I’m sure many of you have tussled with the question of whether it’s better to put excess savings into your super or toward your mortgage.
It’s a question I was asked recently by a listener of Peter Switzer’s The Super Show on 2GB.
For the sake of anonymity, let’s call our caller Jim. He’s in his early 50s and he’ll be receiving an inheritance of $200,000 fairly soon.
Jim earns $70,000 a year and says he will work for another 15 years. He has a $200,000 mortgage that he expects to have it paid off in 10 years.
He also has $500,000 in super and his employer contributes 9% of his salary – equal to $6,300 a year – into his fund. His employer also allows salary sacrifices, which he currently doesn’t use.
The first point is that if Jim can work for as long as possible, then he’ll have more time to save for his retirement. Of course being able to work as long as possible depends upon his health, the health of any family members he may need to care for, and his ability – and desire – to keep working.
Assuming he doesn’t claim any tax deductions on his salary and has little other income subject to tax, then he’ll pay about $14,500 in tax or an average of just under 21% tax for each dollar he earns. Effectively, his mortgage costs him $25,300 in pre-tax income a year.
So what should Jim do with his inheritance?
Pay off the mortgage
If he uses it to pay off his house he will save himself having to pay $200,000 in after-tax mortgage repayments over ten years.
With the $25,300 in pre-tax income no longer needed to make mortgage repayments, Jim could consider making salary sacrifice contributions of $18,700 a year. This will bring his total super contributions up to the concessional contributions cap of $25,000 while at the same time reducing his taxable income.
(If Jim had less than $500,000 in super, then from 1 July 2012 he might have a concessional contribution cap of $50,000. This would mean his salary sacrifice contributions could be higher. However, this policy is still to be legislated.)
So, after allowing for contributions tax, Jim would have added $238,425 to his super over 15 years.
He still has $6,600 in pre-tax salary leftover ($25,300–$18,700 = $6,600), which is roughly $5,200 after tax, and this could also be put into his super as a non-concessional contribution. This would add up to $78,210 over 15 years.
All together, his total additional net of tax super contribution is $316,635 over the 15-year investment period thanks to paying down the $200,000 mortgage early. However, this figure doesn’t account for capital gains on his super contributions, so the real figure would be somewhat higher depending on the market returns over that period.
Put it in super
But what would happen if Jim put his $200,000 inheritance straight into his SMSF rather than on the mortgage?
Jim could contribute his inheritance straight into his super as a non-concessional contribution. Let’s assume for the sake of this example that Jim’s money grows by a net 7% per annum after allowing for all fees and taxes inside super over 15 years. That is, it has grown to $551,800. Of course, we need to factor in that he still needs to pay off his $200,000 mortgage.
As you can see the choice is not an easy one, with the two approaches in this example having very similar results. In reality, the same strategy will never win out every time because the results can vary considerably depending on investment growth, the term of the mortgage, and the amount of interest paid on the mortgage.
You might find some differences between super and mortgage repayments helpful in your decision making:
- Super is locked away and often can’t be touched until you retire whereas when you put money toward your home loan, you can often access the capital via a line of credit facility on your mortgage.
- If you accidentally breach one of the super contributions caps, then you face severe tax penalties. Putting money into your mortgage generally doesn’t suffer the same problem, unless your lender penalises you for making additional repayments.
- The super system is quite complex and most people find property purchases easier to navigate.
One final point, which is fairly obvious: be careful about putting too much money into any one investment.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
