Super or the mortgage?
The background
On 1 July this year, the cap that applies to concessional super contributions reduced from $50,000 to $25,000 pa for people aged 50 or over. These include contributions made from pre-tax salary (known as salary sacrifice), personal contributions claimed as a tax deduction and certain other amounts. They are called ‘concessional’ contributions because they are taxed at a maximum rate of 15%, not your marginal tax rate.
What this means for you
The traditional approach has been to wait until the home loan’s paid off before investing more in super. But the halving of the concessional cap for people age 50 and over has the potential to change this.
It’s now become much harder to make larger ‘last minute’ super contributions in the years before retirement. If you wait until you’re debt free before topping up your super you could find you’re significantly constrained by the cap.
You may even find you need to look at less tax-effective strategies to boost retirement savings at that time, such as making non-concessional contributions. These contributions are usually made from income that is taxed at marginal rates and are subject to a different cap.
MLC’s Technical expert says, “if you have enough spare cash to make more than the minimum repayments on your home loan, our analysis suggests you could be better off at retirement if you use the money to make additional super contributions instead.
Although you will take longer to pay off your home loan, you could have a higher super balance than if you pay off your loan early and then start investing more in super.
This is because you could use your cashflow more tax-effectively and take greater advantage of the contribution cap over your working life.
But you may need to take at least a moderate degree of investment risk to make the strategy worthwhile, whereas paying more off a mortgage is essentially a risk-free strategy.”
Tax and cashflow differences
While home loan repayments are usually made with after-tax money, super contributions can be:
- made with pre-tax dollars through a salary sacrifice agreement, or
- claimed as a tax deduction.
These super tax concessions can help you use any spare money more tax-effectively.
Here’s an example
If you salary sacrificed $1,000 in pre-tax income into super, you would get to invest a net amount of $850, after 15% tax is deducted from your contribution in the fund.
On the other hand, if you received the same amount of pre-tax money as after-tax salary and you pay tax at a marginal rate of say 38.5% (including 1.5% Medicare), you would only have $615 available to pay off your mortgage.
In other words, you would invest $235 more in super than you would pay off your mortgage. The table below shows the tax implications in both scenarios.
|
Concessional super contribution |
Home loan repayment (from income taxed at 38.5%) |
Pre-tax income |
$1,000 |
$1,000 |
Income tax |
Nil |
($385) |
Tax on super contribution |
($150) |
Nil |
Net amount to invest in super or |
$850 |
$615 |
Things 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 money in super, it’s important to consider whether you’ll need access to the money before you meet a superannuation ‘condition of release’.
A key benefit of making extra home loan repayments is that the money can usually be accessed at any time through a redraw facility or offset account.
What’s your current age and work status?
If you’re 55 or older and intend to keep working, starting a Transition to Retirement pension and using the income to target your concessional contribution cap may be a better solution for you.
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. Have a look at the case study below for more information.
Case study
Max is 45, earns $100,000 pa, plus 9% Superannuation Guarantee (SG) contributions from his employer and wants to retire at 60.
He owns a home worth $700,000 and owes $300,000 on his mortgage. The remaining term is 15 years and the minimum loan repayment is $2,867 per month. He’s considering the following two options:
-
Make the minimum home loan repayments and top-up his employer’s SG contributions so that he takes full advantage of the concessional contribution cap in each of the next 15 years.
This means he:
- Won’t pay off his home loan until he’s 60.
- Will maximise his concessional contributions over the next 15 years.
MLC’s Technical experts estimate he’ll add an extra $740,8381 to his super, including future SG contributions if he chooses this strategy.
-
Use the cashflow he would use topping up his employer’s SG contributions in option 1 above to make extra mortgage repayments. Then when he is debt-free he will top-up his SG contributions to take full advantage of the concessional contribution cap and use any money left over to make non-concessional contributions.
This means he:
- Will pay off his mortgage in an estimated 9 years and 3 months.
- Will only maximise his concessional contribution cap for 5 years
and 9 months.
MLC’s Technical experts estimate Max will accumulate an additional $659,8601 in super, including future SG contributions.
By using option 1, Max could therefore retire with his mortgage paid off and an extra $80,979 in super.
|
Option 1 |
Option 2 |
Time taken to pay off loan |
15 years |
9.25 years |
Total super accumulated over 15 years1 |
$740,838
|
$659,860
|
Value added by option 1 |
$80,979 |
|
Assumptions: Home loan interest rate is 8% pa. Total pre-tax investment return is 7.7% pa (split 3.3% income and 4.4% growth). Investment income is franked at 30%. Salary is not indexed. SG contributions are increased progressively to 12% by 2019/20 as legislated. CC cap is increased by $5,000 in 2014/15, 2019/20 and 2024/25. The proposed increase in the CC cap to $50,000 indexed has been ignored. Earnings in super are taxed at 15%. No allowance has been made for CGT that would be payable if the investments were redeemed.
1 These figures ignore Max’s existing super balance.
Is it right for you?
With the concessional contribution cap having reduced on 1 July for people aged 50 and over, now may be a good time to think about investing more in super rather than paying every spare cent into your mortgage.
While this strategy won’t suit everyone, it could help you retire with more money in super and still pay off your home loan by the time you stop working. But the results will depend on your circumstances, including your age, risk profile and when you’ll need access to your funds.
If you'd like to talk about this strategy in more detail please contact us on 1300 167 826 or info@delphifinancialmanagement.com.au.