So you've got a little spare cash. Not sure whether you should repay your mortgage sooner and pay extra in to super?
It's one of the most common questions we get. Here are some rules of thumb you can follow to work out what's right for you.
A lot of people wait until their home loan is paid off before investing more in super. But with home loan interest rates at record lows (and likely to be that way for a while), is that the right strategy in the current market? Could you be better off when your retire if you make additional super contributions instead?
There are two key reasons why topping up your super could be a better option.
The first is that home loan repayments are usually made with after-tax money. Alternatively, super contributions can be made with pre-tax dollars (if you’re an employee) or claimed as a tax deduction (if you’re self-employed and meet other eligibility requirements).
These concessions can help you use your surplus cash flow more effectively.
The other reason is the amount of concessional super contributions you can make each year is far lower than it used to be (currently limited to $25,000 a year). As a result, it has become much more difficult to make large tax-effective super contributions just before you retire.
To achieve the retirement lifestyle you desire, you may need to make additional super contributions earlier than you had planned. That way you can take greater advantage of the contribution cap over the remainder of your working life.
Why the mortgage
These are a few of things you need to weigh up.
Consider the size of your loan and how long you have left to pay it off
A dollar saved into your mortgage right at the beginning of a 30-year loan will have a much greater impact than a dollar saved right at the end.
The interest on a home loan is calculated daily
The more you pay off early, the less interest you pay over time. In a low interest rate environment many homeowners, particularly those who bought a home some time ago on a variable rate, will now be paying much less each month for their home.
Offset or redraw facility
If you have an offset or redraw facility attached to your mortgage you can also access extra savings at call if you need them. This is different to super where you can’t touch your earnings until preservation age or certain conditions of release are met.
Don’t discount the ‘emotional’ aspect here as well. Many individuals may prefer paying off their home sooner rather than later and welcome the peace of mind that comes with clearing this debt. Only then will they feel comfortable in adding to their super.
Before making a decision, it’s also important to weigh up your stage in life, particularly your age and your appetite for risk.
Case study where paying off the mortgage could be the best strategy
Betty is 55, single and earns $90,000 pa. She currently has a mortgage of $200,000, which she wants to pay off before she retires in 10 years’ time at age 65.
Her current mortgage is as follows:
Betty has spare net income and is considering whether to:
Assuming the loan interest rate remains the same for the 10-year period, Barry will need to pay an extra $820 per month post tax to clear the mortgage at age 65.
Alternatively, Betty can invest the pre-tax equivalent of $820 per month as a salary sacrifice contribution into super. As she earns $90,000 pa, her marginal tax rate is 34.5% (including the 2% Medicare levy), so the pre-tax equivalent is $1,252 per month.
This equals to $15,024 pa, and after allowing for the 15% contributions tax, she’ll have 85% of the contribution or $12,770 working for his super in a tax concessional environment.
To work out how much she’ll have in super in 10 years, we’re using the following super assumptions:
Assuming the assumptions remain the same over the 10-year period, Barry will have an extra $154,458 in super. Her outstanding mortgage at that time is $117,299, and after she repays this balance from her super (tax free as she is over 60), she will be $37,159 in front.
Of course, the outcome may be different if there are changes in interest rates and super returns in that period.
Case study where paying off the mortgage may be the best strategy
32 year old Guy and 30 year old Emma are a young professional couple who have recently purchased their first home.
They’re both on a marginal tax rate of 39% (including the 2% Medicare levy), and they have the capacity to direct an extra $1,000 per month into their mortgage, or alternatively, use the pre-tax equivalent to make salary sacrifice contributions to super.
Given their marginal tax rates, it would make sense mathematically to build up their super.
However, they’re planning to have their first child within the next five years, and Emma will only return to work part-time. They will need savings to cover this period, as well as assist with private school fees.
Given their need to access some savings for this event, it would be preferable to direct the extra savings towards their mortgage, and redraw it as required, rather than place it into super where access is restricted to at least age 60.
Key Issues To Consider
Will you need access to any of the money before you retire?
While making additional concessional contributions could help you retire with more super, it’s important to consider whether you’ll need access to the money before you meet certain conditions. A key benefit of making extra home loan repayments is the money can usually be accessed at any time through a redraw facility or offset account.
How much investment risk is right for you?
Making additional mortgage repayments is considered a low risk financial strategy and provides savings through lower interest costs. It may be more appropriate for you. But if you’re prepared to take a moderate degree of investment risk, making additional concessional contributions could be worthwhile.
The Bottom Line
This super contribution strategy may be an effective way to boost retirement savings, but it won’t suit everyone and the results will depend on your circumstances, including your age, risk profile and when you’ll need access to your funds.
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IMPORTANT This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each individual and investor are different and you should not act on this information without speaking to a financial, tax or legal adviser, who can consider if the financial product and strategies are appropriate for you. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. See full Terms and Conditions here.
Case studies in this publication are for illustration purposes only. The investment returns shown in any case studies in this publication are hypothetical examples only and do not reflect the historical or future returns of any specific financial products. Past performance is not a reliable guide to future returns as future returns may differ from and be more or less volatile than past returns.
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