What Is a 401K in Australia? The Definitive Guide

What Is a 401K in Australia?

Australia is a wonderful place to retire—it boasts moderate climates, friendly people, and an outdoor lifestyle. 

But to benefit from this paradise, one must have an adequate retirement fund set up, which begs the question ‘what is a 401(k) in Australia and how much does this US retirement plan differ from its Aussie counterpart?

What Is a 401(k) in Australia?

The equivalent of a 401K in Australia is superannuation. Both are investment accounts allowing workers to save up enough for a comfortable retirement. 

What Is Superannuation?

Almost all employees in Australia are eligible to receive superannuation, or super for short—an investment account where your employer makes quarterly contributions (also known as Super Guarantee contributions). In addition, workers are entitled to make personal before- and after-tax contributions, provided they do not go over the contributions cap. 

Even though almost half of Aussies leave their job when reaching the super access age, superannuation in Australia is not just a fund for your golden years. It also provides members with significant benefits such as automatic insurance cover (depending on the super fund), tax deductions, protection from bankruptcy (only applies to the money in your super account) and the ability to choose who benefits from your super after you die. 

What Is a 401(K) And How Does It Work?

A 401(k) is the US version of Australia’s superannuation. It is an employer-sponsored,  tax-advantaged account that is meant to provide you with an income after you finish working or no longer receive a regular salary. 

Like superannuation, 401(k) can be taken out either as a lump sum or regular annuity distributions, giving employees a steady income even after they leave the workforce. 

The main benefit of a 401(k) is it provides US workers with a hassle-free way to save up for their retirement. The money is automatically withdrawn from the employee’s paycheck, while most employers match their workers’ contributions giving their pension fund a boost for free. 

What’s more, since these are pre-tax contributions, they reduce one’s taxable income, which in effect means that 401(k) account holders will pay less in income tax. 

401(k) vs Superannuation: What Is the Difference? 

Although the concept is similar, there are some fundamental differences between a super account and a 401(k) plan. 

How Are Contributions Calculated

The biggest difference is that superannuation is mandatory, while a 401(k) is optional. 

Almost all employees Down Under are entitled to superannuation which is calculated according to the employee’s ordinary time earnings and currently stands at 10.5% of an employee’s gross salary.

On the other hand, an employee who signs up for a 401(k) has a percentage deducted from their paycheck into an investment account. The employer can match some or all of that amount. 

Employers use different formulas to calculate how much they need to contribute, with most contributing 50 cents to every dollar the employees pay into the 401(k) plan. It is recommended that employees deposit enough in their 401(k)s to get the full employer match.

Super is paid by your employer on top of the salary you make, while 401(k) contributions are deducted from your monthly paycheck.

Taxes 

Another big distinction between a 401(k) and super is the way savings are taxed.

Super contributions in Australia are taxed at 15%, which is lower than the marginal tax rate. This rule applies to concessional contributions only, whereas non-concessional contributions are not taxed (since they are made with after-tax money). 

Withdrawals are also taxed depending on whether they form a part of a taxed or untaxed super fund. Those who withdraw their super can expect to pay 15% tax, while some might have to pay 45% or higher.  

On the other hand, 401(k) plans are tax-deferred which means you won’t have to pay taxes until you withdraw the funds at which point they will form part of your taxable income. 

Americans can also make after-tax contributions to their retirement plan with a Roth 401(k).  This plan works similarly to non-concessional contributions in Australia—employees top up their account after income taxes have been deducted so withdrawals and investment earnings are not subject to tax.

Super contributions and withdrawals are taxed, while only 401(k) distributions are subject to tax.

Contribution Limits 

Contributions caps in Australia depend on what kind of payments you make. Concessional or before-tax contributions are capped at $27,500, while the non-concessional contributions limit is $110,000. 

In the US, the 401(k) contribution limit for 2022 is USD$20,500, and for everyone older than 50 years, there is an additional catch-up available of USD$6,500, totalling $27,000. Furthermore, the overall annual contributions cannot exceed USD$61,000 (or USD$67,500 including catch-up).

