In Australia we have a mandatory retirement savings scheme called superannuation. Super, as its commonly known, accounts for 9.5% of your pre-tax salary and is taxed at a rate of 15% (ATO 2021) which is usually lower than an individual’s marginal income tax rate. Additionally, workers can contribute up to an additional $27,500 p.a. into their super accounts (ATO 2021). The main downside with using super to retire is that it is only accessible once you reach the preservation age and cease gainful employment. For people born after 1 July 1964 this age is 60 years old (ATO 2021). And herein lies the problem that I have with the system, you can’t use it to retire early!
Or can you?
All my previous posts on this blog do not consider super as an early retirement tool. However, what if you could build an investment portfolio outside of super; retire early; deplete your investment portfolio; and replenish it with super once you reach your preservation age? This could allow you to build a smaller investment portfolio than would generally be required under the 4% rule; allowing you to retire earlier and/or get by with a lower savings rate. Further to this, the super tax benefits could allow you to build a larger overall portfolio come retirement age.
Building the simulation
The simulation that I’ve built seeks to answer the following questions for a single income earner looking to retire after 15 or 20 years in the workforce:
- Given the same annual spending and income, can someone retire earlier by opting for a strategy which uses superannuation to top up their investment portfolio once they reach their preservation age? If so, how much faster?
- Does withdrawing super at 60 or 65 facilitate more income during retirement?
- How much should someone contribute to super (over and above the compulsory 9.5%) to allow for early retirement?
To build this simulation I’ve used the following assumptions:
| Pretax salary | $100,000 |
| Super and investment portfolio growth rate | 7.00% |
| Required withdrawal rate at age 60 | 4.00% p.a. |
| Inflation rate | 2.00% p.a. |
| Single person household | |
| Start work at age 23 | |
| Preservation age is 60 | |
| Salary grows at the same rate as inflation | |
| No fees or taxation on portfolio activities | |
| Standard super contribution remains at 9.5% pre-tax salary | |
| Super cap increases each year with inflation | |
| Additional super contributions tax | 15% |
| The household is exempt from the Medicare levy surcharge | |
| No tax offset for low- and middle-income earners are applied | |
| Additional voluntary contributions are made yearly only during working career |
While fixing all the variables listed in the table above, I then set additional super contributions to $0 and increased the cost of living to find out what is the maximum value (to the nearest $500) that allows the following conditions to be met:
- The investment portfolio (outside of super) must be greater than $0 by age 60
- Due to longevity requirements (retiring at 60 and living until 95), the total value of the superannuation portfolio + the investment portfolio at age 60 must be greater than 25 x annual expenses (adjusted for inflation).
Once the maximum cost of living is determined I then increased additional super contributions in order to determine the effect that additional pre-tax super contributions have on investment portfolio longevity and total portfolio values. The maximum additional contribution value is defined as the maximum value of contributions that still allows the portfolios to satisfy the above conditions.
15-year simulation results
For a single person looking to retire in 15 years (age 38) the maximum cost of living that they can have is $40,500. With this level of annual spending, they can contribute up to $10,000 of pre-tax income into super. This equates to a savings rate of between 40.9% and 46%. It also ensures that their investment portfolio does not run out at 60, or 65 and their total portfolio (investment portfolio + super) satisfies the 4% rule at age 60 and 65.
When compared with only using an investment portfolio outside of super, at a cost of living of $40,500, satisfying the 4% rule will take 19 years.
The following graph shows the simulated portfolio, super, total and required portfolio values with $10,000 p.a. worth of voluntary pre-tax super contributions
The following tables show the summary values at the end of year 15, 37 and 42.
Year 15
Cost of living = $47,501, required total portfolio = $1,187,531
| Super contributions (p.a.) | Investment Portfolio | Super | Total | Withdrawal rate |
| $0 | $976,015 | $202,917 | $1,178,932 | 5.51% |
| $3,500 | $883,453 | $309,715 | $1,193,168 | 6.12% |
| $10,000 | $790,891 | $416,514 | $1,207,404 | 6.88% |
Year 37
Cost of living = $82,615, required total portfolio = $2,065,386
| Super contributions (p.a.) | Investment Portfolio | Super | Total |
| $0 | $1,179,677 | $899,003 | $2,078,681 |
| $5,000 | $769,590 | $1,372,163 | $2,141,753 |
| $10,000 | $359,502 | $1,845,322 | $2,204,824 |
Year 42
Cost of living = $91,214, required total portfolio = $2,280,353
| Super contributions (p.a.) | Investment Portfolio | Super | Total |
| $0 | $1,151,529 | $1,260,898 | $2,412,428 |
| $5,000 | $576,360 | $1,372,163 | $2,500,889 |
| $10,000 | $1,191 | $2,588,351 | $2,589,351 |
20-year simulation results
For a single person looking to retire in 20 years (age 43) the maximum cost of living that they can have is $47,000. With this level of annual spending, they can contribute up to $10,000 of pre-tax income into super. This equates to a savings rate of between 31.1% and 38.8%. As in the previous simulation, it ensures that their investment portfolio does not run out at 60, or 65 and their total portfolio (investment portfolio + super) satisfies the 4% rule at age 60 and 65.
