At a certain stage of life, many wonder what is better: pay off a home loan as quickly as possible or increase your pension?
If your emergency cash stock looks good and you have enough to cover you for three to six months if you lose your job, a super vs mortgage question is a good question to consider. There is no one answer that fits all.
On the face of it, there is a compelling case for building your own super; You can take advantage of the magic of compound interest (and maybe some tax breaks, too) — all while mortgage rates are low.
If you get 8 percent compound interest on your retirement savings and only pay 3 percent on your mortgage, getting to the supermarket may seem like a good option.
But financial decisions are more about psychology as well as numbers. A lot depends on your comfort zone of debt.
It’s best to seek professional help from a counselor or financial advisor – but here are some questions to consider along the way.
1. Am I “On the Right Track” to Getting Enough Pensions in Retirement?
Use the government’s Moneysmart retirement planners or your retirement savings fund calculator to check.
If it seems insignificant – perhaps due to professional interruptions or part-time work – you might consider sacrificing an extra salary in your super (on top of what the employer is already putting there).
An extra $50 a week, for example — even for just a few years — can help remedy your meager expectations.
According to MoneySmart:
“The payments, called concessional contributions, are taxed at 15 percent. For most people, this will be less than the marginal tax rate. You benefit because you pay less tax while boosting your retirement savings. […] The total amount of employer and concessional contributions sacrificed must not be more than $27,500 per fiscal year.”
Try the Industry Super or Moneysmart calculators to see how much extra you would have in retirement if you sacrificed your paycheck to the Super for a few years. Consider seeking advice from your retirement savings fund about superinvestment options and old-age benefits.
You can also consider an after-tax personal super contribution (i.e. putting extra money from savings or your home paycheck into a super account). Contributions may be tax deductible, but even if not, super returns are tax-friendly.
2. What about the pension?
Are you expecting a full retirement? To find out if you’re likely to qualify for one, use our online calculator or ask your own savings fund. People with “very large amounts” do not receive a pension (although most retirees do receive a partial pension). For some, the more you pay for retirement, the less you get in old-age pension payments.
For single homeowners, the minimum assets for a full old-age pension is $270,500 (including the super but excluding your primary residence), while the minimum age pension is $593,000. For a married couple’s homeowners, the combined minimum asset pool for a partial pension is $891,500 (including the super but excluding the main residence).
If your income is average and your super balance is expected to reach between the lower and upper pension asset thresholds, some models predict that for every extra $1,000 put into your super at age 40, you’ll only be about $25 a year better off in terms of retirement income (Due to the gradual decline in eligible old-age pension income).
For people on lower incomes, additional pension contributions may not be the answer at all if the result is more financial stress during your working life and immediate housing security risks.
3. If I retire with a mortgage, can I afford it?
Many people end up retiring earlier than planned, due to health or other problems.
If you were still paying off your mortgage at retirement, would you feel comfortable about it? Or will it be a concern?
Traditionally, most people enter retirement after paying off their home loan but now more people are approaching retirement with some mortgage remaining. It might not be the end of the world if you have $100,000 left on your mortgage when you stop working. After all, you can withdraw up to $215,000 in super-tax credit when you retire to pay off debt. Doing so can also increase your old-age pension entitlement (as your primary residence is exempt from pension asset tests while retirement is not).
The accumulation of wealth in the pension will outweigh the interest on the mortgage in most cases for some time, even after retirement. However, you may feel it is worth getting rid of the last vestiges of your debt in retirement so you can stop worrying about it.
4. Will the choices I make today cost me later – and am I OK with that?
Australian property values have skyrocketed and many have borrowed more to pay for renovations. The full “cost” of the renovation may not be apparent at first.
The real cost of renewing $150,000 over the next 20 years could be more than $700,000. how? Well, if that $150,000 was put into a super balanced allocation for a few decades, it would probably come to about $700,000. This is a compound benefit for you. You are hoping to get that in capital gains from the renewal.
But it’s not just about finances. The additional mortgage may be worth it because it is a payment for a home that provides comfort and pleasure (plus capital gains).
Likewise, paying off your mortgage as quickly as possible could mean giving up the extra money you’d get if you put it in perfect condition. But for some, a mortgage wipeout would be something worthwhile to be debt-free. Perhaps after the mortgage is over, you can maximize your salary sacrifice until retirement, while also reducing your tax bill.
At least do it
There is always more than one solution. To find out what is right for you, you will need to get advice about your personal circumstances.
But it’s a good idea to look at where your higher pension is now and where it’s heading, and calculate the debt-to-income ratio (debt divided by income). It is often used to measure how serious (or not) your debts are. Lenders and regulators may consider a debt-to-income ratio of more than six times your income to be “high,” but your personal debt comfort zone may be much lower.
Emotions play a bigger role in financial planning than many admit. The desire to pay off a mortgage quickly can be affected by the way it was raised, the feelings of anxiety and stigma that often come with debt, and Australia’s cultural bias towards debt-free home ownership.
Depending on the circumstances, it may be time to rethink the bias for housing debt repayment over super wealth accumulation. At least do the sums, so you can make an informed decision.
Dee Johnson is a lecturer in finance at Griffith University. This piece first appeared in The Conversation.