Whether an individual should allocate excess cash flow to their mortgage or make concessional super contributions depends on various factors. Principal considerations include the individual’s tax rate, liquidity needs, cash flow position and risk tolerance. Before analysing these considerations, we will briefly outline the tax benefits of topping up super compared to making extra home loan repayments.
Tax Benefits of Super Contributions v Extra Home Loan Repayments
While home loan repayments are usually made with after-tax money, super contributions can be made with pre-tax dollars (via a salary sacrifice agreement) or claimed as a tax deduction by those who meet certain requirements. As a result, super tax concessions can enable an individual to use their surplus cash flow more effectively. It should be noted that from the 1st July 2012, individuals with income greater than $300,000 may effectively have the tax on their concessional contributions doubled from 15% to 30%. An example of the benefit of someone earning less than $300,000 contributing to super versus home loan repayments is illustrated below:
Benefits of Super v Home Loan repayments for Income Earners under $300k p.a.
|
|
Contribution into super |
Home loan repayment at MTR: |
||
|
34% |
38.5% |
46.5% |
||
|
Pre-tax income |
$1,000 |
$1,000 |
$1,000 |
$1,000 |
|
Tax at MTR |
Nil |
($340) |
($385) |
($465) |
|
Super contribution Tax |
($150) |
Nil |
Nil |
Nil |
|
Net |
$850 |
$660 |
$615 |
$535 |
Liquidity Needs
While making additional superannuation contributions can help an individual retire with more money in super, it is important to consider whether that individual may need access to money before meeting a condition of release. A key benefit of making extra home loan repayments is that the money can usually be accessed at any time via a redraw facility or offset account.
Cash flow Position and Contribution Caps
Not all individuals will have sufficient surplus cash flow to make additional mortgage repayments or super contributions. Therefore, it is important to consider how much an individual earns, the size of their mortgage and any other financial commitments. In addition, concessional superannuation contributions that exceed the $25,000 per financial year threshold are generally taxed at 46.5%, so don’t exceed your cap!
Risk Tolerance
Some individuals may need to be prepared to take on a moderate degree of investment risk to justify increasing their concessional contributions at the expense of paying off their mortgage earlier. This is because additional mortgage repayments are considered a low risk strategy and provides savings through lower interest costs. Furthermore, as home loan debt is not tax deductible the interest rate equates to an after tax return. Taxable income in the superannuation environment will be taxed at 15% (or 0% if in pension phase), therefore a specific return on additional contributions will be needed in order to make this strategy worthwhile.
The table below gives an illustration of this point.
Concessional Contributions v Mortgage Repayments from a Taxable Viewpoint
|
|
Concessional Contribution |
Mortgage Repayment |
|
Excess Cash flow |
$1,000 |
$1,000 |
|
Applicable Tax Rate |
15% |
46.5% |
|
Net amount |
$850 |
$535 |
|
Rate of Return/Interest rate |
7% |
6% |
|
Return/Interest |
$59 |
$32 |
|
Less Taxation (15%) |
$9 |
|
|
Net Return/Interest |
$50 |
$32 |
|
BENEFIT OF CONCESSIONAL CONTRIBUTIONS OVER MORTGAGE REPAYMENTS |
$18 |
|
More Information
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