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Should I put my money into my mortgage or my super?
With interest rates on the rise and investment returns increasingly volatile, Australians with cash to spare may be wondering how to make the most of it. If you have a mortgage, should you make extra repayments or would you be better off in the long run boosting your super?
The answer is, it depends. Your personal circumstances, interest rates, tax and the investment outlook all need to be taken into consideration.
What to consider
Some of the things you need to weigh up before committing your hard-earned cash include:
Your age and years to retirement
The closer you are to retirement and the smaller your mortgage, the more sense it makes to prioritise super. Younger people with a big mortgage, dependent children, and decades until they can access their super have more incentive to pay down housing debt, perhaps building up investments outside super they can access if necessary.
Your mortgage interest rate
This will depend on whether you have a fixed or variable rate, but both are on the rise. As a guide, the average variable mortgage interest rate is currently around 4.5 per cent so any money directed to your mortgage earns an effective return of 4.5 per cent. i
When interest rates were at historic lows, you could earn better returns from super and other investments; but with interest rates rising, the pendulum is swinging back towards repaying the mortgage. The earlier in the term of your loan you make extra repayments, the bigger the savings over the life of the loan. The question then is the amount you can save on your mortgage compared to your potential earnings if you invest in super.
Super fund returns
In the 10 years to 30 June 2022, super funds returned 8.1 per cent a year on average but fell 3.3 per cent in the final 12 months.ii In the short-term, financial markets can be volatile but the longer your investment horizon the more time there is to ride out market fluctuations. As your money is locked away until you retire, the combination of time, compound interest and concessional tax rates make super an attractive investment for retirement savings.
Tax
Super is a concessionally taxed retirement savings vehicle, with tax on investment earnings of 15 per cent compared with tax at your marginal rate on investments outside super.
Contributions are taxed at 15 per cent going in, but this is likely to be less than your marginal tax rate if you salary sacrifice into super from your pre-tax income. You may even be able to claim a tax deduction for personal contributions you make up to your annual cap. Once you turn 60 and retire, income from super is generally tax free. By comparison, mortgage interest payments are not tax-deductible.
Personal sense of security
For many people there is an enormous sense of relief and security that comes with having a home fully paid for and being debt-free heading into retirement. As mortgage interest payments are not tax deductible for the family home (as opposed to investment properties), younger borrowers are often encouraged to pay off their mortgage as quickly as possible. But for those close to retirement, it may make sense to put extra savings into super and use their super to repay any outstanding mortgage debt after they retire.
These days, more people are entering retirement with mortgage debt. So whatever your age, your decision will also depend on the size of your outstanding home loan and your super balance. If your mortgage is a major burden, or you have other outstanding debts, then debt repayment is likely a priority.
Older couple nearing retirement
Tony and Elena, both 60, would like to retire in the next few years. Together they earn $180,000 a year, excluding super, but they still have $100,000 remaining on their mortgage. Tony has a super balance of $600,000 and Elena has $200,000.
They want to be debt free by the time they retire but they are also worried they won’t have enough super to afford the lifestyle they look forward to in retirement.
If they do nothing, at a mortgage interest rate of 4.5 per cent it will take five years to repay their mortgage with monthly mortgage payments of $1,864. At age 65, their combined super balance will be a projected $1,019,395.
Jolted into action, they decide they can afford to put an extra $1,000 a month into their mortgage or super.
- If they increase their mortgage payments by $1,000 a month, the loan will be repaid in three years and two months. But their super will only be a projected $931,665 by then, so they may need to work a little longer to fund a comfortable retirement. From age 63, they might consider salary sacrificing into super with money freed up from early repayment of their mortgage.
- If they salary sacrifice $1,000 a month to super from age 60, their combined super balance will grow to a projected $1,082,225 by the time they are 65 and their home is fully paid for.
These are complex decisions, but whichever option they choose they will probably need to consider working until at least age 65 to be debt free and build their super.
All calculations based on the MoneySmart mortgage and retirement planner calculators.
All things considered
As you can see, working out how to get the most out of your savings is rarely simple and the calculations will be different for everyone. The best course of action will ultimately depend on your personal and financial goals.
Buying a home and saving for retirement are both long-term financial commitments that require regular review. If you would like to discuss your overall investment strategy, give us a call.
i https://www.finder.com.au/the-average-home-loan-interest-rate
ii https://www.chantwest.com.au/resources/super-members-spared-the-worst-in-a-rough-year-for-markets/
How is my insurance taxed?
Most Australian employees have some form of life insurance, often through their superannuation fund, but many of us tend to ‘set and forget’.
To make the most of your life insurance policy, it’s useful to understand how it works, and how premiums and payments are affected by tax.
Various types of life insurance
Life insurance is an umbrella term for a range of policies that cover different situations. They include:
- Life cover, which pays out after your death to someone you have nominated.
- Income protection covers you if you’re unable to work because of illness or injury.
