The sums on gearing versus super

TAX changes and the steady rate rises, place a question mark over whether the golden-oldie super strategies are as good as they once were.

Gear stick /File

The sums on gearing versus super

BABY boomers will thank the outgoing Howard government for one legacy at least: the removal from July 1 this year of any tax on superannuation benefits for those aged 60 or older.

But given several other legacies, such as the steady rise of interest rates, it places a question mark over whether some of the golden-oldie strategies are as good as they once were. One of these is whether gearing to build a retirement pot is still a good idea, and whether it is better to gear for savings outside super or simply invest everything into it.

Zurich senior technical analyst Dimitri Diamantes suggests that while the change to super for the 60-plus set improves its tax effectiveness relative to gearing, it has also enhanced the potential to access offsets to minimise tax payable outside super.

The basics of gearing versus super are fairly simple. Both have a common purpose - to accelerate wealth building.

Gearing  - or borrowing - can be good where the effective return on borrowings exceeds the interest expense on the loan. Of course a gearing strategy has the potential to magnify losses as well as gains.

In turn, tax breaks on super are good. They can accelerate wealth building by using concessional tax benefits, including pre-tax or tax-deductible contributions and favourable taxation of investment earnings and end benefits.

On the downside, funds in super are locked away until you meet the conditions of release, such as retirement.

The big winner for super is that contributions and earnings in a fund are taxed at a maximum rate of 15 per cent, which is less than most people's marginal income tax rate.

Drawings from super - whether in the accumulation or pension phase - are tax-free when paid to someone 60 or older, and so are earnings on assets in super income streams.

By selling assets in the pension phase (when savings are used) a super fund can unlock capital without triggering capital gains taxes.

There are other benefits too, as Mr Diamantes points out:
* PAYG tax instalments that would otherwise be withheld are potentially immediately available for investment in super.
* Retirement savings in the accumulation phase are assets-test-exempt for social security purposes prior to age pension age.

Being barred from your savings along the way is without doubt the biggest drawback of investing in super. And who is to know what a government of any persuasion might decide down the track -- the so-called legislative risk.

And there are other risks: an employer can delay contributions for up to three months after they fall due, and there are caps on how much can be contributed in any year - now $50,000 ($100,000 if you're 50 or over) a year in concessionally taxed contributions and $150,000 a year in non-concessionally taxed contributions.

Turning to gearing, the benefits include the ability to claim interest expenses as a tax deduction. The lump sum can be invested immediately, generally within a matter of days after transfer.

Perhaps most attractive is the ability to get at the funds easily.

On the flip side, Mr Diamantes says, small unfavourable movements in interest rates or investment returns can cut profits or cause a loss for a leveraged investment. And there's the usual risk of legislative changes, such as altering the deductibility of interest on existing loans.

Which to choose? It's a hard call , but there are several rules of thumb:

* Super is better if you are risk averse.
* Gearing is inherently riskier, yet can work better for those on higher marginal tax rates.
* Drawdowns in gearing need to be judged according to the best capital gains tax outcome.
* Super has attractions, such as the ability to set up a transition-to-retirement income stream.

Mr Diamantes says people need to remember that a leveraged investment is inherently more risky than super because of its sensitivity to interest rate rises.

"Also, strategies can be introduced in the latter part of a client's working life to increase the end benefit from investing in super.

"These include drawing income from a transition-to-retirement pension to free you to increase concessionally-taxed contributions to super.''

These can make super perform better than gearing outside.