Putting the miracle of compound interest to work, money advice for millennials

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They say "youth is wasted on the young," but don't be one of those who waste the precious opportunities that youth offers. Photo: Shutterstock.

The start of the year is a great time to think about your finances and make plans for the next 12 months.

Given that people have different needs at different stages in their lives, I've written today's column for the under-25s. Next week will cover the 25 to 45-year-olds, and the plus-45s have the week after that.

They say "youth is wasted on the young," but don't be one of those who waste the precious opportunities that youth offers.

It is the perfect time to be laying the foundations for good money habits and putting the miracle of compound interest to work. Getting it right early can literally be worth millions to you over your lifetime.

There are three habits necessary for financial success: first, spend less than you earn; second, increase your skills so as to improve your income; and third, invest the surplus wisely.

Spending less than you earn sounds simple, and it is simple - but it's definitely not easy.

There are just too many traps lurking along the way. The main one, by a long shot, is the credit card. And like many bad habits it starts slowly.

Unfortunately, as soon as most young people experience the ease of making purchases on a credit card, they use it more and more. But spending money on credit cards never feels like spending real money.

That is why people's normal reaction to their monthly credit card statement is: "how could all those small transactions possibly add up to such a big amount?"

Most people lack the self-discipline to handle credit cards. This is why, in Making Money Made Simple, I emphasise that the easiest way to avoid spending more than you earn is to give up using a credit card, and use a debit card instead.

These days, a debit card can do almost everything a credit card can, but it can't get you in over your head, since it only allows you to access money you already have in a bank account.

You also need to learn the difference between good debt and bad debt. This is essential, because financial winners borrow at low rates of interest to buy quality property and shares that go up in value, while financial losers borrow at horrific rates of interest to "invest" in consumer items that are virtually worthless the day after they are bought.

Don't fall into the trap of thinking, "when I start to earn more money, I'll manage it better." You almost certainly won't.

Usually, there is no relationship between how much people earn and how much of it they keep. Spending less than you earn is a habit you can learn whatever your income.

To learn about and practise saving, I suggest you open a RAIZ account, which has a great app to teach financial skills, and enables you to start investing with very small amounts and watch your savings grow.

The strategy that goes hand-in-hand with all this is to become good at setting and achieving goals. At first, it's not so much the goal that matters, as developing these skills.

Maybe your first goal is to accumulate $1000. After you achieve that, you save enough money to buy a car. After that it may be a house deposit. If you become an expert at setting and achieving goals at an early age, you virtually guarantee your financial success.

Don't be scared to have a go - this is the time of your life when you can afford to make mistakes. And you learn much more from your failures than your successes. If you don't fail now and again you aren't stretching yourself, and if you don't stretch yourself you will never reach your potential.

Noel answers your money questions

Question

I am currently 65 years of age and receiving a capped defined benefit superannuation income stream with a taxable component-untaxed element, which I pay tax on at the normal ATO marginal rate rate. My defined benefit income stream puts me in excess of the transfer balance cap (which is $1.6 million), so I cannot make any further non-concessional contributions to my super. My superannuation account is in accumulation phase. Can I make personal concessional contributions (and claim a tax deduction) to my super account of $25,000 a year, up to my 67th birthday?

Answer

The balance in your superannuation fund is not relevant to your ability to make concessional contributions of up to $25,000 a year in total. You can make concessional contributions up to your 67th birthday.

Question

I am 58 and my husband is 65. We both work full time and salary sacrifice the maximum into super. I earn $120,000 a year, and my husband earns $113,000 a year. He has $470,000 in super and I have $450,000. We still have a mortgage of $367,000 on our family home worth $1.6 million. My husband hopes to retire at 70 in five years. Are we better off paying down the mortgage over the next five years or making after tax contributions to super?

Answer

It's great that you're planning now to make the best of your retirement years. The interest rate on your mortgage should be no more than 3 per cent per annum, and I would hope that the returns on your superannuation fund will be at least of 7 per cent per annum. Therefore, I think you are perfectly placed to maximise your non-concessional contribution to superannuation. There is no entry tax on these contributions, and they also reduce the overall taxable component of your fund.

The concessional contributions you are making to super will be $21, 250 a year each after allowing for the 15 per cent contributions tax. If your funds earn 7 per cent, husband's super should be worth around $780,000 when he retires at age 70. If you work to age 65 your superannuation should be worth $900,000. The non-concessional contributions will boost these numbers even more.

Question

My wife and I retired two years ago and we both took our defined benefits as income steams at that time. We are self-funded and currently over our preservation age but under 60.

Due to COVID, I started casual work as a contractor and work approximately three days a week through a skilled labour supplier. In this agreement, I am performing work for my original employer. We have also moved closer to my aged parents and sold our house.

We are now looking at buying a new more expensive property. I was planning to take a cash lump sum superannuation payment from my secondary accumulation fund, separate to the defined benefit. Will the lump sum withdrawal meet the tax office rules considering my casual work?

Answer

Based on the information provided there may be an amount that can be withdrawn. Your first task is to get the latest statement from the fund that has the accumulation balance to see if there is any amount which is unpreserved from the old rules. This is unlikely and you will probably find that all your funds became unpreserved when you retired.

However, your fund may require you to satisfy them that you did actually retire, if you did not notify them at the time. Any contributions and earnings after you recommenced work will, in your case, be preserved until you satisfy a condition of release.

In essence until you turn 60 you have to retire to access those amounts. Your partner may be in a different position. In short, there is no simple answer - you need to liaise with your fund to find out where you stand now.

  • Noel Whittaker is the author of Retirement Made Simple and numerous other books on personal finance. Email: noel@noelwhittaker.com.au