- Total and permanent disability (TPD) insurance provides medical and living costs if you become permanently disabled.
- Accidental death and injury cover pays a lump sum if you die or are injured.
- Critical illness or trauma insurance pays a lump sum to cover medical expenses for major medical conditions.
- Business expenses insurance covers ongoing fixed business costs if you’re a business owner suffering serious illness or injury.
Tax benefits and deductions
The premiums for most types of life insurance are not tax deductible, but there are exceptions. Premiums for income protection held outside of super are tax-deductible and inside super for the self-employed. Business expenses insurance premiums are also tax deductible.
The tax treatment of benefits paid out by policies also varies according to the type of policy and your situation, so it’s important to talk to us. Generally, life cover paid to someone who’s financially dependent on you (typically a spouse and children under 18 years) is not taxed. But if the beneficiary isn’t your financial dependent, they can expect to pay tax.
Income protection insurance payments must be declared on your tax return and will be taxed at your marginal rate, just like your usual salary. Business expense insurance payouts also taxable.
Lump sum payments made through other policies are not taxable.
Inside super or outside?
Some of these insurances, particularly life cover, income protection and TPD, can be purchased through your super fund. Most people have a basic level of cover held this way, but you should check to see if it’s adequate for your needs.
If you are aged under 25, have a super balance of $6,000 or less, or your account is inactive, you will need to “opt in” if you want insurance cover.
If you have a self-managed super fund (SMSF), you’re required to consider whether to hold life insurance for each of the fund’s members, although there’s no obligation to buy.
Super pros and cons
You’ll need to do the sums for your circumstances, which is where an adviser can assist, but there may be an advantage to using your super to pay the premiums. The main reason is cost.
Sometimes, the buying power of larger super funds allows them to negotiate competitive pricing for insurance products.i It’s not always the case, so you’ll need to shop around to make sure you’re getting the best deal.
Another potential financial benefit in paying the monthly premiums out of your super account, is that you’re using funds taxed at 15 per cent. Whereas, if you pay the premium from your own bank account, you’d be using funds already taxed at your marginal tax rate, which may be higher. That means your pre-tax dollars are working harder and you’ve still got your cash in the bank.
The main drawback to paying insurance premiums through super is that you’ll be reducing your super balance, which means less for retirement. However, you could choose to boost your balance using salary sacrifice or personal contributions.
Your safety net checklist
- Decide on who and what needs to be financially protected if something should happen to you.
- Weigh up the best type of life insurance to meet your needs and shop around.
- Be clear about any tax implications of an insurance payout
- Make sure the policy benefit is adequate and check it annually.
Deciding on the type of life insurance you need can be tricky, so give us a call to discuss your insurance needs.
i Insurance through super – Moneysmart.gov.au
Go on… take a break!
One of the things many of us have been missing over the past few years is holidays, but now that the world is opening up again for travel and destinations that have been pretty quiet are now eagerly welcoming back tourists, taking a break has never been more appealing.
Holidays are not just a lovely way to spend time, they are fantastic for us on so many levels. Having a break from the daily grind gets us out of our usual routine, opens us up to new experiences and is good for us mentally and physically.
However, the stats tell us that for many Australians it’s been a long time between breaks. In fact, around 8 million Australians have accrued nearly 175 million days of leave over the past 12 months, up from 151 the previous year.i That’s a lot of missed holidays!
Whether you are one of those who hasn’t had much of a break lately or even if you’ve just got back from a trip and are planning your next one – there are a host of good reasons to take a holiday.
Holiday to keep the doctor away
Holidays have been proven to lower stress which has a myriad of benefits including addressing the risk of cardiovascular issues like stroke and heart attack. A study following more than 12,000 middle-aged men at high risk for heart disease, found those who took yearly breaks were less likely to die from any cause, including heart attacks and other cardiovascular issues.ii
It’s not just physical health that benefits, taking a break is unsurprisingly pretty good for mental health with even a short break of a few days having a powerful mood enhancing effect.iii
Travel to broaden the mind
Lifelong learning is not only good for our careers but also important for our personal growth. And travel is a learning experience like no other, whether you are heading to a new country or a different part of your city or state you’ll meet new people and experience a different way of life.
Travel is also the ultimate experience in mindfulness – you are living in the moment when you are on holiday. A break in routine takes us off autopilot and puts us in charge.
Having a break makes you more productive
If you are worried about the impact a break can have on your career – don’t be! Research by Boston Consulting Group found that professionals who took planned time off were significantly more productive than those who spent more time working.iv Holidays offer time for introspection, goal setting and a chance to recharge your batteries for a new lease on life.
Planning for a wonderful time
Not all vacations are created equal. Just taking any quickly thrown-together escape may not provide all the health and productivity benefits associated with taking a vacation. A poorly planned break can be a source of tension and stress, rather than the opposite.
So how do you get the best out of a break?
