Lock away your money for a long time?

[urbanista]

Need to pick the community brains. Will you lock away your money so that you cannot touch it until the age of 60, if you were us?

Our situation:
36 years old couple living in Australia.
Net income (2 salaries) after tax 138K, spending 54K

Assets: 300K cash in the bank account + 200K in retirement account (the mix of index funds) = 500K total
We also own our house valued at about 630K, but I never include the house into my FIRE calcs.
Liabilities: none

Our goal is to be financially independent as soon as possible, but don't really want to reduce expenses.

We need to make a decision of whether to max out our super (the retirement account called "super" in Australia) or not. It makes heaps of sense to do it, since our marginal tax rate is 42%, but it is only 15% in super. So we would save 27% on any extra contributions straight away. Then, any earnings in super are taxed at 15%, whereas we would have to pay 42% on the earnings in any other account.

Here is the thing though. In Australia, the money in super totally locked away until the age of 60. One can choose any type of investments, but absolutely cannot withdraw any money until the age of 60. So it is very inflexible.

However, I am having a hard time to justify investing outside super. We already have 300K doing nothing in the bank. If we max out super every year, our take-home pay will reduce but we still be saving 70K a year outside of super. We absolutely would not need the money for the next 5 years, and then we will have 650K sitting in the bank. I know it's suboptimal, but we want to keep large cash balance in case in 5 years time we decide to sell the family home and buy even more expensive one. It does make sense in terms of moving close to a good public school vs. paying 250K to educate two children in a private school.

I guess our problem is how do you let go of the control over your money for 23 years? It is such a long time. The government may change rules any time, such as increasing the age to 70, for example.

Everyone we know, including popular financial advisers, paper columnists etc. do not recommend putting extra money into super precisely because of this uncertainty.

But if we don't, I really don't see any other options that may suit us. Our bank account just keep growing... Help!

[kaetana]

At your ages, I tend to agree that extra contributions into your super funds wouldn't be the best way to go, for the reasons that you stated. However, I do think that you should reconsider leaving large sums of money in a bank account. Even assuming you're leaving the money in a high-interest savings account, you would get, what, 4% max? Why not look into investing it in something like Vanguard index funds ( https://www.vanguardinvestments.com.au/ )? You could always cash everything in if you really wanted to, and you would get a much higher rate of return than 4%! Just my 2 cents.

[urbanista]

Why not look into investing it in something like Vanguard index funds ( https://www.vanguardinvestments.com.au/ )? You could always cash everything in if you really wanted to, and you would get a much higher rate of return than 4%! Just my 2 cents.

Thanks! I hear this advice all the time. That's what I was thinking in 2005/2006/2007 and invested heavily in index funds. Then wanted to buy a house and sold in 2008. Lost 100K. The rate of return was much lower than 4%. So I don't want to repeat this again.

[urbanista]

At your ages, I tend to agree that extra contributions into your super funds wouldn't be the best way to go, for the reasons that you stated.

The only disadvantage of super is the legislation change risk. I am wondering how the Americans cope with this risk, I guess it would be pretty similar in the U.S.? Since the general advice for someone in the U.S. is to contribute into 401(K) at any age whatever young, how do people cope with the legislation change risk?

[Abe]

Regarding the legislation change risk in US: that is a possibility, but it would be hugely unpopular to make it unable to be accessed for certain situations or with a penalty (that is how it is right now, 10% penalty or extenuating circumstances with no penalty).

That being said, we have the option of Roth accounts that don't give tax advantage now, but do later on (supposedly, again legislation can change).  However, there's been no major tax-unfriendly changes since inception of these funds. If there were, most likely people could withdraw their funds if they perceive the change as worse than the current penalty.

Of course the major difference between the US and Australian system is that we can withdraw at any time, you all cannot.

[fixer-upper]

At your ages, I tend to agree that extra contributions into your super funds wouldn't be the best way to go, for the reasons that you stated.

The only disadvantage of super is the legislation change risk. I am wondering how the Americans cope with this risk, I guess it would be pretty similar in the U.S.? Since the general advice for someone in the U.S. is to contribute into 401(K) at any age whatever young, how do people cope with the legislation change risk?

I put a bunch of money into a health savings account when the rules allowed spending on over the counter medical items, and the withdrawal penalty was 10%.  Since then, they've restricted what you're allowed to spend on, and increased the withdrawal penalty to 20%.  That experience still makes me cringe at the thought of giving politicians control over my money for decades.  I'm coping with the situation by slowly spending it down rather than adding.

[kaetana]

At your ages, I tend to agree that extra contributions into your super funds wouldn't be the best way to go, for the reasons that you stated.

The only disadvantage of super is the legislation change risk. I am wondering how the Americans cope with this risk, I guess it would be pretty similar in the U.S.? Since the general advice for someone in the U.S. is to contribute into 401(K) at any age whatever young, how do people cope with the legislation change risk?

I have to admit I don't know anything about US retirement funds. But another disadvantage of super is that it is 'old man money'. Even if legislation doesn't change, we can't access it until we're 60. I just feel like it doesn't benefit someone who plans to retire decades earlier than the preservation age.

What asset allocation strategy did you use the last time you invested in index funds? And was this with Vanguard as well?

