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- Stefan (60) is a freelance web designer who earns approximately $76,000 per year.
- He hasn’t always put money aside for super, so his balance is a relatively low $120,000.
- His wife Marta (58) is a registered nurse on a salary of $85,000 with a super balance of $230,000.
- Their two children are independent adults, and they have a home with a mortgage of $135,000.
Now that their children are independent, Stefan and Marta have more disposable income. With retirement edging closer, they have done a budget and calculate they can afford to save an extra $600 per month.
Like many people, Stefan and Marta are wondering whether they would be better off putting the extra cash into their mortgage or super. They plan to retire in seven years’ time when Stefan is 67, but their home loan isn’t scheduled to be repaid for another ten years. The decision about whether to put extra cash into your mortgage or super depends on many variables, including years to retirement, the remaining term of the loan, mortgage interest rate and the investment returns in super.
Extra mortgage payments generally make more financial sense in the early years of the loan when they will have the biggest impact on the total amount of interest you pay. But extra repayments may be attractive in later years if it means retiring with a home fully paid for. A growing number of Australians are retiring with mortgage debt, which can be a financial and personal strain, especially for those on lower retirement incomes.
The current interest rate on the couple’s home loan is 3.66%, so repaying the mortgage would provide a tax-free return of 3.66% per year in the form of reduced interest expenses.
If they increase their monthly repayments by $600 per month to $1,945, they will save $9,489 in interest and shave three years and five months off the term of their loan. That would leave them debt free by the time they plan to retire.
This is an appealing strategy, given the fluctuating nature of super returns in the short term and the personal satisfaction that comes from owning your home outright. But how do the numbers stack up in the long run?
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The couple currently has a joint super balance of $350,000 and combined after-tax income of $124,448. Stefan makes personal tax-deductible contributions of $600 per month while Marta’s employer contributes 9.5% of her pre-tax salary, or $8,075 per year.
If they do nothing, according to MoneySmart’s Retirement Planner calculator, they will have an estimated super balance of $576,576 if they both retire when Stefan turns 67, which will provide retirement income of $61,743 per year until age 90.
Initial estimated annual retirement income until age 90
Source: MoneySmart Retirement Planner
This is very close to the ASFA Retirement Standard’s comfortable retirement budget of $61,909 per year but well short of their current standard of living. If they set their target retirement income at 66% of joint net income of $124,448 they would need $82,136 per year.
To boost their retirement income they could use all their super by age 85, which would give them $68,569 per year.
Alternatively, they have the financial capacity to increase their combined concessional contributions by $600 per month and are currently well within their individual annual caps of $25,000 per year. If Stefan increases his contribution from $600 per month to $800 and Marta salary sacrifices $400 per month, they would have a combined retirement balance of $625,772 when Stefan is 67 and income of $63,155 per year until age 90, or $70,676 per year until age 85.
As concessional (pre-tax) super contributions are taxed at 15% rather than at your marginal tax rate, Stefan will also earn a handy annual tax deduction for his increased contributions.
Revised estimated annual retirement income until age 90 (after increased ongoing contributions)
Source: MoneySmart Retirement Planner
So how does this compare with increasing their mortgage payments?
By directing an extra $600 per month into their mortgage they would save $9,489 in interest over the remaining term of their loan.
But by directing an extra $600 per month into super they could be $1,412 better off each and every year from retirement at age 67 until age 90 (the difference between projected retirement income of $61,743 if they do nothing and $63,155 with extra contributions of $600 per month). Or $2,107 better off each year until age 85.
Of course, these are back-of-envelope estimates only. In the case of super, they are based on historic performance, which may not be a reliable guide to performance over the next seven years until Stefan plans to retire. And while Stefan and Marta are paying the average variable mortgage rate, you may be paying less, which would reduce the potential savings of increasing your repayments.
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Stefan and Marta have some complex decisions to make if they want to give their savings a significant boost in the run-up to retirement. They decide to seek professional advice from a licensed, independent financial adviser who can walk them through their options.