Compounding interest and personal super contributions. Yes, I know it sounds boring but before you yawn and close this browser, give me five minutes of your time. Because I want you to understand how these seemingly boring terms are a powerful combination in the world of finance.
Benjamin Franklin famously said,
“Money makes money, and the money money makes, makes more money”.
Albert Einstein also talked about the brilliance of compound interest referring to it as,
“The eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it”.
Have I got your attention yet?
If there is one financial tool I want you to understand, it’s compounding interest and how it applies to personal superannuation contributions. Because once you do, you can use it to your advantage. And over time, it can change your life.
The theory part is pretty simple. An initial amount of money (the principal amount) will earn money through interest or other sources of investment income. That interest when re-invested, creates more money.
Prudence puts $10,000 in a term deposit earning 3% per annum interest (not realistic in today’s climate but neither is the name Prudence so let’s run with it).
After one year, Prudence has $10,300 ($300 in interest). That additional $300, along with the $10,000 Prudence originally had, then earns 3% per annum interest the following year.
After five years, she has $11,616 ($1,616 in interest).
After 10 years, she has $13,494 ($3,494 in interest).
After 20 years, she has $18,208 ($8,208 in interest).
Now let’s look at compound interest in a more complex system – our superannuation. The current super guarantee (SG) contribution means all employees* receive a minimum 9.5% of their employment income as a super contribution paid by their employer. That 9.5% will grow over time and, if invested wisely, will give you more money for retirement.
But what if we added more than the 9.5% to our super through a concessional contribution? How much of a difference would it make to our super balance when we retire?
For the 2019/20 financial year, the maximum amount that can be deposited into superannuation on a pre-tax basis is $25,000 per annum. That provides us with two big benefits – we get more money growing for us and may pay less personal income tax.
Herbert receives an annual salary of $105,000 and receives SGC of $9,975 per annum. Herbert decides to increase his superannuation contributions to the $25,000 maximum so he contributes an additional $15,025 per annum into his superannuation fund.
Let’s assume that Herbert has a starting superannuation balance of $200,000 and has a superannuation investment portfolio that provides a net return of 4.4% per annum.
If Herbert contributes only the mandatory 9.5% per annum over 25 years, his superannuation balance will grow to $722,029.
If Herbert contributes the maximum $25,000 per annum over 25 years, his superannuation balance will grow to $1,207,365.
While Herbert’s super grows over time thanks to the extra money he is putting in, the amount of tax he saves equals $1,368.97 per year.
This shows how a bit of planning can change your life.
While I’ve kept the above explanation pretty simple, you do need to be aware that there is a bit of fine print involved in adopting these strategies.
I can work with you to harness the power of compounding interest so you can boost your super and stroll into retirement feeling calm, content and ready for adventure.
If you’re ready to grow your super, I’m ready to help. Book in a free 30-minute phone consultation and let’s boost that balance.
Profile Piece: Professional Planner. Read a recent article published on the Professional Planner website, written by the talented Tahn Sharpe.Keep Reading
Have you heard of a Self-Managed Super Fund (SMSF) but never really known what it was about?Keep Reading
General advice disclaimer: This article has been prepared by FMD Financial and is intended to be a general overview of the subject matter. The information in this article is not intended to be comprehensive and should not be relied upon as such. In preparing this article we have not taken into account the individual objectives or circumstances of any person. Legal, financial and other professional advice should be sought prior to applying the information contained on this article to particular circumstances. FMD Financial, its officers and employees will not be liable for any loss or damage sustained by any person acting in reliance on the information contained on this article. FMD Group Pty Ltd ABN 99 103 115 591 trading as FMD Financial is a Corporate Authorised Representative of FMD Advisory Services Pty Ltd AFSL 232977. The FMD advisers are Authorised Representatives of FMD Advisory Services Pty Ltd AFSL 232977.