Australians increasingly have mortgage debt later in life while still trying to prepare for retirement. Which is why one of the most common questions we’re asked is:
Should I pay off my mortgage or put more into my super?
This question comes up repeatedly and is the million-dollar question for many people over 50. In considering this question below- we are addressing it for people in the 50+ age group who are closer to retirement.
Firstly – we will talk about the extra mortgage repayment.
Making additional repayments to a mortgage provides a certain outcome- which is a guaranteed rate of return equivalent to the mortgage interest rate. This extra repayment comes straight off the loan principal- saving interest and shortening the term of the mortgage.
An extra $1,000 paid off a mortgage with an interest rate of 3% is giving us the equivalent of a 3% rate of return on that $1,000 and we know with certainty this outcome will occur.
For cash savings already in our bank account that we’ve already earned and paid tax on- putting extra onto the mortgage gets us that saving of the interest otherwise payable at the higher mortgage rate (which is always higher than the savings interest rate on bank deposits). Also, from a tax perspective- extra repayments to a principal mortgage does not normally impact a person’s tax position whereas having money in a bank account earning interest generates taxable income.
For some the certainty and the comfort of having a steadily reducing mortgage might provide peace of mind and security to be in their preferred home. This psychological benefit may trump other strategies regardless of their potential mathematical advantages.
It should be noted that we are only considering mortgage repayment here and not personal debts like unsecured debts such as credit cards. Debts like credit cards normally attract higher interest and their repayment should generally be prioritised over a lower interest rate mortgage debt.
We are also assuming this mortgage debt is a non-tax-deductible debt connected to a principal residence. Also, that this principal residence is one someone intends to stay in ie a future downsize is not planned to pay off the remainder of a mortgage.
Lastly- whether the extra mortgage repayment is going into the mortgage account itself or into a linked mortgage offset bank account- the overall effect is the same- saving mortgage interest. You should also check with your lender if there are limits on how much can be repaid off the mortgage principal each year- as for example- there can be restrictions on fixed rate mortgage products
But what about the other option of contributing more to superannuation?
Because if you think about it- working hard to earn money, paying tax to get that money in the bank only to then pay off a relatively low interest debt- might not always be the smartest move.
Making extra contributions to super can provide tax advantages depending on the contribution type and the person’s tax situation. An example is someone earning say $200,000. On their high income their highest marginal tax rate might be 46.5%. Compare that to the much lower 15% rate of tax deducted inside super off a super contribution (made via salary sacrifice or as a personal deductible contribution). If we look at $1,000 of income- normally this person only sees $535 of that hit their bank account after tax. But with the lower tax on concessional contributions of only 15%- with that same $1,000 going into super you could instead get $850 into super- a 30% return on your money before it earns a cent invested inside super! Then a tax effective superannuation withdrawal later could help to clear some remaining mortgage at retirement if needed.
The most common investment strategies in major super funds are typically a ‘growth’ or balanced’ option where your super is invested with a larger allocation to growth assets like shares and property. This mix generally outperforms the cash returns you could earn in savings in the bank and is historically higher than the mortgage rate you pay on your home loan over the long term. The investment return result does come with less certainty, particularly in the shorter term compared to the mortgage repayment result– however the longer time frame we have the more likely we will achieve historically strong long term returns when invested in growth assets inside super and be well compensated for a sometimes-bumpy ride along the way.
Regular investing into your superannuation and doing it as soon as possible can mean we can enjoy the benefits of these higher long term returns and compounding interest over time. As Einstein said compounding interest- ‘is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it’.
If this is done as part of a salary sacrifice/ packaging arrangement through an employer – it can be thought of as an automated auto pilot strategy that happens each pay cycle- effectively paying yourself first. It also means not having to make an active decision or a manual payment from your bank account to your super- which would only likely occur once everything else that competes for your money (both wants and needs) has whittled away your hard-earned money each pay cycle.
Some people worry about what happens to the extra super they’ve contributed in the event of death or divorce- but the accumulated superannuation balance is still there to be paid out/split just like the rest of your super.
One downside of the tax effective superannuation system to consider is the loss of access to funds contributed to super until a later age. So, in this way you have to ensure you won’t need those funds until able to access it and are leaving yourself with enough outside super funds for other cashflow needs. Also, there is always the potential for changes in terms of the superannuation laws and age when we can access this money. However, we generally find major changes to superannuation and age pension ages, tend to impact those much younger first who have decades to adjust to these new rules rather than pre-retirees or those about to retire.
So, in deciding which is the best plan for you- there are a multitude of things to consider and a carefully determined strategy is required with adjustments over time.
There is no perfect plan but doing nothing comes at a huge opportunity cost and the cost of inaction is high.
We can help clients to strike the right balance between mortgage payout and super fund contributions for their situation, future goals, and comfort. Speak to us today to get a tailored plan that suits you.
The information contained on this site is general in nature and has been prepared without considering your objectives, financial situation or needs. You should, before acting on any advice, consider its appropriateness to your circumstances (including your objectives, financial situation and needs). You should also consider the relevant PDS before making any decision about any product.
