Mortgage v super

It may be the result of thrift or a windfall. Suddenly you find you have a few thousand dollars up your sleeve and you want to make it count.

Do you throw it at your mortgage, make a personal super contribution or park it in a term deposit?

Before you act you need to think about your goals and your overall financial situation (see box). Someone in their 20s saving for a trip will need a different strategy to a 55-year-old focused on boosting their retirement savings.

"People confuse tools with objectives. You need to look at the purpose of your savings first, then look at the investment structure and asset classes," says AMP financial planner Andrew Heaven.

Centric Wealth financial planner Greg Pride agrees. "It is not about returns. The focus needs to be on what you would like to achieve and how to make that happen given your resources," he says.

SUPERANNUATION

Super is the most tax-effective vehicle for long-term savings, provided you don't need to access your money before retirement, because investment earnings are taxed at 15 per cent rather than at your marginal tax rate and once you retire you can withdraw savings tax-free.

If you earn less than $37,000 there is no point putting your $5000 into super for the tax benefit alone because your marginal rate of tax on earnings outside super is also 15 per cent.

But if you qualify for the government's super co-contribution it may be worth tipping some cash into super. If you earn less than $31,920, the government will match your voluntary contributions dollar for dollar up to a maximum of $1000. The co-contribution phases out for incomes above $61,920.

"If you expect you will qualify it is good to invest regularly - say $20 a week - so you will have the money there at the end of the financial year," Heaven says. Using this strategy, a 40-year-old earning part-time income of $28,000 and contributing $20 a week could boost their super by $48,000 by age 65.

MORTGAGE

As a rule of thumb, people on higher incomes generally gain more by making additional mortgage repayments.

If you put $5000 into your mortgage redraw or offset account you are effectively earning an after-tax return equivalent to your home loan interest rate. So if you are paying 7 per cent interest your after-tax return on additional repayments is 7 per cent.

"To generate an after-tax return of 7 per cent you would need a 10-12 per cent return elsewhere to beat knocking out the mortgage," Pride says.

TERM DEPOSITS

The best rates for term deposits are now around 6 per cent but you pay tax on that interest at your marginal rate.

The average long-term return on super investment earnings after fees and tax is about 7 per cent. The actual dollar outcome will be different for everyone and depends on your age, income, mortgage balance and financial goals.

A good place to start is the "Super v Mortgage" calculator on the government's MoneySmart website (moneysmart.gov.au). Take the example of a 40-year-old on an income of $70,000 with a $300,000, 7.5 per cent mortgage. By making a one-off mortgage repayment of $5000 the calculator shows they would save $14,903 by age 65 and be $654 better off than if they had put the cash into their super fund instead.

While a guaranteed return of 6 per cent from the bank may sound appealing at a time when financial markets are volatile, it is not an effective use of your cash if you have a big credit card debt.

"You can't save and have debt at the same time. It's like being half pregnant, it's not possible. You need to look at the after-tax costs of debt," Heaven says.

Say you earn $70,000 a year, which puts you in the 30 per cent tax bracket. You have a credit card debt with an interest rate of 18 per cent and money in a high-interest account earning 7 per cent (4.9 per cent after tax).

"For every dollar of interest you earn on your savings it costs $3.67 interest on your credit card [18 divided by 4.9]," Heaven says.

Best investments close to home

Deciding how to invest a lump sum is never easy. Investors want a good return but they also want a good level of security and tax-effectiveness.

For most people, the two best places to put any windfall is towards the mortgage or superannuation. The beauty of putting money into super or the mortgage is that the effective investment returns beat just about anything else and nothing has to go into the investor's income tax return. Also, the investment risk is low.

Most other investments come with costs, such as brokerage or management fees.

It costs nothing to pay down the mortgage. And most superannuation funds have low administration fees, though the money cannot be withdrawn tax-free until age 60.

If you think you may want to redraw the money, an offset account tied to the mortgage is a good idea.

The money held in the offset account reduces the balance of the mortgage on which interest is calculated.

The best way to maximise the benefit of an offset account is for borrowers to have their pay go straight into the offset account, which saves interest.

The most effective way to get ahead

O Clear non-deductible debt on your credit cards, personal or home loans

O Build an emergency fund in a highinterest account, term deposit, mortgage redrawor an offset account.

O If you have no debt and plan to buy a house in five years, invest in growth assets such as shares.

O If you have no debt other than a mortgage, dump the funds into a redraw or offset account.

O If you want to put the cash aside for retirement, put it in super where it will be tax free once you retire.

Source: AMPs Andrew Heaven