Do you have some extra cash and are not sure how you can make the most of it? The fact that most financial advisors will suggest you put it all in superannuation or pay down your home loan doesn’t mean it’s always the best option.
Your hard-earned money is on the line and it’s crucial that you know what’s the best option for you. This article examines some of the factors you need to consider before making any decisions.
Before deciding between a mortgage payment and a super contribution, you need to assess your current financial situation.
Calculate your marginal tax rate – The more you earn, the more tax you’ll have to pay. Fair. If your annual income is less than $18,200, you don’t have to pay any tax. You are taxed 19c for every dollar above $18,200, up to $37,000.
You are then taxed 32.5c for every dollar above the $37,000 threshold up to $40,000, Between $90,000 and $180,000 you will pay 37c on the dollar. For incomes over $180,000 the tax rate is 45%.
For example, if you earn $30,000, only $11,800 will be taxed ($30,000 – $18,200), bringing your payable to $2,242 (a marginal tax rate of 19%).
Check your employer super contributions – Your employer is required to contribute a minimum amount to your super fund each year. This is known as the SGC (superannuation guarantee contribution). It currently sits at 9.5% of your gross salary.
Be that as it may, some employers often contribute more than the bare minimum. It’s important to know how much your employer contributes so as to not exceed the contribution cap.
The more you make, the more your employer will be contributing. But if you make more than $260,000 per annum, you may exceed the current cap of $25,000. Once the cap is reached, additional contributions are taxed at your marginal rate.
Learn more about your super returns – Knowing where your super fund has invested money and the returns for the past ten years is also very important. Although these past returns may not be indicative of future performance, they are a good starting point. If you haven’t reviewed your super lately, now might be a good time to do so.
People with low and medium incomes may be eligible for the offsets to reduce the tax payable. In addition to income tax, depending on your income you may also be required to pay the Medicare Levy.
Weighing Up Between Super and Mortgage Payments
- Calculate the current balance and interest rate of your mortgage. If you have several years (or decades) remaining on your loan, then you might want to consider paying off your mortgage first.
- Check whether the interest rate is fixed or variable.
- Find out if you can make extra repayments. If your interest rate is fixed, your ability to make additional repayments may be restricted. If you have an offset or review facility on your loan, making extra repayments can save you on interest and provide additional flexibility (i.e. you can withdraw the amounts in the future if required)
- If your loan has an introductory interest rate, this would be a good time to check when this rate will change and what the rate will be after the change. This way you can plan early and think ahead.
Putting Money into Your Superannuation
You can contribute to your super in one of two ways. Either as a payment made before tax as salary sacrifice through pay or a personal tax deductible contribution (these are known as concessional payments). You can also make payments after tax (known as non-concessional payments).
Benefits of salary sacrifice/ Personal tax deductible contribution
- If your marginal tax rate is above 15%, the contributions that you make to your super can potentially reduce the tax you pay. The reduced amount depends on your total earnings.
- If you earn $60,000 a year, your marginal tax rate is 32.5%. If you sacrificed $1,000 after tax into super (1,450 before tax), then you’d only have to pay 15% tax for it, which translates into a super contribution of $1,258. Not bad!
- That spare $1,000 in tax income translates to either a flat $1,000 payment on your mortgage or a $1,258contribution to super. A difference of $258. It might not sound like a lot, but the gap between the two widens as your marginal tax rate increases. However, remember that your concessional contributions cannot exceed the current $25,000 contribution cap!
After tax contributions
Although possible, making contributions to super after tax may not be as attractive if you have a mortgage. This is because such contributions do not come with the same tax benefits as concessional contributions.
In this case, a payment of $1,000 towards your mortgage and a contribution of $1,000 into superannuation would be exactly the same.
- Contribution caps are at an all-time low. The concessional contribution cap dropped from $100,000 to $25,000 in just 10 years! If you exceed the limit, your money will not be lost of course, but will be returned to you as taxable income, which will be taxed at your normal marginal tax rate. An ECC (excess concessional contribution) charge will also have to be paid. Extra tax is a no-no!
- Superannuation returns are not stable and are likely to fluctuate much more than the rate of your mortgage loan.
- Your money remains locked away in superannuation until you retire. Don’t want to sound too dramatic, but any money put into super is money you won’t be seeing anytime soon. Choose wisely!
Reducing Your Mortgage
The keyword here is ‘interest`. You might want to consider paying off that mortgage as soon as possible. Making additional mortgage payments will:
- Ensure that you don’t have to worry about unexpected changes in interest rates. Interest rates fluctuate over time and are considered by most economists to be ‘low’ currently. Faster repayment of your mortgage loan could save you thousands of dollars in the years to come.
- Take a weight off your shoulders. Repaying your loan a bit sooner is never a bad thing. It offers increased financial security and opens up for new investment opportunities.
- If your loan comes with a redraw/offset facility, you can use the additional repayments to reduce your interest now, but still have the flexibility to withdraw them in the future to purchase other investments, a new car or go on that holiday you have always dreamt of.
- No tax benefit. You won’t be contributing as much because you won’t be benefitting the same way you would with the tax reduction on concessional super contributions.
- The cash is technically still there, which is both good and bad. We list it as a drawback, because the chance of one being tempted into spending it is quite high.
- There can be complications. Making additional payments on your mortgage loan is usually relatively easy, but depending on your bank and circumstances, it may be more complicated
There are, of course, other factors that can, and probably should, affect your decision that we’ve not yet discussed. Stress is one of them. Yes, putting money into superannuation is more tax effective.. But we are not banks or calculators. We are human beings with feelings and emotions.
Stressing over a mortgage loan and its constantly increasing interest rate is human too. Take a step back and think. No one knows what the future has in store. If we’ve learned anything, it’s that economies are fragile. Interest rates could keep rising and the annual concessional contribution cap to super could drop below $20,000 within a decade.
It’s a hard decision to make. One thing you should keep in mind is that one way or another, you will have to pay off your mortgage loan. If you want to be on the safe side, then paying off your home loan now and worrying about super later is one choice. If, on the other hand, you’re confident in the economy and are willing to take a risk, contributions to super might be the better choice for you.
And remember, there’s always choice number three. You could use some of your money to make extra mortgage payments and put the rest into super at the same time. Whatever your choice is, it is a good idea to discuss it with your financial advisor first.
This document contains general advice only. You need to consider with your financial planner, your investment objectives, financial situation and your particular needs prior to making an investment decision. Charter Financial Planning Limited and its authorised representatives do not accept any liability for any errors or omissions of information supplied in this document except for liability under statute which cannot be excluded. The financial advisers at Kennedy Barnden Financial Services are authorised representatives of Charter Financial Planning Limited ABN 35 002 976 294 Australian Financial Services Licensee Licence Number 234 665.