24 August 2015

Pay off house or boost super?

While there are a wide variety of financial strategies, the two main options for most Australians remain building up their retirement nest egg in the form of superannuation, and paying off the mortgage on their home. But assuming you are fortunate enough to have some spare income, which will make you (or save you) more money, salary sacrificing into your super, or increasing your mortgage repayments?

Assuming you have an additional $10,000 per year (pre-tax) that you can put towards either one, how do the figures stack up? First of all, the main incentive for people to make pre-tax payments into their super is the low (15%) tax rate that you pay on superannuation income, including contributions. So after tax, you will have an additional $8,500 in your superannuation for the year.

If you have $10,000 spare income, you will certainly be in the 32.5% tax bracket ($37,000 to $80,000 p.a.) and more likely the 37% bracket ($80,001 to $180,000). If it’s the latter, you will only have an additional $6,300 per year to add to your mortgage after tax.

As an example, let’s assume a mortgage of $500,000 spread over thirty years and an interest rate of 4% (at the low end of the current comparison rates available). Repayments would be $28,915 per year and you would pay $367,450 in interest over the life of the loan. If you add the extra $6,300 per year to make the repayments $35,215, the loan will be paid off in 21.4 years and you will only pay $253,249 in interest. By making the additional repayments, you will save $114,201 in interest over the life of your loan, and pay the mortgage off over eight and a half years faster.

But what if you add the income to your super? As explained, you will be adding $8,500 per year to your superannuation fund. In order to make a fair comparison, let’s assume that you do that for the same length of time as the mortgage (30 years). The return on superannuation funds has averaged 6.8% over the last fifteen years, so we will use that figure.

Using these figures, adding $8,500 to your fund for thirty years at 6.8% p.a. will result in a balance of $774,596. If you deduct the amount you added (because we are only looking for the growth of the account) – which is 8,500 by 30, or $255,000 – you will arrive at a figure of $519,596. So over the 30 years of your mortgage, you would be $405,395 better off by using your $10,000 a year to salary sacrifice into your superannuation rather than making additional payments to your mortgage.

Because interest rates are at record lows, it is worth noting that increases in the interest rate would result in greater saving on your mortgage by making the additional payments; however, even if the interest rate jumped to 10%, you would still only save $440,004 through the higher repayments, still less than the $519,596 benefit you receive through the additional super contributions.

Are there any negatives to salary sacrificing into your super?

Yes. For all intents and purposes, the money is untouchable until you reach preservation age at retirement, so you could find yourself short of cash flow in the short-term if you don’t budget accurately. On the other hand, additional repayments onto your loan can usually be redrawn fairly easily, so the extra cash is still available if you really need it.

So how much can you contribute into your super?

The current caps on contributions into your superannuation are $30,000 p.a. in concessional (pre-tax) contributions ($35,000 for those 50 years and over, although you will have to meet the ATO’s ‘work test’ – proving that you are working at a minimal level during the year – if you are over 65), and $180,000 p.a. in non-concessional (after-tax) contributions. Because the non-concessional contributions are made after incurring income tax, they do not incur tax as part of your superannuation income; however like the mortgage contributions, you will not benefit from the 15% tax rate for superannuation income. Between these options, maximising your concessional contributions through salary sacrifice and your employer’s guaranteed contributions provides the best tax minimisation and wealth generation results for your money.