It’s a dilemma many of us face – are we better off directing extra money to our mortgage vs super? As with most financial decisions, it’s not a one-size-fits-all approach and here are some factors to consider in deciding what’s right for you.
Mortgage vs Super Key takeaways:
- There may be tax advantages when you contribute to super, especially if you salary sacrifice or you’re eligible to claim a tax deduction for personal super contributions but your super is usually locked up till you retire.
- The power of compounding returns could mean that even small contributions to your super over many years could make a world of difference.
- By making extra mortgage repayments, coupled with any potential increase in the value of your property, you will pay less interest and build equity in your property at a faster rate than if you were to make just the minimum repayments.
Building the Case for Super over Mortgage
You might think your super is already being taken care of – after all, that’s what your employer’s compulsory Superannuation Guarantee contributions are all about. But these contributions alone often aren’t enough to ensure you achieve the retirement lifestyle you want to live.
Extra contributions to your super are a great way to boost your retirement savings. As an investment vehicle, super is a very tax-effective way to save for the future.
The Power of Compounding Returns
Super is a long-term investment, at least until you retire, and potentially much longer if you leave your money in super and draw a pension after you retire.
This long investment term, coupled with the tax rate on your super account investment earnings (generally 15% in accumulation phase but tax free for pension accounts). This means your money can add up fast and generate further investment returns on those returns. This is known as compound returns or compounding.
The expenses of daily life can be considerable. Thinking about directing money to super might not seem like a priority when we feel overwhelmed by the effort to save a deposit for a home, pay off debt, and pay off the costs of raising a family.
However, the benefit of compounding returns means that even small, frequent contributions can make a big difference. It’s about striking a balance that is right for you today, and remember, nothing has to be forever. You can adjust your contribution strategy to suit your needs as your life changes.
The best approach is to start early to maximise your retirement savings by allowing compounding returns to do the heavy lifting. The longer compounding continues, the more significant your savings could be. Entering retirement debt-free is an attractive prospect. It can be easy to think that you need to repay your debt before you can start thinking about saving for retirement. However, it doesn’t have to be one or the other.
You can see the difference small regular contributions could make to your final retirement income using the MoneySmart retirement planner calculator.
Tax Benefits of Super Contributions
Super contributions can be incredibly beneficial from a tax point of view. Salary sacrificing some of your before-tax salary or making a voluntary contribution from your net pay for which you can then claim a tax deduction can be effective ways to grow your retirement savings and reduce your taxable income.
One great benefit of investing in super is these concessional (before tax) contributions are taxed at a 15% for most people (but at 30% for people earning over $250,000).
Mortgage repayments are usually made from your take-home pay after you’ve paid tax at your marginal tax rate. Your marginal tax rate could be as high as 47% leaving you only 53% to pay off your loan. So, depending on your circumstances, making a voluntary deductible contribution to super or salary sacrificing may result in an overall tax saving of up to 32% and result in 85% of your contribution being invested.
There is a limit on the amount you can contribute to super every year. These are referred to as contribution caps. Currently, the annual concessional contributions cap is $27,500 for 23/24 but it has been increased to $30,000 for 2024/25. If you’re eligible to use the catch-up concessional contributions rules, you may be able to carry forward any previously unused concessional contributions for up to 5 years. If you exceed these caps, you may be liable to pay more tax.
Tax on Super Investment Earnings
The initial tax savings are only part of the story. The tax on earnings within the super environment is also low.
The earnings generated by your super investments are taxed at a maximum rate of 15%, and eligible capital gains may be taxed as low as 10%. Once you retire and commence an income stream with your super savings, the investment earnings are exempt from tax, including capital gains. Also, when it comes time to access your super in retirement, if you’re 60 or over, you can access lump sum amounts that are generally tax-free.
The Catch
However, it’s important to remember that once contributions are made to your super, they become ‘preserved’. Generally, you can’t access these funds as a lump sum or pension until you retire and reach your preservation age, between 55 and 60, depending on when you were born.
So, before you add extra to your super, it’s a good idea to think about your broader financial goals. Also, how much you can afford to put away because, with limited exceptions, you generally won’t be able to access the money in super until you retire.
In contrast, many mortgages can be set up to allow you to redraw the extra payments you’ve made or access the amounts from an offset account.
Building the Case for Reducing Your Mortgage Over Super
For many people, paying off debt is the priority. Paying extra off your home loan now will reduce your monthly interest and help you pay off your loan sooner. It also reduces your exposure to the risk of increasing interest rates or issues if you were to have cash flow difficulties. If your home loan has a redraw or offset facility, you can still access the money if things get tight later.
Depending on your home loan’s size and term, interest paid over the term of the loan can be considerable – for example, interest on a $500,000 loan over a 25-year term, at a rate of 6%, works out to be over $460,000. Paying off your mortgage early frees up that future money for other uses.
Before you start making additional payments to your mortgage, it’s suggested that you should first consider what other non-deductible debt you may have, such as credit cards and personal loans. Generally, these products have higher interest rates attached to them, so there is a more significant benefit in reducing this debt first before your low-interest rate mortgage.
Conclusion: Mortgage vs Super
Mortgage vs Super. It’s one of those debates that rarely seems to have a clear-cut winner – should I pay off the mortgage or contribute extra to my super?
The answer is that it depends on your circumstances.
There is no one-size-fits-all solution regarding the best way to prepare for retirement. On the one hand, contributing more to your super may increase your final retirement income. On the other hand, making extra mortgage repayments can help you clear your debt sooner, increase your equity position, and put you on the path to being debt-free and financial freedom.
When weighing up the pros and cons of each option, there are a few key points to keep in mind.
The peace of mind from being debt-free should not be underestimated but it’s a challenging decision to make if the rate of return on your super fund is higher than the interest rate on your mortgage.
Another critical question to consider is the likely balance you’ll need in your super. Work backwards, starting with working through what retirement looks like for you, the type of lifestyle you’d like, and how much you need to live on each year.
From there, you can consider your sources of income in retirement. This is likely to include super but could also include a full or part Age Pension or income from an investment property or other sources.
You can then start thinking about your current balance, contributions strategies, and whether you’re on track to have enough saved to supplement your other retirement income sources.
The MoneySmart retirement planner calculator can help you estimate how much super you may have in retirement and how long your super may last. You also need to consider how you plan to spend your money in retirement.
In most cases, there isn’t one set strategy you should follow, and it can quickly change as you grow older, start a family and reach retirement age. You should also consider whether you’ll need to access any additional funds you put aside before you retire. If it’s in your super, it’s locked away. If it’s in your mortgage, there are generally options to redraw.
Homeownership and comfortable retirement are financial goals that many strive towards. If you reach a point where there’s some surplus cash flow to consider where to put your extra money, it’s an excellent dilemma.
Life is complex, so it pays to speak with a financial adviser before you make any significant financial decisions regarding your Mortgage vs Super.
Source: MLC