Pay off the mortgage or contribute to super?

Which should come first, super or the mortgage?
Most people still believe that they are better off putting surplus money into their mortgage before investing elsewhere. But now with new super rules about to come in, are Australians better off in the long run by investing in super?

Case Study – Meet Alan:
Alan is 50 years old and plans on retiring in 10 years at age 60. His salary is $100,000pa and his living expenses are $65,000 pa.

Mortgage interest rate: 8.00%
Super earnings rate: 7.00%

He has a mortgage of $300,000 that requires a minimum annual payment of $30,000 (included in his living expenses).

Alan also has a current super balance of $100,000.

He thinks he should put any surplus money into paying off his mortgage as he only has 10 years till retirement. However, he also wants to build up his super for retirement, and so he is unsure which investment strategy will give him a better result in the long run.

Alan can either put his surplus into his mortgage or into super

Scenario 1 – Alan chooses to make additional mortgage repayments:
Alan has an additional surplus income of $5,650 available in the first year (when he is 50) that he can use to pay off his mortgage. His employer will continue to pay 9% into his super fund over the 10 years.

If he does this for 10 years, he will be in the following situation:

Final super balance

Final mortgage balance
Net Wealth
$296,787
$49,601
$247,186

Scenario 2 – Salary sacrificing surplus income into super:
Alan is able to salary sacrifice $9,658 in the first year (when he is 50) and still meet his living expenses of $65,000. He will also need to continue to make minimum mortgage repayments of $30,000 each year (included in his living expenses).

If he does this for 10 years, he will be in the following situation:

Final super balance

Final mortgage balance
Net Wealth
$516,973
$213,081
$303,892

Which scenario provides a better financial result for Alan?
Alan is better off by $56,707 over 10 years by electing to salary sacrifice rather than make additional mortgage repayments. His super balance has significantly increased which will assist him to maintain a comfortable lifestyle during retirement.

He is better off salary sacrificing because once his income goes into super, his money is only taxed at the concessional rate of 15%. If he had taken that money as income, he would be paying tax of 41.5%. That’s a tax saving of 26.5%!

Once Alan retires, he will still need to pay off his mortgage. He can do this very effectively in one go by withdrawing the full mortgage balance from his super. This lump sum withdrawal will be tax-free (as long as current legislation is still in place).

But how would this strategy fare if the interest rate on his super earnings or his mortgage changed? Or what if his salary changed?

Scenario 3 – Different interest rates
Let’s assume that the interest rate on Alan’s mortgage increases to 10% and his super earnings fall to 5%pa.

In this situation, Alan is still $30,725 better off over 10 years by electing to increase salary sacrifice instead of increasing mortgage payments.

Scenario

Final super balance
Final mortgage balance
Net Wealth
Increased mortgage payments
$261,690
$123,735
$137,955
Increased salary sacrifice
$468,680
$300,000
$168,680

Scenario 4 – Lower salary
Let’s now assume that Alan’s salary falls to $60,000 and his expenses (including mortgage payments) fall to $40,000.

Still assuming that interest rates are 10% and super earning rates are 5% (as in Scenario 3), Alan is still $2,915 better off over the 10 year period by electing to increase his salary sacrifice rather than increasing mortgage repayments.

Scenario

Final super balance
Final mortgage balance
Net Wealth
Increased mortgage payments
$217,663
$122,237
$95,425
Increased salary sacrifice
$398,340
$300,000
$98,340

Overall, Alan is better off by putting his surplus income into super via salary sacrifice, however, we must note that there are certain risks associated with this strategy.

What are the risks associated with this strategy?
In Alan’s case, he is financially better off salary sacrificing surplus income into super instead of increasing mortgage payments. However, your own situation will be different and there are some risks associated with this strategy such as:

  • The risk of interest rates rising and super earnings falling – in scenarios 3 & 4, Alan is still advantaged, but this could change if rates were significantly altered or if he were younger and had longer till retirement.
  • The risk of legislative change – the superannuation and tax systems could potentially change making this strategy more, or less tax-effective for Alan.
  • Super is preserved until at least age 55 – if Alan suddenly needed his money for an emergency it would be locked away in super until he was at least 55.
  • Age – these examples assume that Alan will not draw on his super balance until age 60, at which age withdrawals become tax-free. If this strategy is undertaken by someone under age 60, tax may be payable and therefore this strategy may not be appropriate.

In Alan’s case, he can significantly benefit by investing more in super rather than investing more to reduce his mortgage. However, it is important to note that your own situation will be different and this strategy may or may not be suitable. If you think this strategy may be applicable, speak to your Count Adviser who can assess your situation and recommend a suitable plan.

Tax rates and information can change, so make sure you discuss your options with your Count Adviser.