The super mortgage balancing act

PORTFOLIO POINT: Load up on super, or pay down the mortgage? It’s a tough call sometimes, but here’s what you need to consider.

They’re two parallel, but sometimes competing, interests. If there’s leftover cash at the end of a month, should it be used to pay down your mortgage or accelerate super contributions?

Most people want to do both. And many people can.

But how do you do it to maximise overall wealth, without unnecessarily locking money away? Sadly, it’s not a case of a simply “do this” or “do that”. What leads to the best situation for you is going to come down to a few main determinants, including age, income and medium- to long-term cash requirements.

And, of course, the prevailing interest rates must come into the equation.

For example, should a 40-year-old with a monster mortgage and two kids about to go to private school be making huge salary sacrifice contributions to super?

Or how about a 54-year-old with a smaller mortgage, but kids that are done, or nearly done, with their education?

The short answers are that the 40-year-old should probably have a tendency to focus on the mortgage, while the 54-year-old might want to consider the straight tax savings of super and leave paying off the mortgage for a little while.

But it’s just not as simple as that. Here is what you need to consider and, more importantly, why.

Age to access super

The closer you are to being able to access your super is an important consideration. Any money that is put into superannuation is locked up until, potentially, 65, or whenever you reach your preservation age and meet a condition of release.

It is taking a bit of a risk for a 40-year-old to put too much into super when they might not be able to get their hands on the money for, potentially, 25 years.

Those born before June 30, 1960, have a preservation age of 55. Those born after July 1, 1964, can’t consider touching their super until age 60. (There is a sliding scale for those born in between those dates.)

However, our 54-year-old was born in 1958, so can potentially begin to access super from when they turn 55.

For those who are closer to preservation age, it can make sense to put excess savings into super via concessional contributions (for example, salary sacrifice), particularly because access to those funds is closer.

Income tax versus contributions tax

And they also have the benefit of immediate, guaranteed, tax savings.

That is, a 54-year-old earning $150,000 a year can contribute to super and swap a 38.5% marginal tax rate (MTR) for a 15% super contribution tax rate, saving $2350 in super.

Let’s take $10,000 for someone earning $120,000. If they salary sacrifice $10,000 into super, $8500 goes into their super fund. If they take it as salary, they receive just $6150 to pay into their mortgage.

The sum of $8500 is 38.2% higher than $6150. The $6150 in the mortgage will save, on average, around 7.5% tax free (though interest rates are considerably lower than that currently).

If that money is put into super, any earnings on that money will be taxed at 15%.

In any case, it would take a number of years sitting in the mortgage to catch the 38% difference of having the higher amount in super (assuming normal, positive, returns from super).

However, those earning less than $80,000 are swapping a 34% marginal tax rate for the 15% super contributions rate and those earning less than $37,000 a year are, likely, swapping a 19% MTR for a 0% super contributions tax rate (thanks to the low-income super contribution, or LISC, that was introduced on July 1.

Medium to long-term cash requirements

Simply, you shouldn’t be putting money into super that you might need back in a few years, because it’s locked away until you reach your preservation age.

Medium-term cash requirements can include children-related expenses, funding home improvements and/or renovations, house upgrades and funding to start a business.

You need money set aside to cover some of your medium and longer-term commitments. If you don’t have those covered, then it’s far more important to build non-super cash reserves (which potentially includes money in redraw and offset accounts) rather than in super where you can’t get your hands on it.

Despite the obvious tax savings of a higher MTR versus the 15% super contributions tax, there’s no point having all of your money sitting in a super fund, if you have significant cash needs in your 40s or 50s.

Sure, there will be higher taxes paid by keeping the money outside super. But that’s the price you sometimes have to pay for access to your money when you need it.

Both super and investments are investment-based. Superannuation, however, gets a lower tax rate in return for restricted access.

Lower concessional contribution limits

Importantly, don’t forget that you are limited to making contributions of $25,000 as concessional contributions to super each year.

If you are earning more than about $200,000 a year and your employer is putting in the full 9% super contribution to your fund, then you aren’t able to put much more into super via concessional contributions.

Someone earning $200,000 a year is likely to be getting $18,000 a year contributed to their super by their employer. So they are unable to put more than about another $7000 in as salary sacrifice in any case.

Those earning around $80,000 to $150,000 possibly have the greatest ability – that is, most to gain – from salary sacrificing up to the $25,000 limit and then directing any spare cash to their mortgage.

Interest rates ... and they’re tax free!

The prevailing interest rates are also clearly important, but in an inversely proportional way.

If interest rates are low, as they are now, then the relative benefit gained by putting money into your mortgage is going to be comparatively less.

When interest rates were high, as they were in early 2008, then the strategy of paying down the home loan is going to be more worthy.

And what’s more, interest “saved” through a home loan is worth more than interest earned, because it’s tax free.

Current interest rates for most borrowers are around 6%. If you’re “saving” 6% through an offset account, you really need to gross that up by your marginal tax rate to find out what it’s truly worth.

If you’re earning $70,000, then 6% grossed up for the real return is actually more like 9.09% (6% / 0.66).

Mix and match

For many, the $25,000 concessional contribution limit will take care of the discussion. If you’re bumping up against it, or can afford to go all the way to $25,000 and still have cash to spare, then maximising super contributions might be part of the answer, but then redirecting the rest to paying down the mortgage might complete the picture.

Youth versus experience

There’s a delicate tightrope to walk on the mortgage versus super. In very broad terms, the closer you are to your preservation age, the bigger the benefits of contributing to super, then paying the mortgage out later.

And the higher your income, the bigger the benefits of contributing to super.

But, in any case, it’s a balancing act, which is often going to be best handled by splitting the benefits over super and paying down the mortgage. If in doubt, ask a financial adviser.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking.

• The biggest news for DIY investors came this week from the federal government’s Mid-Year Economic Fiscal Outlook, or half-year budget update. The major changes for self-managed super funds include an increase to the supervisory levy and changes to the pension exemptions upon death. The supervisory levy paid each year by SMSFs has been lifted to $259 from July 1, 2013, or a rise of 35%. It is currently $191.
• In better news for the sector, the government will allow pension exemptions to continue until the deceased member’s benefits have been paid out of the fund. This is important because a tax ruling last year suggested that if a member in pension mode died with unrealised capital gains, the fund would face CGT implications if those assets were sold because the pension would cease unless otherwise provisioned. Cavendish Superannuation head of education David Busoli said the announcement “will bring a major smile to the faces of SMSF trustees and advisers alike”, and said the government should be applauded for announcing this “major concession”.
• Illegal and incorrect early access of superannuation is again a hot topic before the Administrative Appeals Tribunal. In the recent Yrorita and Commissioner of Taxation case the tribunal remitted penalties against a man who withdrew $53,000 from his super fund but did not roll it into another regulated fund, and said he used the money to pay for his disabled son’s surgery. The tribunal found that if he had followed the correct procedures, “he may well have been permitted to withdraw all or part of the $53,000”, but instead the amount must be included as taxable income. However the tax penalty was then remitted, given the circumstances. There were also remitted penalties in the case of Sinclair and Commissioner of Taxation, where a man rolled over $40,000 of super to an SMSF but was then used for personal purchases, including a new car. Like many cases of this kind, a large amount (almost $15,000) was withheld by a promoter, and Mr Sinclair apparently believed it was paid as tax. As SMSF Academy head Aaron Dunn explains: “This case is an important reminder that there is no place for illegal early access (IER) of benefits, in particular through the use of a SMSF.”