In this guide
It’s very common to wonder about the best vehicle for money you can afford to save. Is it better to pay down your mortgage or make extra contributions to super and boost your retirement savings?
Answering this question, like many things in life, is not simple.
The option that is most likely to leave you financially better off depends on how your mortgage interest rate and super investment return are expected to compare in the long term, your income, and how much space is available for you to make concessional contributions to super under the concessional cap.
Of course, any decision involving your home is unlikely to be purely financial. Repaying the mortgage can be attractive for the sense of emotional security it brings or the freedom it affords you to move on to a larger property or renovate.
Mortgage interest vs super fund returns
When you make additional mortgage repayments or save in a mortgage offset account you’re effectively ‘earning’ the interest rate attached to your mortgage on your savings.
When making a choice between saving in super or towards the mortgage, it’s natural to compare the interest rate on the mortgage with the likely investment return from your super. Both your mortgage and super are long-term savings vehicles, so the average return over a long period of time is important.
According to data from the RBA and SuperRatings covering the period to June 2022, the 10-year average of standard variable mortgage rates was 5.35% per year while balanced super fund options returned an average of 7.9% per year. The 30-year average for mortgage rates was 6.96% per year and for balanced super funds was 7% per year.
While history can’t tell us what will occur in future, it can give us information about trends.
The investment strategy you have chosen for your super will affect the likelihood that your super return outpaces your mortgage interest rate. More conservative options with lower exposure to growth assets like shares and property have a lower long-term return while more growth-oriented options are more likely to experience a return higher than mortgage interest rates.
If your contributions to super will be non-concessional (after tax), the only way saving in super can leave you better off financially is if your super return is higher than your mortgage interest rate. However, if you can make concessional contributions, the picture changes thanks to tax savings.
Tax savings
If your marginal tax rate is higher than the 15% contribution tax for concessional super contributions, you can reduce income tax by making concessional super contributions. This tax saving increases the amount you can afford to contribute to super vs the mortgage, for the same cost to your after-tax income.
Example: Melissa
Melissa earns $135,000 per year. She pays 39% tax (including Medicare Levy) on each dollar she earns above $120,000.
Melissa has decided she can afford to save $500 a month from her take-home pay.
If she saves outside super, she can put $500 per month into an investment (or her mortgage). Alternatively, she can salary sacrifice $819.67 per month to super. This will only reduce her take-home pay by $500 because she would otherwise pay income tax of $319.67 on this amount.
After 15% contribution tax is deducted, $696.72 will be credited to Melissa’s super account.
For Melissa, making concessional contributions to super means nearly $200 a month extra going into her investment.
When making concessional contributions to super, it is important to be mindful of the concessional contribution cap. Contributions above the cap do not generate a tax saving because they are taxed at your marginal rate.
If you are an employee, remember that contributions your employer makes for you are counted in the cap. If you’re a high-income earner, you may not have much space under the cap to make additional contributions on top of what your employer pays.
Lastly, if your income plus concessional super contributions exceeds $250,000 for the financial year, additional tax applies to your concessional contributions – Division 293 tax. This reduces the tax saving from concessional contributions but does not eliminate it. People with income at this level are liable for 47% income tax (including Medicare) and pay a total of 30% tax on concessional super contributions – generating a tax saving of 17% from concessional contributions that are under the cap.
Learn more about concessional contributions.
