Super or the house?

04-May-2015

Got extra cash? Should you put it into super, or pay off the mortgage on your house? As usual, the best alternative will depend on your situation.

Advantages of super

› If your total income is below $49,488 (in the 2014–15 financial year) and you qualify for the government's co-contribution Scheme, it can be a good idea to put your extra money into your superannuation. For every dollar you contribute from your after-tax income, the government will put in 50 cents, up to a maximum of $500.

› If you're self-employed, you can claim a full tax deduction on super contributions up to $30,000 a year for 2014–15 ($35,000 for people aged over 49). 

› Super provides a tax-effective environment to help save for your future. In general, the earnings on your super balance are taxed at a maximum of 15%. 

› Salary sacrifice contributions are taxed at 15% when they are paid into your super. Even though the earnings on the contribution are also taxed at 15%, and may be taxed when they are withdrawn, this strategy may still result in you paying less tax if you are in a higher tax bracket.

› After-tax contributions (also known as non-concessional contributions) are returned to you tax-free. These contributions include personal contributions, spouse contributions and government co-contributions.

Disadvantages of super

› Money in superannuation is generally not accessible until you reach your preservation age. You need to think carefully about when you will need to access the money. 

› There's a contribution limit of $30,000 a year for 2014–15 ($35,000 for people aged over 49) for all before-tax contributions. This includes salary sacrifice, superannuation guarantee and other employer contributions. Anything that exceeds these limits will be taxed at your marginal tax rate plus an additional excess concessional contributions charge. 

Advantages of paying off your mortgage

› Any capital gain made on the sale of the family home is tax-free, potentially making it a very tax-effective investment.

› If you pay off your mortgage, you're effectively earning an after-tax return that is equivalent to the mortgage interest rate you're paying. At the same time, you are reducing debt.

› Many mortgage loans allow a redraw of additional payments, giving you easy access to the money.

› Interest on a home mortgage is not tax-deductible. By making mortgage repayments you will pay less interest overall and should improve your short-term cash flow.

› If the value of your home rises, your equity increases. You can borrow against this equity to buy other income-producing assets (like an investment property) or to renovate your home.

Disadvantages of paying off your mortgage

› You may have heavy exposure to the property market, which can go down, as well as up.

So, what's the answer?

Whether it makes sense to put the money into super or to pay off your mortgage will vary from person to person. Either option will almost invariably be better than leaving the money in a savings account.

Overall, there are three major considerations:

  1. Where does the money come from?

Pre-tax dollars can be put in your super as a salary sacrifice contribution. But post-tax dollars are probably invested more tax-effectively if they are used to make mortgage repayments.

  1. What's your tax bracket?

The higher the tax bracket, the more attractive super is as an investment.

  1. What returns do you expect from your investment in your home?

These returns include the movement in the price and the rent you'd otherwise pay. What matters is how these returns compare with the likely returns from your super

The super or the house: case study

Consider Adam who's 34, earns $80,000 per year and has an outstanding mortgage of $300,000. His current mortgage interest rate is 6.5% and he's making repayments of $26,840 a year so the loan will be repaid in 20 years. 

Adam decided he can afford to contribute an extra $100 per week either to his mortgage or his super. The table opposite compares how much more he will have in retirement (at age 67) depending on which option he chooses. 

Current situation

Pay Morthgage

Maximise Super

Income

$80,000

$80,000

$80,000

Salary sacrifice

$0

$0

$5,200

Taxable income

$80,000

$80,000

$74,800

Tax and Medicare

$19,147

$19,147

$17,353

After-tax income

$60,853

$60,853

$57,447

Mortgage payments

$26,840

$32,040

$26,840

Disposable income

$34,013

$28,813

$30,607

Additional savings over 20 years^

-

$93,241

$140,175

Additional savings at retirement (age 67)^

-

$261,246

$322,696

It is important to note that the outcomes for different people will vary, and will depend on factors such as interest rates and investment returns.

^ Figures are in today's dollars.

Note: All tax calculations include 2% Medicare levy. Income is assumed to increase by 3.5% each year. General inflation is 3% annum. The annual rate of return on superannuation is assumed to be 7% after fees and tax. Adam uses all his net income to meet his cost of living requirements. In the ‘Pay Mortgage' scenario, following the repayment of Adam's home mortgage it is assumed the amount that was directed to his repayments is treated as surplus income. This surplus is added to a bank account earning 2% (before tax) with interest reinvested.

 

 

All information contained in this article is sourced from Russell Investment Management Limited (ABN 068 338 974).and is considered to be reliable however is not guaranteed. This article is issued by the Trustee of The Victorian Independent Schools Superannuation Fund (ABN 37 024 873 660, RSE Registration number R1000436, MySuper Authorisation 37024873660599) VIS Nominees Pty Ltd (ABN 11 006 586 367 AFS Licence number 235097, RSE Licence number L0000321). The information provided in this article is general information only and does not take into account your personal financial situation or needs. You should consider obtaining advice that is tailored to suit your personal circumstances.

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