Treasurer Joe Hockey has suggested that first homebuyers should be allowed to dip into their superannuation to buy their first home. The idea has been widely condemned by liberal luminaries such as Peter Costello and Malcolm Turnbull. And damningly condemned by Paul Keating.
One of the main arguments is that superannuation funds should be left to fund retirement.
I have modelled one scenario where a superannuation contributor, Joe Average, draws down his superannuation funds as a deposit on a house.
As with all models, there are a number of assumptions built into this one.
These assumptions are:
The model is calculated in today’s dollars. This means there is no allowance for inflation in Joe’s salary and is no allowance for inflation in the value of his accumulated super. (The advantage of this is that it provides an easy-to-understand picture in today’s terms of what the Treasurer has suggested
Joe Average begins work at the age of 20 and works to 65.
His starting salary is $60,000 and it rises to just under $65,000 by the time he retires. The increase is a result of promotions but has no cost of living adjustments built into it.
His superannuation investment increases on average 5% per annum (this assumes the normal rate of capital gain in the stock market of 8% per annum less 3% for inflation).
Joe decides to draw down all of his superannuation, some $94,000, when he is 32 and use as a deposit on a house.
The graph below shows the impact of this withdrawal on Joe’s retirements savings.
If he leaves his superannuation investment intact Joe’s final accumulated assets at retirement will be $956,000. If he withdraws the $94,000 in the 12th year of his contributions, his final payout at retirement will be $465,000, slightly less than half had he left his fund intact.
The important principle that is at work here is that of the exponential growth which is what superannuation funds are based on.
In other words, withdrawing $94,000 in year 12 of a 45 year investment costs around $450,000 at retirement. The small blip in the growth in the right-hand graph indicates the impact that early with clause can have on exponential growth schemes
The important consideration is what this means Joe’s retirement income.
With a working income of $65,000, Joe would have been paying around $13,000 a year in tax, leaving him with $52,000 disposable income.
If he retires, without using his superannuation for a deposit on a house, he will be able to draw down the minimum 5% of his lump sum of $956,000 and have an income of $48,000 (tax-free). This is slightly less than Joe receives during his working life.
As 5% rate is equal to the estimated annual capital gain in the stock market, Joe’s superannuation investment remains intact during his life and his children will inherit his super when he dies.
Joe can withdraw his super at 6% which will give him an annual income of $57,000 which is slightly more than he received during his working life.
This means that his accumulated super will decline to around $870,000 by the time his 85. So there will still be a respectable amount of money to pass on to the children.
However, if Joe has withdrawn the $94,000 as a deposit on the house, his annuals superannuation benefit (5% of $465,000) will be $22,000.
This is some $30,000 less then he was earning when he was working and will represent a significant decline in his standard of living.
If he wishes to maintain his standard of living and withdraw $52,000 a year, his superannuation investment will have reached zero by the time he is 83. No more money in benefits, nothing for the kids.
But he does have his house which he may choose to liquidate for living expenses.
This is a single limited scenario. But the principles, which apply across the income ranges, are important.
Withdrawing money from the superannuation fund early in the contribution period has a disproportionately severe impact on the final superannuation benefit.