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It’s very common to wonder about the best vehicle for money you can afford to save. Is it better to pay down your mortgage or make extra contributions to super and boost your 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 how your mortgage interest rate and super investment return are expected to compare in the long term, your income, and how much space is available for you to make concessional contributions to super under the concessional cap.
Of course, any decision involving your home is unlikely to be purely financial. Repaying the mortgage can be attractive for the sense of emotional security it brings or the freedom it affords you 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.
According to data from the RBA and SuperRatings covering the period to June 2022, the 10-year average of standard variable mortgage rates was 5.35% per year while balanced super fund options returned an average of 7.9% per year. The 30-year average for mortgage rates was 6.96% per year and for balanced super funds was 7% per year.
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 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.
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. This tax saving increases the amount you can afford to contribute to super vs the mortgage, for the same cost to your after-tax income.
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 space under the cap 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.
Why choose the mortgage?
While the competitive return of super and the tax savings available make it attractive, its major pitfall is that it is preserved for retirement.
The clear advantage of making additional mortgage repayments or saving in an offset account is flexibility. Additional mortgage repayments can generally be redrawn if needed and the funds in an offset account are always accessible.
If circumstances change, the saved funds can be used for other expenses.
For younger people, super may be unattractive because of the length of time savings will be locked away. Giving up access to your money until retirement age might not seem like a fair exchange, even if it would make sense financially.
Perhaps you have a short-term savings goal like a dream overseas trip. Accumulating those savings in a mortgage offset account would reduce your interest charges while you save and withdrawing the money later to pay for your trip would be simple. Saving in super would not allow you to achieve this goal – unless the holiday is taken after retirement!
You may just feel more comfortable knowing that your mortgage is paid down as much as possible. There are those among us who feel safer when debt is minimised, particularly in an environment of rising interest rates.
Maybe you have additional income you can save now but are worried about affording mortgage repayments if interest rates rise further or when your fixed-rate period ends. Directing your savings towards mortgage offset to build a buffer zone could make more sense than saving in super. This way, if your mortgage payments do rise you can draw from the savings to help meet the increased cost.
It is important to note that all modelling relies on assumptions. The outcome will vary if real-life circumstances are different.
The examples below have been modelled using the ASIC’s compound interest calculator (interest compounded annually) and a mortgage amortisation calculator using a mortgage interest rate of 5.5% and super return of 7%. The super return used is broadly reflective of the 30-year average for balanced super investment options after investment fees and tax.
They are simple illustrations only and do not consider the impact of super administration fees or mortgage fees. Estimates have not been adjusted to account for inflation and assume salaries, tax rates, and contribution limits remain static throughout the modelled time period.
Approaching retirement – Robert and Theresa
Robert and Theresa are 55 and plan to retire in 10 years. They have just refinanced their home loan for a term of 15 years and owe $300,000 at an interest rate of 5.5%, paying $2,451 per month.
The couple both earn salaries of $100,000 per year and are not making any voluntary super contributions.
Option 1: Additional mortgage payments
The couple could repay their mortgage in 10 years and be debt free on retirement by increasing monthly mortgage repayments to $3,270 per month – an additional $819 per month.
If they choose this path, they will not accumulate any voluntary super savings but will be debt free on retirement.
Option 2: Additional super contributions
If Robert and Theresa instead decide to salary sacrifice, they can each contribute $625.20 per month.
After tax, this will reduce their take-home pay by $409.50 each – a total of $819 combined, the same as the additional mortgage repayment they are considering.
The net amount added to super after contributions tax will be $1,062.84 ($531.42 for each person). After 10 years, these net contributions are expected to grow to $176,077.
The couple will still owe $128,330 on the mortgage at retirement.
By contributing to super, Robert and Theresa can repay the remaining mortgage at retirement using the additional super savings they accumulated. After the mortgage is repaid, $47,747 is estimated to remain.
For the same monthly cost, the couple can accumulate these additional retirement savings, while still achieving their goal of a debt-free retirement.
What if the super return was lower?
If we instead assume the super savings will earn 5.5% – the same as the mortgage interest rate – the salary sacrifice is estimated to accumulate to $164,084 at retirement.
Robert and Theresa are still estimated to be $35,754 better off by saving via super. This is because the income tax saving allows them to contribute $1,062.84 per month to super versus $819 towards the mortgage for the same impact on their wallets.
Mid-life – Marek
Marek is 45, single, and wants to retire at 65. He owes $500,000 on his home loan, which will be repaid in 20 years – at retirement. The monthly repayment is $3,439.
Marek earns $150,000 per year as a private physiotherapist – he does not receive any employer super contributions. He estimates he can afford to save $1,000 per month and wants to compare saving into his mortgage or super.
Option 1: Additional mortgage repayments.
If Marek directs an additional $1,000 per month to his mortgage, it will be repaid in 13 years and three months.
He is estimated to save $120,552 in interest by making these additional repayments.
Option 2: Additional super contributions
If Marek makes personal tax-deductible super contributions, he can afford to contribute $1,639.34 per month. This will reduce his after-tax income by $1,000 thanks to the tax saving.
After 13 years, these additional contributions are estimated to have increased his super balance by $396,126.
He will still owe $232,288 on the mortgage.
Marek’s overall wealth is predicted to be $163,838 higher after 13 years if he chooses to contribute to super instead of making additional mortgage repayments.
He retains a mortgage of $232,288 but has accumulated $396,126 in super, versus making additional mortgage repayments and having no debt and no accumulated super savings.
However, Marek also needs to consider that if he repaid his mortgage early, the entire monthly mortgage payment he was previously making would then become available to invest, either into super or another investment.
Deciding whether to make additional super contributions or extra mortgage repayments can be a difficult and personal choice.
If you have space under the cap to make concessional contributions, super is an attractive option thanks to the income tax saving that allows you to save more without increasing the impact on your hip pocket. However, if you have a low income, the tax saving from super contributions may be small or there may be no saving at all.
If you can’t reduce tax with concessional contributions, either due to low income or because you have reached the contribution cap, super is a less attractive prospect but could still leave you better off if the investment return is likely to be higher than your mortgage interest rate.
Of course, money that you contribute to super is preserved for your retirement. If you can’t give up access for that long, saving via the mortgage is a more obvious choice. You may also simply have personal or emotional reasons to choose the mortgage – the security of knowing you are minimising debt or plans to use that extra equity to add the dream renovation you’ve always wanted.
A frequent compromise is to make the best of both worlds. Why not consider additional savings towards both mortgage and super?