the match can vary significantly between companies and some companies have no match.

Jayamanne: All right. So now in Australia, super is compulsory, but people who are self-employed, like contractors, don’t have to make contributions. So in those cases, savings rates do vary with ASFA estimating that nearly 20% of all self-employed Australians have zero in super.

LaMonica: Now, unsurprisingly, it’s a lot higher in the U.S. So half of all Americans have zero in retirement savings, and 20% of all people that are older than 50 have zero. So even when you’re getting close to retirement, Americans are either choosing not to participate or can’t afford to participate or potentially don’t have access to plans. But we’ll talk through some of the other ways you can save for retirement as well.

Jayamanne: And I think one place that we’re both in agreement is that we both like the compulsory aspect of super.

LaMonica: That is true. And I do know there are a lot of people, and I understand the arguments, that people should be able to choose what they do with their money, which would be the U.S. system, choosing to save for retirement or not choosing. And I’m certainly sympathetic to that argument, but I think the goal obviously, or at least to me and I think to you as well, the goal is to have as many people retire with dignity as possible. And so that’s why I think in this case, the pluses probably outweigh the minuses of having a compulsory super.

Jayamanne: Exactly, Mark. So why don’t we move on to taxes? So in super, the first tax is the 15% tax on contributions. What are the contribution taxes on the U.S. retirement accounts?

LaMonica: Now we have to talk about all the different flavors of savings in the U.S., retirement savings, because it is a little more complicated. So basically, retirement savings accounts fall into two buckets. There are regular retirement savings accounts, and then there are Roth retirement savings accounts. So they apply both to employer setup plans, so 401(k)s. There’s a regular 401(k) and a Roth 401(k). And it applies to just voluntary savings. Those are called individual retirement accounts or IRAs. So there’s a Roth IRA and a regular IRA. So got all of that. There’s going to be a quiz for you at the end, Shani.

Jayamanne: Got all right. Well, I think I’ve got all of that. It sounds a little bit complicated, but I’m guessing the difference between those accounts are probably the taxes.

LaMonica: Exactly. So for a regular retirement account, you pay no taxes on contributions. So that compares to that 15% tax and super contribution. So no tax. It’s tax-free money that goes in there. So that’s obviously huge incentive. That incentive does depend in scale based on your tax bracket. So the higher your marginal tax rate, the more you save in taxes because you’re not paying anything. The Roth variety of accounts, you pay full taxes on contributions. So those are after-tax contributions into the accounts.

Jayamanne: So just hearing that, initially, I feel like I need to ask, why would you contribute to a Roth?

LaMonica: Well, there’s a very good reason for that. And I will get there, but let’s just go through the rest of the tax situations first. So first all, Shani, why don’t you talk about the taxes once something’s in a super account?

Jayamanne: All right. So with super, capital gains and income are taxed once again at 15% during the accumulation phase when you’re still working and contributing to super. A long-term capital gains discount applies to that 15% tax rate. And so if an asset is held for more than 12 months, it does drop to 10%.

LaMonica: Okay. So in the U.S., once money is in one of those retirement accounts, there are no taxes. So no taxes on capital gains, no taxes on income. And this does have implications. And this is during accumulation. We’ll talk about retirement in a second. That does have some implications. We will get there though.

Jayamanne: All right. And finally, we have taxes when you are retired. So in Australia, that’s when you’re in pension mode. So in 2025, as of July 1st, the pension transfer balance cap is $2 million. And any assets in pension have no taxes on capital gains or income and no taxes on withdrawals.

LaMonica: Okay. Unsurprisingly, things are more complicated in the U.S. So for the regular version of retirement accounts, there is still no tax on income and capital gains in retirement. But any withdrawals from those accounts are counted as regular income. So that means based on how much you take out of those retirement accounts, it will put you into a certain tax bracket. And you have to pay that marginal tax rate on that withdrawal.

Jayamanne: So obviously, there is a big incentive to only take out what you owe. So how do withdrawals work?

LaMonica: Well, similar to Australia, there’s something called a required minimum distribution. I won’t get into all the specific rules, but you can delay withdrawals until you’re retired. But even if you are still working, you do need to take them at 73. The calculation is based on your account balance and a life expectancy factor that the IRS puts out. And I assume still will, even though I think Trump fired everyone who works at the IRS. But hopefully somebody’s around to put that number out.

Jayamanne: Just the one person. So if we go back to the beginning, these are the accounts where you pay no tax on contributions, but you pay your full marginal tax rate on the way out.

