Focusing on super, instead of mortgage repayments

Technical resource

This strategy can boost retirement savings and reduce overall tax liability. Upon retirement, individuals have the ability to make loan repayments with tax-free super monies.

This strategy is best suited to clients in a higher tax bracket who are currently paying principal and interest repayments on their mortgage, are close to retirement and plan to retire after they attain age 60.

By switching to interest only or reducing the amount of the repayments, the client’s repayment amount is reduced. The amount they save on mortgage repayments, can be redirected to their superannuation fund using a salary sacrifice / personal concessional contribution strategy.

This strategy can boost retirement savings and also reduce your client’s overall tax liability. When the client retires, they have the ability to make loan repayments with tax-free super monies (once they turn 60).

Things to consider when advising on this strategy

  • This strategy works best for investors who can achieve long term average investment earnings exceeding 6% per annum (based on the current low interest rate environment).
  • The strategy is less attractive if interest rates rise.
  • The strategy is less attractive if the client’s marginal tax rate drops to a lower tax bracket.
  • The tax saving is restricted to how much additional concessional contributions can be made, and potentially any catch-up concessional contributions.

Case Study

Robert is a 50 year old, full time employee and owns a home which he purchased using a mortgage. After 10 years of making repayments of $2,000 per month, the outstanding loan balance has reduced to approximately $289,600 with interest charged at 3% per annum, compounding monthly.

As he is nearing retirement he wants see if he should start contributing more into superannuation. His loan terms allow him to reduce his regular monthly repayments to as low as $1,100 per month. He decides to reduce his repayments to $1,216.40 per month, as this allows him to salary sacrifice $1,291.66 per month into superannuation and maintain his current net income level.

Financial position

No super contribution

With super contribution

Salary income

$100,000

$100,000

Concessional contribution

$0

$15,500

Taxable income

$100,000

$84,500

Tax Payable1

$25,717

$19,620

Loan repayments

$24,000

$14,597

Increased contributions tax

$0

$2,325

Net Income

$50,283

$50,283

Overall tax saving

n/a

$3,772

Based on an interest rate of 3%, there will be additional interest incurred of $282 p.a. on the loan. However, this will compound for the life of the loan. If Robert maintained his $2,000 per month mortgage repayments, he would have repaid his mortgage at his retirement age of 65, however by reducing his repayments he will have an outstanding loan balance at retirement.

Loan position2

No super contribution

With super contribution

Loan balance at retirement

$0

$177,849

Total interest paid from age
50 to age 65

$69,665

$106,471

Increased interest for the period

-

$36,806

 

Offsetting the increased interest payable may be any earnings on the additional funds now in super and the outstanding loan balance may be repaid as a lump sum from his increased superannuation savings. Based on Robert's investment time horizon of 15 years until retirement and his attitude to risk, he invests in a 'growth' investment option, which has an average net after tax return of 6% per annum, compounding monthly.

Superannuation increase3

With super contribution

Increased superannuation balance at age 65

$300,693

Less lump sum withdrawal to repay outstanding loan

($177,849)

Increased net superannuation savings

$122,844

 

1 Based off 2020/21 income tax thresholds, rates and offsets.
2 Assuming interest rate remains at 3% per annum, compounding monthly.
3 Assuming salary sacrifice contributions of $1,291.66 per month are maintained for the duration of the analysis and average net after tax returns are 6% per annum, compounding monthly. 

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