In this guide
It’s a common question that arises when people have money they can afford to save and want to make the most of it. Is it better to pay down my mortgage or make extra contributions to super and boost my retirement savings?
Answering this question, like many things in life, is not simple.
The option that is most likely to leave you financially better off depends on several factors:
- How your mortgage interest rate and super investment returns are expected to compare in the long term
- Your income (and income tax bracket)
- How much space is available for you to make tax-deductible contributions to super under the concessional cap.
Of course, any decision involving your home is unlikely to be purely financial. Repaying the mortgage may give you a sense of emotional security or the freedom to move on to a larger property or renovate.
Mortgage interest vs super fund returns
When you make additional mortgage repayments or save in a mortgage offset account you’re effectively ‘earning’ the interest rate attached to your mortgage on your savings.
When making a choice between saving in super or towards the mortgage, it’s natural to compare the interest rate on the mortgage with the likely investment return from your super. Both your mortgage and super are long-term savings vehicles, so the average return over a long period of time is important.
At the time of writing, the average standard variable interest rate is around 6.55%. The long-term historic average is hard to come by, but according to the Reserve Bank of Australia (RBA) the five-year average to June 2024 was 4.06%. If you think mortgage interest rates are likely to fall from their current highs, then you may need to factor this into your calculations.
The returns from super have also been relatively high recently, and substantially higher than mortgage interest rates. According to Chant West, in the year to June 2024 the average return from Growth funds (61–80% growth assets) was 9.1%. The average annual return over five years was 6.3% while the return over 10 years was 7.2%.
While history can’t tell us what will occur in future, it can give us information about trends.
The investment strategy you have chosen for your super will also affect the likelihood that your super return outpaces your mortgage interest rate. More conservative options with lower exposure to growth assets like shares and property have a lower long-term return while more growth-oriented options are more likely to experience a return higher than mortgage interest rates.
If your contributions to super will be non-concessional (after tax), the only way saving in super can leave you better off financially is if your super return is higher than your mortgage interest rate. However, if you can make concessional contributions, the picture changes thanks to tax savings.
Tax savings
If your marginal tax rate is higher than the 15% contribution tax for concessional super contributions, you can reduce income tax by making concessional super contributions. The higher your income, the greater the tax savings, but everyone earning more than $45,000 may benefit.
Find out your income tax bracket.
Reducing the tax you pay increases the amount you can afford to contribute to super vs the mortgage, for the same cost to your after-tax income.
Example: Melissa
Melissa earns $150,000 per year. She pays 39% tax (including Medicare Levy) on each dollar she earns above $135,000.
Melissa has decided she can afford to save $500 a month from her take-home pay.
If she saves outside super, she can put $500 per month into an investment (or her mortgage offset account). Alternatively, she can salary sacrifice $819.67 per month to super. This will only reduce her take-home pay by $500 because she would otherwise pay income tax of $319.67 on this amount.
After 15% contribution tax is deducted, $696.72 will be credited to Melissa’s super account.
For Melissa, making concessional contributions to super means nearly $200 a month extra going into her investment.
When making concessional contributions to super, it is important to be mindful of the concessional contribution cap. Contributions above the cap do not generate a tax saving because they are taxed at your marginal rate.
If you are an employee, remember that contributions your employer makes for you are counted in the cap. If you’re a high-income earner, you may not have much room to make additional contributions on top of what your employer pays.
Lastly, if your income plus concessional super contributions exceeds $250,000 for the financial year, additional tax applies to your concessional contributions – Division 293 tax. This reduces the tax saving from concessional contributions but does not eliminate it. People with income at this level are liable for 47% income tax (including Medicare) and pay a total of 30% tax on concessional super contributions – generating a tax saving of 17% from concessional contributions that are under the cap.
Learn more about concessional contributions.
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