LaMonica: Exactly.

Jayamanne: So that is for regular retirement accounts. What about Roth accounts? Those are the accounts where you pay the full taxes on the contributions, which on the surface makes you think nobody would want to do that.

LaMonica: Yeah, well, It does. So there obviously needs to be some sort of incentive to do that. And the incentive is you never have to pay taxes on the money again. So as I said, there are no taxes on capital gains or income, no taxes on any of the money that you take out. You also never have to take the money out. So there are no required minimum distributions. So you can leave it in there until death. And then when your heirs get it, then there are taxable events. But you never have to pay taxes on that money again.

Jayamanne: There you go. There’s one final tax that has been proposed on super and that is the tax on account balances over $3 million. Is there anything like that in the U.S.?

LaMonica: There isn’t right now. But I will say that I’ve heard some people worrying about that. I’ve also seen some people advocating for that. So governments obviously go after large pockets of money, both because they want to raise funds, of course. And cynically, there’s probably some other reasons. So especially with this idea of Roth accounts, never owing taxes again. Some people do worry that politicians are going to go after those large balances because some people have very large balances in there because they are never paying taxes on them. But right now, there’s nothing.

Jayamanne: Alright, so why don’t we pause now and talk about the implications of tax policies on investors in both countries? In the U.S., ultimately, taxes have no impact on how you would invest. And that isn’t the case in Australia. Even with the lower tax rate in super, it pays to invest in a tax efficient way. Minimizing short term capital gains, for example, and considering the after tax returns of different investments.

LaMonica: Exactly. So let’s move on to investment options. So in the U.S., we’ll start with those employer plans. So those are the 401(k)s. And in that case, your company will select a provider, just like a company in Australia would select a default super provider. Now, the difference is you don’t have a choice to pick someone else. So you have to go with whoever your company selects. And that does have some implications. Obviously, you can choose to not participate. But if you want to save in a 401(k), it has to go through the company that your company selected.

Jayamanne: What if it’s a dud? Well what are the main issues with that?

LaMonica: What are the main issues?

Jayamanne: Yeah.

LaMonica: I mean, the main issues are that, and we’ll get into fees a little bit. But yeah, if there’s a provider that has very high fees, or you don’t like the investment options that they have, you’re basically screwed. There’s nothing you can do. And we’ll get into fees in a bit. But this is once again, we’re based on the company you work for, it does have implications because the investment options and these things are generally funds or ETFs, which range from passive products to active products. But what those products are is all who the provider, it’s all through who the provider you pick.

Jayamanne: Okay. And what about individual accounts?

LaMonica: Okay, one thing you can do is you can save in individual accounts, people generally do it, I’m not going to say generally, you can do that instead of saving in your 401(k). You can do that in addition to saving your 401(k). And all that is a retail brokerage account. So whatever broker you want to use, you can pick, you can invest in funds, ETFs, individual shares, anything you could trade through your broker. And one thing that is important is because a 401(k) is tied to your employer, when you leave your company, you can transfer that money into an individual retirement account. So either a regular account or a Roth account.

Jayamanne: Alright, so in some cases, this is similar, you have the options of picking your own investments with an SMSF, or you can go with a premixed option from a superfund or invest in funds or ETFs in a member direct option. And we made the point a minute ago, but you can also select your own super fund, and you don’t have to go with the default option that your employer provides.

LaMonica: Yeah, which is great. And I think a huge advantage to Australia that you do have that freedom to pick whatever super fund you want, your employer has to support that by making contributions there. Why don’t we move on to fees, Shani?

Jayamanne: Well, given some of your previous opinions that you’ve expressed during your articles and the podcast, I can guess where this is going. But I do agree with your opinion.

LaMonica: Thank you. For once, you’ve agreed with me.

Jayamanne: For super, you are paying admin fees and investment management fees. Australian Super is the largest super fund in the country. And at $250,000 in the balanced premixed option, you’re paying fees of 0.69% a year.

LaMonica: Yeah, and Australian Super’s actually pretty cheap.

Jayamanne: That’s right. And according to a 2023 Rainmaker Superannuation Benchmarking Report, the average industry fund MySuperOption charges 1% in annual fees, with 0.71% of that for investment management fees. So how does that compare to the U.S.?

LaMonica: Okay, we’ll start with individual retirement accounts, the IRAs. So as I said earlier, those are the ones that are set up with a retail broker. So you can pay a fee of zero for these accounts. For instance, my accounts are with Charles Schwab, so one of the biggest brokers in the U.S. zero admin fees, trades are free. So the only fee I would ever pay would be if I picked a specific ETF or fund, and I would pay the investment fee on that.

