Nick Bruining: How the carry-forward super rules can give a 20yo today a $7m pot in retirement

As crazy as it seems, a young professional — or any young employee who starts work in a high income-paying job today — has an opportunity to set themselves up for retirement in just a few months and, potentially, wipe out most income tax liabilities for the next year or so.

The superannuation-based strategy would see a 20-year-old with an estimated $2.1 million at age 60, with not a cent being added to the fund between now and then.

Fly-in, fly-out workers, young sport stars, social media celebrities and beneficiaries of a deceased estate might be some of those lucky enough to be earning high incomes and looking to reduce their tax bills by using a safe and perfectly legal strategy.

And it’s not just for young taxpayers. Almost anyone who receives a large taxable payment during the year can use the same trick.

The strategy makes use of the special carry-forward cap rules that apply to concessional contributions to super.

A concessional contribution is one where a tax deduction has been claimed. It includes the employer’s 12 per cent compulsory super contribution, but also voluntary contributions such as salary-sacrificed amounts or payments made directly to a fund and claimed as a personal tax deduction by the member.

It is the latter type of contribution which lies at the heart of this strategy.

Under the current rules, the annual concessional contribution limit — or cap — for an individual is set at $30,000 a year. It increases in $2500 increments and is linked to average weekly ordinary time earnings.

Provided the member’s account balance is less than $500,000 on June 30 in the previous financial year, they can carry-forward unused cap amounts for up to five prior financial years.

Almost every new entrant to the workforce would easily pass that test.

Including this financial year, a person who received no compulsory super over the past five years now has one year at $27,500, then four years at $30,000, and this financial year at $30,000 — or a grand total of $167,500.

And here’s the twist — the rules do not specify a minimum age for the carry-forward contribution cap to start accumulating. In essence, the cap starts accumulating the moment a child is born. Age restrictions only kick in at the other end of life, when you reach 67.

A 20-year-old who makes a $167,500 tax-deductible contribution to super now will see at least 15 per cent come out as a contribution tax. If their total income exceeds $250,000, this tax effectively increases to 30 per cent, which is still much less than their marginal tax rate of 45 per cent, plus at least a 2 per cent Medicare levy. Assuming the 15 per cent contributions tax applies, that leaves $142,375 to be invested.

Given our young member has about 40 years to go until they can access the benefit tax-free at 60, it makes sense to invest the funds in a long-term growth strategy.

While there’s bound to be a share market crash or two between now and retirement, an average return of 7 per cent a year over that period would see the super pot grow to $2.14m by the age of 60.

You can thank the magic of compound returns for that.

According to research house Super Ratings, the 31-year average return for a “balanced” type fund is 7.2 per cent a year. That also assumes no other money is invested between now and retirement.

If our young worker just receives compulsory super over that same period based on a salary of $150,000 a year, in addition to the $167,500 contribution at age 20, they would be looking at a superannuation benefit easily reaching $7m by the time they reach retirement.

As a final benefit, if our young worker faces a financial disaster through their working life and is declared bankrupt, one thing the Bankruptcy Trustee can’t touch will be their super. In most cases, it’s completely protected.

The only thing they need to worry about is any future changes to the rules.

Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association