- When interest rates are low, it’s usually better to put extra cash into super if you can salary sacrifice.
- The downside is that you tie it up until your preservation age, which for most people is 60.
- If you can’t salary sacrifice, it’s still better to put money in super over the mortgage if you’re confident you won’t need it and that the super fund’s performance will be higher than your mortgage rate.
“Your home loan or your super” is not like that old Andrew Denton TV program titled “Your money or your gun”, but rather the question I get asked almost as often as “where to invest”.
That is – I have some extra cash – so do I pay off my mortgage, or put the money into super?
And just before you tune out because, like many SMSF trustees, you have already paid off your home loan, the chances are that in your extended family, someone is paying off a mortgage.
Mathematically, in these periods of low home loan interest rates and reasonable investment returns – the answer is pretty clear-cut – put the money into super. Definitely, if you have the capacity to salary sacrifice, and even if the super dollars are from your own cash, it will often still make sense. However, there are some downsides with super – so let’s deal with these first.
The super downsides
The main downside is that once you put money into super, you can’t get your hands on it. If you were born after 1 July 1964, you can’t access your super until age 60 – and there is a very high chance that for those in their thirties today, the preservation age will be further increased to at least age 62 and possibly age 65. One other downside is that you can’t use your super monies as security for a loan.
For many people, there is also an emotional upside in paying off their home loan early, and in some cases, the benefits here are very real. Financially, however, the maths wins.
The maths, with salary sacrifice
To demonstrate the maths, let’s assume that you have the capacity to pay an extra $500 off your home mortgage each month –or to reduce your take home salary by $500 a month and have the gross amount salary sacrificed by your employer into super.
With the mortgage, we will assume it is for $300,000, the interest rate is 5.0% per annum, and you are currently paying this off a little quicker than the 25 year schedule at $2,000 per month (the schedule amount would be $1,753). You now increase your repayment to $2,500 per month.
Table 1 shows the impact of increasing your mortgage payment by $500 per month. After 10 years, you owe $105,897 compared to $183,538 – an improvement (or additional mortgage reduction) of $77,641.
Table 1 – $300,000 Mortgage, interest rate 5%
Now for the super option. We will assume that your gross salary is $100,000 per annum, your effective marginal tax rate is 39% (37.0% plus Medicare of 2.0%), and that you reduce your take home salary by $500 a month. To do this, over a year you will salary sacrifice $9,836 into super or $820 per month. After the super fund pays tax at 15%, $697 will be invested in super.
Further, we will assume that your super fund earns an investment return of 7.0% per annum after tax.
Table 2 shows the impact of investing this amount in super each month. After 10 years, your super is worth $120,640.
Table 2 – Salary Sacrifice into super, investment return 7.0% pa
Table 3 compares the two alternatives. After 10 years, the super option is worth $42,999 more!! Depending on your age, this could potentially be used to repay a good chunk of your mortgage.
Table 3 – Mortgage vs. Super (with salary sacrifice) – $500 per month
Financially, there is no argument – the super option wins hand down. However, there are, as you probably suspect, some important caveats.
Firstly, you need to have room within your concessional contributions cap to salary sacrifice. For most people, this cap is $25,000 – if you are 50 or over, it is $35,000. The employer’s super guarantee contribution, of 9.5%, and any salary sacrifice contribution is included in this cap – so if a person is earning (say) a salary of $200,000 and the employer is paying $19,000 in super, there isn’t going to be much opportunity to salary sacrifice.
Next, putting money into super rather than a home loan works much better when home interest rates are low, and/or investment returns from super are high. If interest rates are at 10.0% per annum, it is far less attractive.
Critically, the example above has assumed an average annual return from super of 7.0% after tax. Historically, this is a reasonable and fairly conservative assumption to make, and the 10-year period helps to normalise some of the swings in the market. However, if your super is invested in a very defensive option, or if the strategy is reviewed over a short-term horizon, you may not get that sort of return.
Finally, the strategy works best at higher marginal tax rates. As discussed above, however, those paying tax at 49% (45% plus 2% Medicare and 2%Tempory Budget Repair Levy) probably won’t have much opportunity to salary sacrifice.
The maths, without salary sacrifice
Same example – $500 extra in your mortgage account each month, or $500 into super.
The $500 into super is from your after tax dollars – so no tax to pay when it hits the fund – however, this time, it is only $500. Table 4 shows that it is worth $86,524 after 10 years, assuming an investment return of 7.0% per annum after tax.
Table 4 – Personal super contribution of $500 per month
As Table 5 shows, you will be marginally better off in super, however it does come with those strings around lack of accessibility.
Table 5 – Mortgage vs. Super (no salary sacrifice) – $500 per month
Again, this favours super when investment returns are high relative to the home loan interest rate.
Bottom line
If you can salary sacrifice, put the money into super rather than paying off your home loan.
If it is your own cash, then put it into super if you are sure you won’t need it and you are confident that your investment return in super will be higher than your home loan interest rate.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.