Date posted: 30/04/2020 3 min read

Early release of super – what’s its real cost?

A difference of definition

In brief

  • Comparing nominal versus real returns
  • Overlaying the rule of 72
  • The net results

How do you accurately work out the real cost of taking up to A$20,000 out of superannuation before retirement under the Australian Government’s coronavirus early release policy?

This is a highly subject exercise and depends on a large number of variables, such as:

  1. What do I intend to do with any money I take out of super now?
  2. How long before I retire?
  3. Will I make catch-up contributions to my retirement?
  4. What investment return will I earn in the future?
  5. What fees and taxes will I pay on my remaining retirement money?

Ideally you would think that this is not a controversial area given its complexity. Sadly, you would be wrong.

The problem with the results anyone produces is that it depends on all of the above variables.

The end net result is highly sensitive to the investment assumptions that are made.  The key ingredients are:

  1. the average rate of return on investments
  2. the likely average fees
  3. the tax rates
  4. the average inflation rate.

It’s important to talk about these assumptions.  In my experience, actuaries spend a long time building an investment model to work out what average returns should be.  Financial planners also typically like using average returns.

Let’s take the S&P/ASX200 as an example.  Between March 1982 and March 2020 (a 38-year period), the average return (share price only) was 7.9% per annum without taking into account fees, taxes or inflation.  

How often did the ASX actually deliver this result over any single year?  Never.

Here’s how the returns looked at the end of each year:

This is hardly a picture that shows using averages is a suitable solution.  Surely a better approach would be to make assumptions about future returns based on past volatility and offer a range of potential results based on random variability for each year.

Sometimes this is called Monte-Carlo simulation. Admittedly, even this method isn't perfect and depends on how well you have built your data model.

Where's my super invested?

Sadly, APRA-regulated super funds are not required to tell their members where their money is invested. All that is provided is a range of investment funds and broad asset allocation ranges.

Nominal vs real returns

Nominal returns are simply what an investment is expected to produce without taking into account inflation.

Real returns take inflation into account.

For example, if I take the S&P/ASX200 nominal average return above of 7.9% and assume inflation over that period was 3%, then my real return is 4.9%.

Does the average consumer understand these differences?  In my experience, most consumers understand that prices increase because this is their lived experience (in fact, many seem to erroneously think that prices increase faster than wage increases).  But what its impact is over the medium to long term is often seen as simply a deep dark impenetrable mystery.

What is more accurate nominal or real returns?  Indeed, is there a right or wrong answer?  In my view, most definitely not.  The key issue is: Do I want to look at my investment results using future dollars or using today's dollars?  What's required, however, is a full description of what has been calculated including the assumptions.

The rule of 72

A handy actuarial formula is the rule of 72.

To know how long it will take for money to double in value based on an average return, divide the rate of return by 72.

For example, if we assume a 7% return, then it will take about 10 years for money to double in value.

The net results

Assume for the sake of the simplicity that A$20,000 is withdrawn from super in one lump sum (not correct in that you have to take out two withdrawals of A$10,000 each over roughly a six-month period).  What reduction in super benefits might this lead to?

Example 1

Net of fees and taxes average return – 3% per annum
Inflation rate – 2% per annum

Investment period (years)

Nominal return (A$)

Real return (A$)

10

$26,878

$22,092

20

$36,122

$24,403

30

$48,545

$26,956

40

$65,240

$29,777

Example 2

Net of fees and taxes average return – 5% per annum
Inflation rate – 2% per annum

Investment period (years)

Nominal return (A$)

Real return (A$)

10

$32,577

$26,878

20

$53,065

$36,122

30

$86,438

$48,545

40

$140,799

$65,240

Example 3

Net of fees and taxes average return – 7% per annum
Inflation rate – 2.5% per annum

Investment period (years)

Nominal return (A$)

Real return (A$)

10

$39,343

$31,059

20

$77,393

$48,234

30

$152,245

$74,906

40

$299,489

$116,327