Mortgage vs super: where should I put my extra money?
It’s a dilemma many of us face – are we better off directing extra money to our mortgage or super? As with most financial decisions, it’s not a one-size-fits-all-approach.
- There may be tax advantages when you contribute to super, especially if you salary sacrifice or you’re eligible to claim a tax deduction for personal super contributions.
- By making extra mortgage repayments, coupled with any potential increase in the value of your property, you will build equity in your property at a faster rate than if you were to make just the minimum repayments.
- The power of compounding returns could mean that even small contributions to your super over many years could make the world of difference.
It’s a dilemma many of us face – are you better off directing extra money to your mortgage or super? Deciding between eliminating debt and investing for the future is a difficult decision.
In the mortgage versus super debate, there’s no one-size-fits-all-approach, and no two people will get the same answer. There are some factors to consider in deciding what’s right for you.
We speak with Head of Technical, Jenneke Mills, to understand the different elements and assess the options.
Building the case for super over mortgage
You might think your super is already being taken care of – after all, that’s what your employer’s compulsory Superannuation Guarantee contributions are all about. But these contributions alone often aren’t enough to ensure you achieve the retirement lifestyle you want to live.
“Making extra contributions to your super is a great way to boost your retirement savings,” explains Mills.
“As an investment vehicle, super is a very tax-effective way to save for the future.”
The power of compounding returns
Super is a long-term investment, at least until you retire, and potentially much longer if you leave your money in super and draw a pension after you retire.
This long investment term, coupled with the rate of tax on your super investment (generally 15%), means your money can add up and generate further investment returns on those returns. This is known as compound returns, or compounding.
“The expenses of daily life can be considerable. Thinking about directing money to super might not seem like a priority when we feel overwhelmed by the effort to save a deposit for a home, paying down debt, and the costs of raising a family,” says Mills.
“However, the benefit of compounding returns means that even small, frequent contributions can make a big difference down the track.
“It’s about striking a balance that is right for you today and remember, nothing has to be forever. As your life changes, you can simply adjust your contributions strategy to suit your needs.”
Building super early
To maximise your retirement savings while allowing compounding returns to do the heavy lifting, the best approach is to start early. The longer compounding continues, the bigger your savings could be. Entering retirement debt free is an attractive prospect. It can be easy to think that you need to repay your debt before you can start thinking about saving for retirement. However, it doesn’t have to be one or the other. The power of compounding returns means that even small contributions over many years could make the world of difference to your super balance come retirement.
You can see the difference small, regular contributions could make to your final retirement income using the MoneySmart retirement planner calculator.
Tax benefits of super
From a tax point of view, super can be incredibly beneficial. Salary sacrificing some of your before-tax salary, or making a voluntary after-tax contribution for which you can claim a tax deduction, can be effective ways to not only grow your retirement savings but also reduce your taxable income.
“One great benefit of investing in super is that concessional (before-tax) contributions are taxed at a maximum rate of 15%. This can be higher though if you earn over $250,000,” explains Mills.
“Mortgage repayments are usually made from your take home pay after you’ve paid tax at your marginal tax rate. Your marginal tax rate could be as high as 47%. So, depending on your circumstances, making a voluntary deductible contribution to super or salary sacrificing may result in an overall tax saving of up to 32%.”
There is a limit on the amount you can contribute into super every year. These are referred to as contribution caps. Currently, the annual concessional contributions cap is $27,500. If you’re eligible to use the catch-up concessional contributions rules, you may be able to carry forward any unused concessional contributions for up to 5 years. If you exceed these caps, you may be liable to pay more tax.
Tax on super investment earnings
The initial tax savings are only part of the story. The tax on earnings within the super environment are also low.
“The earnings generated by your super investments are taxed at a maximum rate of 15%, and eligible capital gains may be taxed as low as 10%,” explains Mills.
“Once you retire and commence an income stream with your super savings, the investment earnings are exempt from tax, including capital gains.”
Also, when it comes time to access your super in retirement, if you’re aged 60 or over, amounts that you access as a lump sum are generally tax free.
However, it’s important to remember that once contributions are made to your super, they become ‘preserved’. Generally, this means you can’t access these funds as a lump sum until you retire and reach your preservation age - between 55 and 60 depending on when you were born.
“Before you start adding extra into your super, it’s a good idea to think about your broader financial goals and how much you can afford to put away because with limited exceptions, you generally won’t be able to access the money in super until you retire,” says Mills.
“In contrast, many mortgages can be set up to allow you to redraw the extra payments you’ve made, or access the amounts from an offset account.”
Building the case for reducing your mortgage over super
For many people, paying off debt is the priority. Paying extra off your home loan now will reduce your monthly interest and help you pay off your loan sooner. If your home loan has a redraw or offset facility, you can still access the money if things get tight later.
“Paying off your mortgage and entering retirement debt-free is pretty appealing,” says Mills. “It’s a significant accomplishment and means the end of a major ongoing expense.”
Depending on your home loan’s size and term, interest paid over the term of the loan can be considerable – for example, interest on a $500,000 loan over a 25-year term, at a rate of 6% works out to be over $460,000. Paying off your mortgage early also frees up that future money for other uses.
“Reducing your mortgage decreases the total amount of interest paid over the duration of the mortgage and effectively equates to a return equivalent to the home loan interest rate,” explains Mills.
Before you start making additional payments to your mortgage, Mills suggests you should first consider what other non-deductible debt you may have, such as credit cards and personal loans.
“Generally, these products have higher interest rates attached to them so there is greater benefit in reducing this debt rather than your low interest rate mortgage.”
Conclusion: mortgage or super
It’s one of those debates that rarely seems to have a clear-cut winner: should I pay off the mortgage or contribute extra to my super?
The answer–probably somewhat annoyingly–is that it depends on your personal circumstances.
“There is no one size fits all solution when it comes to the best way to prepare for retirement,” says Mills.
“On the one hand, contributing more to your super may increase your final retirement income. On the other, making extra mortgage repayments can help you clear your debt sooner, increase your equity position and put you on the path to financial freedom.”
When weighing up the pros and cons of each option, Mills suggests there are a few key points to keep in mind.
“One of the key questions to consider is what is the likely balance you’ll need in your super? Work backwards starting with working through what retirement looks like for you, the type of lifestyle you’d like, and how much you need to live on each year.
“From there, you can start to consider your sources of income in retirement. This is likely to include super, but could also include a full or part Age Pension, or income from an investment property or other sources.
“You can then start thinking about your current balance, contributions strategies and whether you’re on track to have enough saved to supplement your other retirement income sources.”
Use the MoneySmart retirement planner calculator to estimate of how much super you may have in retirement, and how long your super may last. You also need to think about how you plan to spend your money in retirement.
In most cases, there isn’t one set strategy that you should follow, and it can quickly change as you grow older, start a family and reach retirement age. You should also consider whether you’ll need to access any additional funds you put aside before you reach retirement. If it’s in your super, it’s locked away. If it’s in your mortgage, there are generally options to redraw.
“Home ownership and comfortable retirement are financial goals that many strive towards. If you reach a point where there’s some surplus cash flow to consider where to put your extra money, it’s a good dilemma to have,” says Mills.
Life is complex, so it pays to speak with a financial adviser before you make any big financial decisions when it comes to your super or mortgage.