Mortgage vs super: where should I put my extra money?

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.
  • By making extra mortgage repayments, coupled with any potential increase in the value of your property, you may build equity in your property at a faster rate than if you were to make just the minimum repayments.
  • The power of compounding returns could mean that even small contributions to your super over many years could make the world of difference to your super balance come retirement.
     

It’s a dilemma many of us face – are you better off directing extra money to your mortgage or super? Which strategy will leave you better off over-time? What does an interest rate rise mean for your mortgage repayments and super returns? Do you need to fully eliminate your debt before you start thinking about retirement savings? Deciding between eliminating debt and investing for the future is a difficult decision.

In the mortgage versus super debate, there is no one-size-fits-all-approach, and no two people will get the same answer – but there are some factors to consider in deciding what’s right for you. We speak with MLC’s Technical Manager, Jenneke Mills, to understand the different elements and assess the options.
 

The case for super

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, right? But these contributions alone often aren’t enough to ensure you achieve the retirement lifestyle you want to live.

“Making extra contributions to your super is a great way to boost your retirement savings,” explains Mills.

“As an investment vehicle, super is a very tax-effective way to save for the future.”

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 concessional rate of tax on your super investment returns, means your returns can add up 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, paying down debt, and the costs of raising a family,” says Mills.

“However, the benefit of compounding returns means that even small, frequent contributions can make a big difference down the track,” explains Mills.

“It’s about striking a balance that is right for you today – and remember, nothing has to be forever. As your life changes, as your expenses change, and as your cashflow changes, you can simply adjust your contributions strategy to suit your needs”.

To maximise your retirement savings while allowing compounding returns to do the heavy lifting, the best approach is to start early. The longer compounding continues, the bigger 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 - the power of compounding returns means that even small contributions over many years could make the world of difference to your super balance come retirement. You can see the difference small, regular contributions could make to your final retirement income using our Small Change, Big Savings Calculator.
 

Manage your tax and invest more for retirement

From a tax point of view, super can be incredibly powerful. Salary sacrificing some of your pre-tax salary, or making a voluntary after-tax contribution for which you claim a tax deduction can be effective ways to not only grow your retirement savings but also reduce your taxable income. These types of contributions form part of your concessional contribution limit

“One great benefit of investing in super is that concessional (before tax) contributions are taxed at a maximum rate of 15%. Or at 30% to the extent your concessional contributions within your cap, together with your income from certain sources is over $250,000,” explains Mills.

“Mortgage repayments, however, 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%. So, depending on your circumstances, making a voluntary deductible contribution to super or salary sacrificing may result in a tax saving of up to 32%.”

However, there is a limit on the amount you can contribute into super every year. These are referred to as contribution caps. In the 2021/22 and 2022/23 financial years, the annual concessional contributions cap is $27,500. If you’re eligible to use the catch-up concessional contributions rules, you may be able to carry forward any unused concessional contributions for up to 5 years.

Contributions above your concessional contributions cap (including any catch-up contribution limits you have available) are taxed at your marginal tax rate, rather than the concessional rate explained above. Also, if you exceed your contribution caps additional taxes and penalties apply. You can find out more regarding concessional contributions through our website.1

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Tax on super investment earnings

The initial tax savings are only part of the story. The tax on earnings within the super environment are also low.

“The investment 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%.” explains Mills.

“Once you retire and commence an income stream with your super savings2, the investment earnings are exempt from tax3, including capital gains.”

Also, when it comes time to access your super in retirement and if you are aged 60 or over, amounts that you access as a lump sum are generally tax free. If you’ve reached your preservation age, but are under age 60, no tax is payable on the tax-free component of your withdrawal. You can also withdraw up to $225,000 from your taxable component without paying any lump sum tax in 2021/22 (this is known as the low-rate cap).4

However, it’s important to remember that once contributions are made to your super, they become ‘preserved’. Generally, this means you can’t access these funds as a lump sum until you retire and reach your preservation age – between 55 and 60, depending on when you were born.

“Before you start adding extra into your super, it’s a good idea to think about your broader financial goals and how much you can afford to put away,” says Mills, “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, should you require access to capital.”
 

The case for reducing the mortgage

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 – and if your home loan has a redraw or offset facility, you can still access the money if things get tight later.

“Paying off your mortgage and entering retirement debt-free is pretty appealing,” says Mills. “It’s a significant accomplishment and means the end of a major ongoing expense.”

Depending on a 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, even at a low interest rate of 4% works out to be over $300,000. Paying off your mortgage early also frees up that future money for other uses.

“Reducing your mortgage decreases the total amount of interest paid over the duration of the mortgage and effectively equates to a return equivalent to the home loan interest rate,” explains Mills.

Before you start making additional payments to your mortgage, Mills suggests 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,” explains Mills, “so, there is greater benefit in reducing this debt rather than your low interest rate mortgage.”
 

How does an interest rate rise affect my mortgage and super returns?