When compared with only using an investment portfolio outside of super, at a cost of living of $47,000, satisfying the 4% rule will take 24 years.
The following graph shows the simulated portfolio, super, total and required portfolio values with $10,000 worth of voluntary pre-tax super contributions
Year 20 results
Cost of living = $68,470, required portfolio = $1,711,753
| Super contributions (p.a.) | Investment Portfolio | Super | Total | Withdrawal rate |
| $0 | $1,227,157 | $331,039 | $1,558,196 | 7,14% |
| $5,000 | $1,075,793 | $505,269 | $1,581,063 | 8.09% |
| $10,000 | $924,430 | $679,500 | $1,603,930 | 9.32% |
Year 37 results
Cost of living = $95,875, required portfolio = $2,396,868
| Super contributions (p.a.) | Investment Portfolio | Super | Total |
| $0 | $1,420,003 | $1,045,690 | $2,465,693 |
| $5,000 | $941,873 | $1,596,053 | $2,537,926 |
| $10,000 | $463,743 | $2,146,416 | $2,610,159 |
Year 42 results
Cost of living = $105,853, required portfolio = $2,646,336
| Super contributions (p.a.) | Investment Portfolio | Super | Total |
| $0 | $1,407,866 | $1,466,634 | $2,874,499 |
| $5,000 | $737,263 | $2,238,547 | $2,975,810 |
| $10,000 | $66,661 | $3,010,459 | $3,077,121 |
Observations
Comparison to not using super
To be able to retire in 15 years exclusively using a portfolio outside of super a household with the same income level would require a cost of living less than $35,000, which equates to a ~54.8% savings rate. To retire in 20 years, a household would require a cost of living less than $42,500 which equates to a ~43.4% savings rate. Both savings rates are significantly higher than what the simulation above has shown (40.9% and 31.1% with for $0 additional super contributions).
Alternatively, when not using super to top up at the preservation age and keeping costs of living the same a household will need to work for an additional 4 years before being able to retire.
Withdrawing super at 60 vs 65
In both cases, withdrawing super at 65 results in significantly higher overall portfolio values than withdrawing super at 60 years of age. This observation is consistent across all additional super contribution levels. It should be noted that in all cases, withdrawing super at 65 resulted in lower investment portfolio values but higher super values.
Making additional super contributions
Making additional super contributions creates more risk for the household as it leaves less in the investment portfolio during the 37th and 42nd years. Depending on when someone chooses to access their super this can become problematic. The worst case of this is the 15-year, $10,000 contribution scenario where the investment portfolio balance falls to $1,191 in the 42nd year.
The major benefit of contributing to super is having a greater total portfolio balance at the end of the 37th and 42nd years. This was observed across all simulations, where the difference between the maximum and minimum super contributions scenarios at the end of the 42nd year was seen to be around $200,000 extra.
Portfolio longevity and withdrawal rates
The 20-year scenario can tolerate higher withdrawal rates than the 15-year scenario (9.32% vs 6.88%) as the portfolio only needs to last 17 years as opposed to 22 years. This implies that using super allows a household to retire without necessarily meeting the “4% rule”.
Implications
Increased risk
While this simulation shows that super can be used as an effective tool for helping someone retire earlier than would normally be possible using the “4% rule” higher withdrawal rates significantly increase the risk of running out of money. Whilst tweaking the numbers, I found that this simulation was highly sensitive to portfolio returns and cost of living changes. For example, in the 15-year scenario if the maximum household cost of living was increased by $1,500 to $42,000, in year 37 the total portfolio value falls from $2.2M to $1.8M and the household is no longer financially independent. Further to this modelling for portfolio returns at 6% results in a negative portfolio value at year 36.
As it is well known, retiring early using a safe withdrawal rate is riskier than retiring at age 65; this is due to the inability to access government support before reaching the pension age. Hence, I would consider a strategy which involves retiring early with the plan to partially deplete an investment portfolio even risker. The fact that real portfolio returns vary greatly year to year, means that this strategy is heavily exposed to sequence risk. An example of this is retiring after the 15-year period and experiencing a 30% drop in portfolio value while making a 10% withdrawal, even if the following year’s growth very high, it is unlikely that the portfolio will last the necessary time.