Jayamanne: That’s hard to beat, zero, Mark.

LaMonica: That is true. That is true. Things are a little different with a 401(k) plan. So in that case, the fees will vary based on the plan that’s picked by your employer. And this is probably obvious, but if you work for a large company with lots of employees, it’s to your benefit. So in that case, your company can negotiate a better deal. There was a recent survey by an organization called the Investment Company Institute in the U.S., and they looked at fees. So the largest companies paid fees, or their employees paid fees, of 0.27% a year, which is better than what we get out of super, especially when you consider the scale of a company like Australian Super.

Jayamanne: All right, how about the smallest plans?

LaMonica: Okay, so those are generally small businesses. So these are the ones where many employees don’t even get that option. But so this is mostly small businesses, and the fees are significantly bigger. So 1.26%. So I would say that is significantly worse than what we’re getting most of the time in Australia.

Jayamanne: And that’s obviously a really big range of fees that we see out of the U.S. What’s your take away from this?

LaMonica: Yeah, I mean, I think the takeaway is that we should expect better from our giant super funds in Australia. Right, there’s been all this consolidation, certainly in terms of assets being managed, they compare to some of these large U.S. companies, the money that employees are investing, and yeah, the fees should be lower. And I think we’ve talked about this before, especially that admin fee is a really large burden because it’s fixed. So on lower account balances, that’s a huge problem. The investment fee is really high as well, for those premixed options. And I think this also extends to a self-managed super fund, that’s basically the equivalent of an individual retirement account like mine with Charles Schwab, yet the fees are a lot higher.

Jayamanne: And as we alluded to in the beginning, at the end of the day, this is just a brokerage account except for the regulations and taxation of super during the accumulation phase.

LaMonica: Yeah, exactly. And I think the regulatory burden and tax burden introduces all this admin and that clearly costs money. And I think with all of these constant changes and super regulation, it should be considered, and I’m sure it won’t, but government should just consider that it’s all these changes that are adding to the admin burden, which is adding to the fees, which is making people’s life a lot harder. When just like what I’m doing with my broker, all you’re trying to do in a self-managed super fund is just invest your money. And yeah, it’s frustrating, I think that the fees are that high.

Jayamanne: Well, I think we’ve covered a lot of aspects on the two different retirement systems. Do you have any final thoughts on them both? Or one in particular?

LaMonica: Yeah, yeah, I mean, I’ll go through both. So I think, I think if you look at the U.S. system, in many ways, it mirrors other things in the U.S. So there’s a lot of choice. That choice includes great options and poor options. I can’t really think of a better situation for retirement than having a good amount of money saved in a Roth IRA. You will never pay taxes again, you have no withdrawal requirements, you pay no fees, I don’t really know what could be better from a retirement perspective. At the same time, if we look at the overall retirement picture, most people don’t have good options. And so that’s what happens when you make participation a choice. The other thing that we didn’t talk about is if you want to pull money out of these retirement accounts, you can at any time, it’s a 10% tax basically penalty tax if you pull money out. But a lot of people will save in their 401(k). And then when they switch jobs, they’ve got some money, they just pull it out and pay that 10% fee. And so I think that’s why there’s so many people in the U.S. without retirement savings. And we can call those bad choices by individuals. But that’s also not a great situation to be in.

Jayamanne: So I think maybe the summary here is that you think as an individual, the U.S. tax system is probably better and you’d prefer it if you have the means and the desire to save for your own retirement. But overall, you think the Aussie system.

LaMonica: Yeah, yeah, I think that’s a great way of putting it. I think if we judge a retirement system by the outcomes, the retirement outcomes of the overall population, then I think things are a lot better in Australia.

Jayamanne: So we have a winner.

LaMonica: We have a winner.

Jayamanne: But, of course, I think that also means that there can always be improvements. Fees are one area where things could really improve in Australia. And I also think that in an ideal world, people would be more engaged with their super as well. And the overall population would be more financially literate to make more informed decisions.

LaMonica: Yeah, absolutely. So was that enough of declaring a winner? I mean, I hedged it a little bit.

Jayamanne: You did a little bit.

LaMonica: Good. Well, we declared a winner. Shani’s happy. Hopefully people listening are somewhat happy. If you’re not happy. You can email me at [email protected]. Thank you very much for listening.

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