Be flexible – While it’s important to plan before you leave, have enough flexibility for discovery – be open to new experiences and willing to change the schedule to accommodate those spontaneous magical moments.
Don’t sweat the small stuff – Things can and do go awry once you are away but don’t let silly little things spoil the break.
Switch off – Don’t be tempted to check your emails or socials every few minutes – stay in the moment. A decent break from work will also reinforce that the office doesn’t need you 24/7 and that life comes first.
Watch the budget but have some allowances to splurge – Focus on experiences and the memories you’ll take home with you rather than what’s on sale at the gift shop or duty free.
And finally, don’t feel that a holiday must be a luxurious destination or for a long period of time to count. A change of scenery can be as good as a holiday – even taking a mini break and heading off for a weekend away to a lovely destination can provide all the benefits of a holiday. So, what are you waiting for? Start planning that next trip. The wide, wonderful world awaits!
i http://www.roymorgan.com/findings/8696-annual-leave-holidays-march-2021-202105170711
ii https://pubmed.ncbi.nlm.nih.gov/11020089/
iii https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5800229/
iv https://hbr.org/2009/10/making-time-off-predictable-and-required
How much super do I need to retire?
Working out how much you need to save for retirement is a question that keeps many pre-retirees awake at night. Recent market volatility and fluctuating superannuation balances have only added to the uncertainty.
So it’s timely that new research shows you may need less than you fear. For most people, it will certainly be less than the figure of $1 million or more that is often bandied around.
For most people, the amount you need to save will depend on how much you wish to spend in retirement to maintain your current standard of living. When Super Consumers Australia (SCA) recently set about designing retirement savings targets they started by looking at what pre-retirees aged 55 to 59 actually spend now.
Retirement savings targets
SCA estimated retirement savings targets for three levels of spending – low, medium and high – for recently retired singles and couples aged 65 to 69.
Significantly, only so-called high spending couples who want to spend at least $75,000 a year would need to save more than $1 million. A couple hoping to spend a medium-level $56,000 a year would need to save $352,000. High spending singles would need $743,000 to cover spending of $51,000 a year, and $258,000 for medium annual spending of $38,000.i
While these savings targets are based on what people actually spend, there is a buffer built in to provide confidence that your savings can weather periods of market volatility and won’t run out before you reach age 90.
They assume you own your home outright and will be eligible for the Age Pension, which is reflected in the relatively low savings targets for all but wealthier retirees.*
Retirement planning rules of thumb
The SCA research is the latest attempt at a retirement planning ‘rule of thumb’. Rules of thumb are popular shortcuts that give a best estimate of what tends to work for most people, based on practical experience and population averages.
These tend to fall into two camps:
- A target replacement rate for retirement income. This approach assumes most people want to continue the standard of living they are used to, so it takes pre-retirement income as a starting point. A target replacement range of 65-75 per cent of pre-retirement income is generally deemed appropriate for most Australians.ii
- Budget standards. This approach estimates the cost of a basket of goods and services likely to provide a given standard of living in retirement. The best-known example in Australia is the Association of Superannuation Funds of Australia (ASFA) Retirement Standard which provides ‘modest’ and ‘comfortable’ budget estimates.iii
SCA sits somewhere between the two, offering three levels of spending to ASFA’s two, based on pre-retirement spending rather than a basket of goods. Interestingly, the results are similar with ASFAs ‘comfortable’ budget falling between SCA’s medium and high targets.
ASFA estimates a single retiree will need to save $545,000 to live comfortably on annual income of $46,494 a year, while retired couples will need $640,000 to generate annual income of $65,445. This also assumes you are a homeowner and will be eligible for the Age Pension.
Limitations of shortcuts
The big unknown is how long you will live. If you’re healthy and have good genes, you might expect to live well into your 90s which may require a bigger nest egg. Luckily, it’s never too late to give your super a boost. You could:
- Salary sacrifice some of your pre-tax income or make a personal super contribution and claim a tax deduction but stay within the annual concessional contributions cap of $27,500.
- Make an after-tax super contribution of up to the annual limit of $110,000, or up to $330,000 using the bring-forward rule.
- Downsize your home and put up to $300,000 of the proceeds into your super fund. Thanks to new rules that came into force on July 1, you may be able to add to your super up to age 75 even if you’re no longer working.
While retirement planning rules of thumb are a useful starting point, they are no substitute for a personal plan. If you would like to discuss your retirement income strategy, give us a call.
*Assumptions also include average annual inflation of 2.5% in future, which is the average rate over the past 20 years, and average annual returns net of fees and taxes of 5.6% in retirement phase and 5% in accumulation phase.
i CONSULTATIVE REPORT: Retirement Spending Levels and Savings Targets, Super Consumers Australia
ii 2020 Retirement Income Review, The Treasury
iii Association of Superannuation Funds of Australia (ASFA) Retirement Standard