Superannuation or Pay Off the Mortgage ? By Nick Bruining

As the Government continues to push Superannuation as the key source of retirement funding, many are starting to question whether traditional financial planing techniques such as Salary Sacrifice and other investment strategies still stack up. Issues become more complicated when the much publicised superannuation co-contribution is thrown into the mix.

Financial planners and others have always advised potential investors to pay off non tax deductible debt as quickly as possible. Many families utilise a second income

This is because the income required to make the interest payments on car loans, credits cards and mortgages needs to be based on before tax income rather than after tax income.

Let’s say your car loan is costing you 10 % per annum in interest and you’re earning $40,000 per year. If you tried to find a “magical” investment to meet the interest cost, then before tax, the fund would need to be returning 14.6% to pay you 10% after tax and Medicare. On higher incomes, the differential is even greater and for this reason, advisers generally suggest repayment of debts in preference to investment programs.

Nonetheless, one popular Superannuation Investment strategy is to use a technique known as Salary Sacrifice where the member elects to re-direct pre taxation salary into a superannuation fund rather than making accelerated payments off the mortgage.

To understand the effectiveness, all the taxes and charges need to be taken into consideration. Similarly, realistic rates of return need to be assumed and to provide a valid comparison between risk and return, we’ll use a fixed interest type superannuation fund which charges no entry fees.

The $28,000 pa employee who elects to salary Sacrifice $5,000 into a super fund will see $5,000 invested. A contributions tax of 15% will be deducted by the fund manager so in reality, only $4,250 will be invested. If we assume that the fixed rate super fund is crediting 5.8% and then allow for superannuation earnings tax of 15%, the after tax return on the fund will be 4.93%. At the end of the year, the $4,250 will have gown by $209.53.

Alternatively, let’s say that the $5,000 is applied against the mortgage.

The $5,000 after tax and medicare at 31.5% sees us with $3,425. If this amount is applied against a typical mortgage charging 7.07%, the after tax interest saving at the end of the year is $242.15. This means that paying off the mortgage effectively “beats” salary sacrifice by $32.62.

For a person in the top marginal tax bracket of 47% plus medicare, the numbers are quite different. The $5,000 after tax translates to $2,575 in the hand. This amount, applied to the mortgage at 7.07% results in an interest saving of $182.05. In this case, you would be better off using salary sacrifice. Nonetheless, if you’re subject to the Surcharge Tax and you already have a decent amount in superannuation, the taxes you’ll pay on exit ate are likely to erode some of the benefits.

In almost all cases though, repayment of expensive non deductible loans such as personal loans, credit cards and store charge cards will leave you better off.

The co-contribution however, changes the rules.

This is the payment to superannuation where those on $28,000 pa or less can elect to pay $1,000 into superannuation and the government matches it with $1,500. In effect, this is like a 150% instant return on funds. The benefit phases out when your income exceeds $28,000 at 5c in the dollar and ceases altogether at $58,000. To qualify, you must be receiving the “compulsory” 9% superannuation payment from an employer. This means the self employed or those not working for an employer are ineligible.

Bearing in mind that the payment must be made using after tax dollars and not salary sacrificed funds, our $28,000 example would see the optimal situation made up of a mixture of Superannuation and Mortgage repayments.of the $5,000, $1460 would be taken as cash and the remainder as a repayment on the mortgage. If the member is over 60, then for most, any withdrawals will be tax free.