Mortgage or super?
A common question we get asked is whether to put ‘spare cash’ towards paying off the mortgage or maximising super contributions. So what’s the answer?
For many Australians, owning their home is a priority. And paying off the mortgage on your home as fast as possible is generally a sound financial strategy. By making additional repayments you can save money on interest and reduce the number of years it takes to repay your loan.
Focus on contributions
But if you’re a member of a public sector defined benefit scheme, it can make better financial sense to maximise your scheme benefit by making additional contributions. Why? Generally all or part of your benefit is calculated using a predetermined formula so your returns are not affected by market conditions. So in general, the benefit from your scheme will be greater than the interest savings you can achieve by reducing your mortgage.
Tax makes a big difference
And if you use a salary sacrifice arrangement to contribute to your scheme from your pre-tax salary, you can make significant tax savings in the short, medium and long-term (as long as you stay within the annual contribution limits set by the government). Contributions to super are taxed at 15% so depending on your marginal tax rate you may be able to reduce your tax bill. Another advantage is that investment earnings in super are taxed at a maximum of 15%.
Example: The impact of tax1
Let’s look at an example. Say you earn $80,000 a year with a marginal tax rate of 32.5% (plus the Medicare levy). After doing some budgeting, you decide you can spare $100 a month from your take home pay to put towards either your super or your mortgage. This equates to $1,200 a year after tax, or $1,832 before tax.
If you decide to commit the pre-tax amount of $1,832 to your super through salary sacrifice, you’ll end up with an extra $1,557 in your super fund after paying 15% tax. And if your marginal tax rate is higher, the boost to your super could be even more.
Alternatively if you choose to contribute to your mortgage, you’ll only be able to make an additional payment of $1,200 (your after tax amount).
It’s worth noting that there may be restrictions or conditions on making pre-tax contributions to your scheme so check with your scheme or an Aware Super financial planner to see what your options are.
Look at the bigger picture
Once you contribute money to your super you generally can’t access it again until you retire. So it’s important to think about timing. If you’ll need the money before you retire, paying off your mortgage is a better option because you may be able to redraw the money or access the equity in your home. The other side of this coin is that by ‘locking your money away’ in super you get a helping hand with your savings. The money is not available for you to spend.
What about other types of debt?
Debt such as credit cards and personal loans can have a much higher interest rate than your mortgage. It’s expensive debt. Generally, your priority should be to pay off this debt before making additional payments on your mortgage or contributions to your scheme. Of course each person’s situation is different so seek professional advice before making any decisions about your money.
How do I maximise my contributions?
The rules for each public sector scheme are different. Before deciding whether to pay off extra from your mortgage or contributing to a defined benefit scheme you should check how your scheme works or talk to a financial planner who is an expert in public sector schemes as you may not be able to ‘make up’ any shortfalls at a later date.
Download our guide to getting the most from your defined benefit scheme
Related articles for you
- Salary sacrifice
- How can I make the most of my super nearing retirement?
- Make the most of your public sector benefit
1 All figures quoted in the example are sourced from www.moneysmart.gov.au