Conventional wisdom has long been to pay off the mortgage ahead of all other investments. But caps on the amount of money you can contribute to superannuation at the concessional 15 per cent tax rate mean it may make more financial sense to save for your retirement first and then pay off the house.
Depending on your age and years to retirement, as well as your income and size of the mortgage, putting extra money into super instead of the mortgage could boost the retirement coffers by $80,000.
MLC has crunched the numbers on age and investment scenarios to demonstrate how your extra cash flow may be more tax effectively put to use by taking greater advantage of the contributions cap over your working life rather than paying down the mortgage first.
Of course, that is what the government wants people to do.
The problem for many people is their peak earning period a decade out from retirement coincides with some of life’s biggest expenses including paying down the mortgage, paying for children’s education or helping them buy a home. It is also becoming increasingly obvious that relying on the 9 per cent superannuation guarantee levy (which is rising to 12 per cent) won’t give most people who are in their 50s now enough to live off in retirement.
For a person paying tax at the highest marginal rate, the case for putting extra into super is most compelling, particularly as they get closer to retirement age, MLC’s head of technical services Gemma Dale says. Essentially, rather than paying tax at 46.5 per cent (including the Medicare levy) on $25,000 of income, by investing in super an individual would pay 15 per cent tax, leaving 31.5¢ in the dollar to increase their super balance (all figures in this article as at October 2012).
The idea is that, once a person reaches retirement, they will access their savings tax free and pay off the mortgage completely. If you start early enough, however, you may well be able to pay off your mortgage before retirement and retire with a larger super balance.
Dale says the greater the risk someone is prepared to make with their investments within super, the more compelling the argument for super becomes.
An individual who chooses the growth option offered by a superannuation fund – with an assumed long-term annual return of 7.7 per cent – could expect to end up with more in their account by the time they stop work than if they had opted for the cash option with an assumed long-term return of 4.2 per cent. But life is full of unknowns as are the financial markets.
The performance of the underlying investments that super funds invest in can be volatile. Also uncertain are further changes to superannuation legislation. These may include cuts to the current tax concessions for super contributions or income earnings and the removal of the ability to withdraw funds tax free once you retire.
All of these concessions are forgone revenue of about $30 billion a year any government would love to get its hands on. It is this legislative risk that sends the biggest warning bells to financial advisers, who might otherwise suggest people break from tradition and invest more in the tax-advantaged super environment rather than get rid of any non-deductible debt first.
“Superannuation is a long-term investment strategy and for anyone younger than 40 I’d be wary of the super system because politicians will continue to play around with it,” Prescott Securities adviser Pam Lipert says. “Young people would want to be saving some money outside super as well as inside.”
The possibility that the timing around when you might be able to access the money could change as well as the final retirement savings balance makes it a risky strategy for younger generations, Hewison Private Wealth adviser Andrew Hewison says.
Both advisers agree that the closer someone gets to retirement age, the stronger the case for putting more into super. But here’s the catch. The maximum anyone can put into super at the concessional rate of 15 per cent is $25,000 a year.
Another proposal, yet to be legislated, is that anyone earning more than $300,000 a year will pay contributions tax of 30 per cent. As $25,000 a year for say, 10 or 15 years, isn’t going to give most people enough to live off, they are almost certainly going to have to look at other investments or make use of the non-concessional contributions cap of $150,000 a year.
“You might not get the tax concession on the contribution but at least the earnings are taxed concessionally and having the money locked away is good,” Lipert says. In addition to the $25,000-a-year concessional contributions cap, an individual can contribute up to $150,000 a year to super from after-tax dollars.
BFG Financial Services managing director Suzanne Haddan says anyone considering locking their money into super should consider their long and short-term spending plans. Individuals considering the strategy should have at least 50 per cent equity in their home and have their repayments under control.
“Someone on the highest tax rate with $10,000 to pay off their mortgage would have to earn $18,692 to get the money, which would then save interest of around 6.5 to 7 per cent,’’ Haddan says.
“Or they could put it into super and pay 15 per cent, leaving them with about $16,000 earning about 5 per cent over the longer term, making them 50 per cent better off for just one year,” she says.
As long as all other criteria are met and there is no risk of the client needing the money, then there is a valid argument for individuals on a lower tax bracket also putting money into super rather than pouring all their money into the mortgage. Haddan adds it is important to understand where the money is being invested within superannuation.