Why superannuation could unlock your personal finance potential

Superannuation is looming as a key battleground in the upcoming May Federal Election – but how does it work and why could it be the key to financial freedom?

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Superannuation is looming as a key battleground in the upcoming May Federal Election – but how does it work and why could it be the key to financial freedom?

Why Aussies should love their superannuation system

The Aussie super system has undergone quite a few changes since it was introduced by the Keating Government back in 1992 but still remains largely intact, and in my view, a key to a financially stable retirement.

The basic way that it works, particularly for those looking to achieve financial freedom before reaching the preservation age, is that everyone should have two fundamental financial curves.

Each of the curves represents the assets of the individual, with one being assets outside of super (i.e. your diversified ASX share portfolio or index funds) and the second being your superannuation assets.

Given the current super guarantee of 9.5%, this super will continue to grow thanks to the magic of compound returns and hopefully build a tidy nest egg by the time Australians reach the current preservation and/or retirement ages of 55-60 and 65, respectively.

In terms of mechanics, people looking to retire early try to save hard and invest their cash into funds to build up their out-of-super assets until they reach the present value of their future requirements.

For instance, someone looking to live comfortably on $40,000 at a 4% assumed withdrawal rate might look to build up a share portfolio that is the present value of $1,000,000 at their target retirement age (i.e. $1,000,000 of future money in today's currency).

With the two-curve system, you can reach your target $40,000 income across both your curves, retiring and gradually drawing down on your principal in the out-of-super assets by selling off shares gradually until you reach the superannuation preservation age.

From this point onward, your super principal that has been growing in the meantime should kick in and theoretically allow you to continue to drawdown a $40,000 p.a. income for the rest of your years.

But how can I achieve FIRE myself?

Financial independence and early retirement, or "FIRE", is achievable as long as you keep your expenses low and manage to save (and invest) additional income as your wage increases over time.

With a little help from compounding returns and a bit of time on your side, you could achieve early retirement and financial independence with sheer willpower and a high savings rate.

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Motley Fool contributor Lachlan Hall has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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