[urbanista]

We plan to work full time until we have 1.5M including super, but excluding the house. It will probably happen around 44 y.o., and then it is very likely that we will work part-time until 50 or even longer. Even with only part-time work for both of us, our savings rate will be 30-40%. If the preservation age don't change, the taxable accounts would only need to last for 10 years, which is done easily.

Granted, last time I invested into shares, I was heavily into REIT, so took heavy losses.  The thing is, we are great savers but lack financial discipline as investors. I can easily see myself selling the portfolio in order to buy 1.2M+ family house or DH buying a brand new BMW. I just don't trust us in that regard. So it might be another advantage locking away some of our money in super.

[msilenus]

I find it sometimes helps to approach a problem like this by asking: "if I had perfect information, what's the best way to game this?"

For the super, what you'd do is structure your finances so that on the day before your 60th birthday you finally exhausted the last dollar in your taxable accounts, and have exactly as many dollars in your super as you need for the rest of your life.

You don't have perfect information, so you can't plan on playing a perfect game, but you should be able to do better than putting $0 in the super.  That's sort of like forfeiting.

As a starting point, you might consider asking how much you'd need at age 60 for the rest of your life, and extrapolating investment growth backwards in time to figure out how much you would be putting in now to meet that.   Once you know that amount, you could discount it however you think is appropriate to balance out the risk of needing some or much of the money earlier.  A spreadsheet would help a lot with that, because you could simulate investment returns out to retirement, and play with hypothetical super-savings-amounts and see what pops out at age 60. 

Note: with tax-advantaged accounts, it's usually better to get the money in early and let it ride longer.  You get a better benefit of tax-deferred compounding.  (I'm assuming supers are like our American accounts in that earnings in intervening years are not taxed.)  You also get to realize your tax benefit earlier, which causes that to compound for longer as well.

[msilenus]

Thanks! I hear this advice all the time. That's what I was thinking in 2005/2006/2007 and invested heavily in index funds. Then wanted to buy a house and sold in 2008. Lost 100K. The rate of return was much lower than 4%. So I don't want to repeat this again.

The error here was going heavy into stocks with a time horizon that was short.  Good rule of thumb for stocks is to try to shape things so that your time horizon is at least ten years or so.  Downpayment money should usually be in CDs.

If you'd kept the money in an S&P 500 fund until now (just to be concrete), you'd be up 50% on just the principle and have made loads in dividends besides.  It would probably be in the neighborhood of a 7% return.  Not the best years for stocks, but still a strong showing.

[Thegoblinchief]

Max the super to reduce your tax penalty, no brainer, unless you have health issues where you don't foresee living to 60, or much past it.

 $70K savings is more than my family's entire gross income. Your liquid assets would be my entire ER nest egg. Surely you can ER on "just" the savings after maxing out the super account.

Apologies if overly snarky.

[urbanista]

Max the super to reduce your tax penalty, no brainer, unless you have health issues where you don't foresee living to 60, or much past it.

 $70K savings is more than my family's entire gross income. Your liquid assets would be my entire ER nest egg. Surely you can ER on "just" the savings after maxing out the super account.

Apologies if overly snarky.

All good, it's great to relate our situation to the broader world, as we cannot discuss our situation with friends and family. It seems that everyone's values are a huge house and brand new BMWs, then keep working until 65 to pay it off.

Yes, we can retire on "just" the savings after maxing out the super account. So we will probably max it out!

[Notch]

24 year old on $90,190 here. I salary sacrifice $12,600 of that on top of work contributions to max my super.  The tax saved is basically a gov't contribution of 36%. It increases my total net income, so I can spend more and stay within my overall savings rate of 25%.

[urbanista]

24 year old on $90,190 here. I salary sacrifice $12,600 of that on top of work contributions to max my super.  The tax saved is basically a gov't contribution of 36%. It increases my total net income, so I can spend more and stay within my overall savings rate of 25%.

24 years old, wow. Very impressive.

How does it work out to be 36% in tax savings? My understanding that maximum tax rate 42% - 15% = 27%?

[travelbug]

I would not max out the super unless the tax advantage was going to bring down my pay to be close to my net pay before I maxed out the super. If that makes sense. I do not trust the government not to move the goal posts or the tax rate to pull it all out in 20+ years.

Are you able to salary sacrifice at all?

I agree about investing in blue chip shares, if it's in the bank you are getting 4%-ish but paying the max PAYG tax rate on it. So it's under inflation.

If you invest in shares you can sell and have your money back within 3 days and your dividends are fully franked, which gives you the income without the huge tax rate (capped at 30%, already paid) and you gain franking credits in case you make a capital gain when you want to cash it all in for a house.

Good luck

[kaetana]

24 year old on $90,190 here. I salary sacrifice $12,600 of that on top of work contributions to max my super.  The tax saved is basically a gov't contribution of 36%. It increases my total net income, so I can spend more and stay within my overall savings rate of 25%.

Emphasis added for clarity.

Can you explain what you meant by this? I don't understand. By my calculations you'd actually be decreasing your total net income.

Without salary sacrifice
Gross income: 90,190
Taxes: 22,669.85
Net income: 67,520.15

With salary sacrifice
Gross income: 77,590
Taxes: 17,927.85
Net income: 59,662.15

[Notch]

Reduction in take home pay = $8,000. Tax saved = (0.385-0.15)*12,600 = $3,000.

$3,000 / $8,000= 0.375

I contribute $8,000 and the government gives me another $3,000 to keep.

Yes, it does reduce take home pay, but it increases total net income.