Periods shorter than 15 years
For this simulation I did not model periods shorter than 15 years because the required portfolio lifespan approaches the 30 simulation periods used in portfolio longevity studies. This implies that the chance of running out of money before being able access super, may become too high for one’s risk tolerance if using withdrawal rates greater than 4%. In such cases, the logical conclusion is to build an investment portfolio, external to super such that it meets or exceeds the 4% rule.
Legislation changes
The rules of the super system are defined by the government; so, rules like preservation age, taxation and maximum sizes of super balances are all subject to change. This implies that legislation changes are a significant risk for anyone intending to use the money to retire. Imagine getting to retirement only to realize that there is a cap on withdrawals which is less than your cost of living or that the preservation age has increased.
Controlling for risk
In this simulation I have used a 7% portfolio growth rate throughout the life of the simulation which implies a fairly risky asset allocation e.g., close to 100% stocks. One way to reduce risk in this scenario would be to include less risky asset classes such as bonds into the investment portfolio when approaching retirement while maintaining the risky super asset allocation. However, this would likely drop expected returns which will reduce total portfolio values at the preservation age. Pursuing a strategy of this nature would require a drop in cost of living to ~$36,000 with $0 super contributions which is only $1,000 higher than pursuing a standard FIRE strategy. Ultimately, maintaining an income to cover a large percentage of your cost of living is going to be the simplest and most effective way to de-risk the situation.
Portfolio longevity
In this simulation, given that retiring after 15 years would mean that a portfolio would need to last at least 22 years to access super at 60 what does the research on historical portfolio longevity say?
A study by Cooley, Hubbard and Walz published in 1994 indicates that when using a withdrawal rate of 7%, a portfolio with a 75/25 stocks/bond split has a 91% probability of lasting 25 years. If the portfolio allocation is changed to a more conservative, 50/50 stock/bond split the probability of lasting 25 years rises to 96% (Cooley, Hubbard and Walz, 1994).
These results seem to lend support to my simulation’s finding that, by using super to top up an investment portfolio it is possible to use a withdrawal rate much higher than 4% to retire early – and hence build a smaller portfolio. A 7% withdrawal rate implies a portfolio of approximately 15 times annual expenditure.
Concluding thoughts
Superannuation can be used to facilitate an early retirement by acting as a tool to top up an investment portfolio once the preservation age is reached. My simulations show that time spent in the workforce can be reduced by approximately 4 years. Or, if the desire is to maintain a similar time in the workforce, a household’s cost of living can be increased. Also, contributing the maximum quantities specified above yields the highest total portfolio values, likely due to taxation savings and time in the market.
This strategy is risker than early retirement using the 4% rule. Even though the studies using historical data have presented favorable probabilities for portfolio longevity they merely indicate that the final portfolio value is greater than $0. Applied to this case they do not indicate whether or not the total portfolio value is capable of sustaining a retiree for a further 30-35 years. Legislation changes contribute to risk significantly, where a small change, such as an increase in taxation or cap on withdrawals could mean that the total portfolio is no longer sufficient at perseveration age.
By making minimal pre-tax contributions to super, a household can reduce the risk that their non-super portfolio balance falls too low at the preservation age. This also reduces their household’s exposure to superannuation legislation changes. When retiring, reducing the household’s withdrawal rate closer to 4% will help to further control for sequence risk. Finally, anyone looking to pursue this strategy must be open to continuing to earn an income. Although they will not strictly be considered to be ‘retired’, in my opinion this is the best strategy to de-risk the situation.
Engineer your freedom
References
ATO, 2021, How tax applies to your super, Australian Taxation Office, available from: <https://www.ato.gov.au/individuals/super/in-detail/withdrawing-and-using-your-super/withdrawing-your-super-and-paying-tax/?page=4#How_tax_applies_to_your_super>
ATO, 2021, Concessional contributions cap, Australian Taxation Office, available from: <https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?anchor=Concessionalcontributionscap#Concessionalcontributionscap>
ATO, 2021, Preservation age, Australian Taxation Office, available from: <https://www.ato.gov.au/individuals/super/in-detail/withdrawing-and-using-your-super/withdrawing-your-super-and-paying-tax/?anchor=Preservationage#Preservationage>
Cooley, P, Hubbard, C, and Walz, D, 1998, Retirement Savings: Choosing a Withdrawal Rate That is Sustainable, Bierwirth Vol 10(1)
Simulation spreadsheet
The spreadsheet that I’ve used to produce the graphs above can be downloaded at link below: