Superannuation: What It Is, How It Works, Types of Plans

What Is Superannuation?

A superannuation is an Australian pension program created by a company to benefit its employees. Funds deposited in a superannuation account will grow through appreciation and contributions until retirement.

The term "super" is more commonly used when referring to pension plans available in Australia. The U.S. equivalents to a superannuation plan are defined-benefit and defined-contribution plans.

Understanding Superannuation

Funds are added to the superannuation fund by employer (and potentially employee) contributions. This monetary fund pays out employee pension benefits as participating employees become eligible. An employee is deemed to be superannuated upon reaching the proper age or as a result of infirmity. At that point, the employee can draw benefits from the fund.

A superannuation fund differs from some other retirement investment mechanisms in that the benefit available to an eligible employee is defined by a set schedule and not by the performance of the investment.

Types of Superannuation Plans

There are two types of superannuation funds.

Accumulation Funds

With an accumulation fund, employees and employers periodically contribute to the fund so that it grows over time. The funds are designed to increase by using the contributions in investment strategies to give a return on investment, allowing for larger distributions.

Accumulation funds are distributed to retirees based on the returns generated, so the more you put into the fund and the more it grows, the more you can receive in retirement.

Defined Benefit Fund

Defined benefit plans are funds that make distributions based on a formula to give a guaranteed amount of income when withdrawals begin. These are similar to annuities or pension plans where employment length and salary history are considered.

Benefits of Superannuation

A superannuation has many benefits. Some of the most notable are:

• Lower fee structures: Fees tend to run low compared to other retirement account options.
• Simple features: Most supers only provide what you need and give you choices for any extra services.
• Investment choices: Supers generally allow you to choose your investment types. Depending on your preferences, you can choose from retail, industry, public, corporate, or self-managed super funds.
• They can follow you throughout your career: A super fund can be attached to you instead of your employer so that it follows you throughout your career. These are called stapled super funds.
• You can access them early: If you become incapacitated permanently, temporarily unable to work, or have a terminal medical condition, you can access your super early without penalty.
• Guaranteed income throughout retirement: Super funds guarantee you won't run out of retirement funds before you die.
  
• Government contributions of up to $500: If you meet specific criteria, the government will contribute a maximum of $500 to your super fund.

Superannuation From Multiple Perspectives

Employer

A defined benefit superannuation supplies a fixed, predetermined benefit depending on various factors, but it is not dependent on market performance. Specific factors include the number of years the person was employed with the company, the employee's salary, and the exact age at which the employee begins to draw the benefit.

Employers often value these benefits for their predictability. From a business perspective, they can be more complex to administer, but they also allow for larger contributions than some U.S. employer-sponsored plans.

Accumulation funds are not as predictable, but still rely on the same factors as defined benefit plans.

Employers who contribute to a super account pay a set tax rate of 15% on the contributions. If you're self-employed, you can deduct your contributions from your taxes, but your super fund pays a 15% tax on them.

Employee

In a defined benefit plan, upon qualifying for retirement, an eligible employee receives a fixed amount. It's typically distributed on a monthly basis. The amount is determined by a preexisting formula. In that regard, the function of a superannuation is similar to receiving Social Security benefits upon reaching the qualifying age or under qualifying circumstances.

Accumulation funds can increase payouts, but they can also decrease them if the market doesn't cooperate. Employees should be cautious when choosing this type.

Depending on what other retirement savings vehicles the employee has, there may be other implications that require consideration to access the funds in the most tax-efficient way possible.

Contributions made to a super from after-tax income are not taxable. However, capital gains made in the fund are taxable under certain circumstances. Everyone has a super capital gains tax cap which they can claim under their non-concessional gains.

Superannuation vs. Other Plans

While a superannuation guarantees a specific benefit once the employee qualifies, other traditional retirement vehicles may not. For example, a defined benefit superannuation is not affected by individual investment choices, but U.S. retirement plans such as 401(k)s and Individual Retirement Accounts (IRAs) can be affected by market fluctuations. In that sense, the exact benefit from an investment-based retirement plan may not be as predictable as those offered by a superannuation.

A person on a defined-benefit plan generally will not have to be concerned with the total amount remaining in the account and is usually at low risk of running out of funds. In other investment vehicles, however, poor performance could mean a person might run out of funds before they die.

Companies are required to report the funding status of the plan to the appropriate tax authority annually and to make that information available to employees. In the event a plan is underfunded, a company may be required to provide additional funding to remedy the situation.

The Bottom Line

A superannuation is an employer-sponsored retirement account used in Australia.

There are two versions. The first is similar to defined benefit plans in the U.S., where the retiree receives a set amount based on a formula that accounts for time employed, average salary, and amount contributed.

The second is an accumulated fund, which is similar to defined contribution plans in the U.S., where the benefit you receive depends on the amount you and your employer contribute and market conditions.