News & Information

Super or Mortgage. That is the question!

November 02, 2017

We are often asked by clients if one is better off contributing more to Super or by accelerating the repayment of mortgage debt?

Of course, nothing is ever that simple. But I do hope the following will help you better understand this important question.

While many clients wait until their mortgage has been paid off before they consider making higher Contribution to their Superannuation accounts, this is often not the most appropriate course of action.

LifeTime Financial Group has completed an analysis of this scenario and in many cases, you may actually be better off taking advantage of the Concessional Contributions cap by making higher contributions to your superannuation arrangements. We have also found that clients, in some cases, may also be better off despite super earning lower rates of return than the interest costs of a mortgage.

Buyer beware!

However, in order for this strategy to work, clients will need to be comfortable with accepting some investment risk. Without this, the strategy may not be worthwhile.

Revised Maximum Deductible Contribution limits

The Maximum Deductible Contribution limits are now set at $25,000 in each financial year and include the employers Superannuation Guarantee Contributions as well. Whilst the numbers of Australians contributing at these levels is quite low, this strategy can become more effective where you are close to retirement and still have a mortgage.

Historically, Australians have been encouraged to put away as much in Super contributions as they can afford in order to achieve a more comfortable standard of living in retirement.

Because of the lower Maximum Deductible Contribution limits, people will most likely need to put away more for longer periods in order to achieve the desired outcomes.

Tax effective use of your cash flow

It is important to understand the effect of personal taxation on your discretionary spending dollars.

In our working examples, we will assume your tax brackets are as follows:

  • 34.5%
  • 39% and
  • 47%

By way of a simple explanation, and assuming you are in one of the above tax brackets, in order to have $1.00 of spending money you will need to generate a pre-tax income of more than $1.00 in order to receive $1.00 after tax. In this table, we identify the tax brackets, the amount of income required pre-tax in order to have $1.00 of after tax income to spend, the amount of tax payable and finally, your “net of tax” position.

Tax Bracket

Pre tax income

Tax (based on tax bracket)

Net of tax position.

34.5%

$1.53

$0.53

$1.00

39%

$1.64

$0.64

$1.00

47%

$1.89

$0.89

$1.00

This table illustrates the effect of pre-tax Super contributions. Clients generally quantify a post tax amount they can afford to allocate to mortgage repayments or additional Superannuation contributions. “I can afford an extra $100 per week to my mortgage repayment”…

Whilst mortgages use after tax income to repay debt, Superannuation contributions can be made using pre-tax income. These concessions allow clients to potentially make more tax effective use of their surplus incomes.

On this next table, we consider the net (of tax) amounts that could be used to fund additional pre-tax Superannuation contributions Vs. additional mortgage repayments. We have used $1,000 in pre-tax income and the marginal tax rates noted above for this example.

 

Concessional Contribution to Super

Home Loan Repayment

34.5%

39%

47%

Pre-tax income

$1,000

$1,000

$1,000

$1,000

Tax payable

Nil

($345)

($390)

($470)

*Tax on Super Cont

($150)

Nil

Nil

Nil

Net amount to invest  in Super or reduce debt

$850

$655

$610

$530

* Please note Super contributions tax increases to 30% ($300 in this example) if you earn more than $250,000 per annum

Long term comparison of benefits

To consider the potential longer term benefits of using this strategy, we have modelled additional pre-tax Superannuation contributions Vs. mortgage reduction over a 15 year period.

The table reflects the value add as a result of the cumulative value of $1,000 per annum invested into Super (An investment return is earned and tax savings gained) and the cumulative interest saved from paying an additional $1,000 off your mortgage. All of this has been done across the three marginal tax rates noted above.

The added benefit in Super identifies the difference between investing more in Super Vs. paying off a mortgage all at the various tax rates.

Results after 15 years

 

Super

Mortgage

Pre-tax income

$1,000

$1,000

$1,000

$1,000

Tax rates

15%

34.50%

39%

47%

Rate used

7.2%

7%

7%

7%

Value Add

$21,692

$16,460

$15,329

$13,318

**Added Benefit in Super

N/a

$5,232

$6,363

$8,374

**We subtract the Value add in the mortgage section from the Value add in the Super section to show the added value across all marginal tax rate had the funds been invested in Super.

Assumption used are as follows:

  • The home mortgage is linked to a fully offset linked account
  • Amount is received to the bank account and Super at the end of each year
  • The interest rate on the home loan is 7%
  • Net investment return to Super is 7.20% pa (Split 3.20% income and 4% Growth)
  • We note the investment returns are based on long term return and interest rate expectations. These rates are for illustrative purposes and are not guaranteed.

It is important to consider a range of scenarios if you are potentially going to use this strategy. As you know, home loan rates are currently at their lowest point in many years. Using a lower rate home loan increases the potential benefit of this strategy. When comparing outcomes, we always look too long term rates. This is because short term results can skew outcomes which could mislead someone which we obviously don’t want to have happen… The following table uses mortgage rates more closely aligned to current rates. This makes the case for increased pre-tax Superannuation contributions more compelling.

Results after 15 years

 

Super

Mortgage

Pre-tax income

$1,000

$1,000

$1,000

$1,000

Tax rates

15%

34.50%

39%

47%

Rate used

7.2%

5.5%

5.5%

5.5%

Value Add

$21,692

14678

13669

11877

**Added Benefit in Super

N/a

$7,014

$8,023

$9,815

The assumptions used are the same as the previous table but use a mortgage interest rate of 5.50%. Again, these outcomes are provided for illustration purposes only and are not guaranteed.

There is a wide range of other matters to consider prior to entering into this type of investment strategy. Those include;

  • Liquidity.
    • Placing larger contributions into Superannuation means the funds are not accessible until you have met a condition of release.
    • Funds held in an offset mortgage are generally accessible almost immediately.
  • Alternative strategies
    • There may be other strategies that are better suited to your needs. These could include the repayment of personally guaranteed debt (Credit cards etc.) that have significantly higher interest rates associated with ongoing debt)

You should consider working with a Financial Planning firm who is both experienced in these matters and who can assist you in developing a Financial Plan based on your own specific circumstances, financial position and aspirations for the future.

Who is LifeTime Financial Group?

LifeTime Financial Group Pty Ltd is a Financial Planning firm licenced through Advice Evolution Pty Ltd. All our planners are qualified to provide you with specific advice based on your personal circumstances. We are not owned by any financial institution. This means our advice is not controlled by or directed to any specific products. We always act in your best interests. We do not receive a commission for any investment recommendations. We offer a “fee for service” advice process because we feel this is the best interests of our clients.

Why not call us today?

We would welcome the opportunity to meet with you to discuss your current and future investment needs.

We can be contacted by phone on 03 9596 7733 or via email.