401(k) contributions are capped at USD$27,000 (around AUD$39,250), while concessional and non-concessional super contributions are limited to $27,500 and $110,000, respectively.

Excess Contribution Limits

If you exceed your super contribution limits in Australia, you will get a determination letter and notice of assessment from the ATO. Depending on the type of contribution, you can either leave the money in your account and pay the extra tax yourself or withdraw the excess funds up to 85% and use them to pay tax. With non-concessional contributions, any excess will be taxed at a higher tax rate of 47%. 

If you go over the 401(k) contributions cap, you must notify the IRS via form 1099-R  and include the excess as income on your taxes. This means that you will need to pay income tax on any excess contributions plus a 10% early withdrawal penalty (since you must remove the funds). 

The good news is that you can reverse an excess 401(k) contribution if you made one by accident. Inform your employer of the error and the money will be returned to you. Keep in mind that you still need to add those earnings to your tax bill as income.

Excess contributions in super are taxed at a higher rate than your marginal tax rate. 401(k) excess contributions are subject to regular income tax.

Access 

In Australia, a person can only access super when they retire, reach the preservation age (even if they are still working) or if they meet early access conditions, such as experiencing severe financial hardship, disability or illness. 

Similarly, the IRS allows you to access a 401(k) distribution early if you meet certain conditions. You could also withdraw some of the money if you retire or lose your job at 55, but only the contributions made by your last employer.

Otherwise,  you can’t access your 401(k) until you turn 59 and a half years old—in line with the average retirement age of 60. These withdrawals are not subject to a 10% early access penalty to the IRS. 

401(k) can be accessed when you retire, while you can withdraw from a super account even if you are still working.

Withdrawals

Australian employees do not have to make withdrawals from their super even after they retire. However, they are no longer eligible to make personal contributions after they hit 75. 

Unlike Australian super, 401(k) account holders must receive distributions from their plans when they reach 72 years of age and retire. The percentage is calculated by the IRS based on the member’s life expectancy. Employees are no longer allowed to make contributions after they stop working. 

Employees can make contributions to super even after they retire. US workers cannot do the same with a 401(k) plan.

Investment options

In Australia, employees can choose their own super fund and investment option (most super funds offer anything from high-growth assets like domestic and global shares to low-risk investments, such as fixed interest and cash). Workers can also go with their employer’s choice of super fund, which is usually a company’s default investment option. 

With a 401(k), employees are also in control of their investments, but they choose specific options from a selection offered by their employer. These usually include mutual and target-date funds, as well as guaranteed investment contracts (GICs) or shares in the company they work for. 

Aussies can choose their own super fund, while 401(k) members select investment options from their employer’s offer.

Final Words

Whether you live in the US or Australia, it is important to have a pension plan in place, especially with the cost of living going up. Carefully check investment options to make sure they meet your risk appetite, regularly look into your account balance to ensure that your employer is making regular, or matching, contributions, and you should be well on your way towards building a nice nest egg for your golden years. 

FAQs:

1. What is a 401(k) called in Australia?

Australia does not have a 401(k) plan per see, but a similar investment account called superannuation. 

2. Is 401(k) the same as superannuation?

No, even though they are similar, a 401(k) is an optional retirement fund where employees make contributions that can then be fully or partially matched by the employer. Super, on the other hand, is a mandatory pension scheme under which employers have to contribute 10.5% of an employee’s earnings on top of the salary they receive. 

3. Can you lose money in a 401(k)?

Even though most 401(k) plans invest in mutual funds to lower the risk, this is an investment like any other and can put your capital at risk. 

4. Can you transfer your US pension to Australia?

If your pension fund qualifies as a ‘foreign superannuation fund’ for Australian tax purposes, you can move your foreign pension into super. However, when it comes to what is a 401(k) in Australia, the rules are not crystal clear so it would be best if you discuss your options with a financial advisor before moving your retirement fund. 

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