Interest rates have been extremely low in Australia – and many places around the world – for years now. Rates began falling after the GFC, and then went even lower during the COVID-19 pandemic. Our official interest rate has sat at 0.1% since November 2020.5

Central banks raise and lower interest rates to stimulate economic growth and control inflation. If inflation is high, they might raise rates to try and control it. If it’s low, they may lower rates to encourage consumers to spend and borrow money.

In Australia, we’re currently experiencing higher inflation than in recent years. The annual inflation rate reached 3.5%6 in December 2021, which is about the Reserve Bank of Australia’s (RBA) target range of 2-3%. That’s one of the main reasons why the RBA lifted interest rates at its 3 May meeting. It’s the first time in more than a decade that the cash target has been increased. So, what does this mean for your mortgage and super returns?

“With interest rates on hold or falling for so long many people have probably forgotten what it was like when rates were above the current low levels,” says Mills. “Many new entrants to the property market have never experienced an increase to their interest rate.”

“For borrowers, it is important to understand what a rate rise means for your finances,” Mills says. “Are you able to meet your mortgage repayments under the new rates?”

You can use MoneySmart’s mortgage calculator to estimate what impact the rate rise will have on your home loan repayments. If you’re worried about the impact of the rate rise on your mortgage payments, you might want to consider making an appointment with your lender to discuss what options may be available.

If your super is invested across several asset classes - like Australian shares, global shares, property, fixed interest and cash - an interest rate rise could make your super balance go up or down, depending on how it’s invested.
 

So, what’s the answer? Do I make extra payments to my mortgage or contribute to my 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 – probably somewhat annoyingly – is that it depends on your personal circumstances.  

“There is no one size fits all solution when it comes to the best way to prepare for retirement,” says Mills. “On the one hand, contributing more to your super may increase your final retirement income.”

“On the other, making extra mortgage repayments can help you clear your debt sooner, increase your equity position and put you on the path to financial freedom.”

When weighing up the pros and cons of each option, Mills suggests there are a few key points to keep in mind.

“One of the key questions to consider is what 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 start to 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,” says Mills.

“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 Retirement forecaster is designed to give you an estimate of how much super you may have in retirement, and how long your super may last. You also need to think about how you plan to spend your money in retirement.

In most cases, there isn’t one set strategy that 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 reach retirement. If it’s in your super, it’s locked away. If it’s in your mortgage, there are generally options to redraw.

“Home ownership 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 a good dilemma to have,” says Mills.

Whatever strategy you choose, you’ll need to regularly review your options if you’re making regular voluntary super contributions or extra mortgage repayments. As bank interest rates move and markets fluctuate, and indeed your own lifestyle, personal circumstances and expenses change, the strategy you choose today may be different from the one that is right for you in the future. It’s also important to weigh up your stage in life, particularly your age and your risk appetite.

Life is complex, so it pays to speak with a financial adviser before you make any big financial decisions when it comes to your super or mortgage.


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Further reading

1 If you meet certain eligibility conditions, you may be able to access unused concessional contributions from an earlier financial year, under what’s referred to as the ‘catch-up concessional contribution’ rule. These rules are complex. For more information see ato.gov.au.
2 If you’re drawing a transition to retirement income stream the investment earnings are taxed at up to 15% until you turn 65 or notify your super fund that you have met a prescribed condition of release. A limit of $1.7 million broadly applies to the amount you can transfer into the tax-exempt retirement pension phase.
3 Also applies where certain other conditions are met, including if you are permanently incapacitated or terminally ill.
4 Any amount you withdraw over the low-rate cap will be taxed at a maximum of 17% (including the Medicare levy) or your income tax rate, whichever is lower. The low-rate cap is increasing to $230,000 in 2022/23.
5 Reserve Bank of Australia, Cash Rate Target, February 2022.
6 Australian Bureau of Statistics, Consumer Price Index, December 2021.

Important information and disclaimer

This article has been prepared by NULIS Nominees (Australia) Limited ABN 80 008 515 633 AFSL 236465 (NULIS) as trustee of the MLC Super Fund ABN 70 732 426 024. NULIS is part of the group of companies comprising Insignia Financial Ltd ABN 49 100 103 722 and its related bodies corporate (‘Insignia Financial Group’). The information in this article is current as at May 2022 and may be subject to change. This information may constitute general advice. The information in this article is general in nature and does not take into account your personal objectives, financial situation or needs. You should consider obtaining independent advice before making any financial decisions based on this information. You should not rely on this article to determine your personal tax obligations. Please consult a registered tax agent for this purpose. Opinions (if any) in this article constitute our judgement at the time of issue. The case study examples (if any) provided in this article have been included for illustrative purposes only and should not be relied upon for decision making. Subject to terms implied by law and which cannot be excluded, neither NULIS nor any member of the Insignia Financial Group accept responsibility for any loss or liability incurred by you in respect of any error, omission or misrepresentation in the information in this communication.