If you’ve ever asked the question, shall I pay off my mortgage or put more in super, this is for you.
Usually in the morning reading run, which comes before the morning breakfast and school run, the media turns up a few gems. This morning’s find in a financial institution newsletter aimed at clients, was more lump of rock than diamond.
One could reasonably assume, given the source, that this article exists for the purpose of selling a financial product. What it completely ignores is the fact that life often gets in the way of smarty pants plans.
Have a quick read below, I’ve added a pragmatic view at the end.
Question to financial insitution from, “A Reader”
“We have a modest mortgage and I work full-time. I’m wondering whether I should pay more off my home loan or make additional super contributions?”
Answer from venerable financial institution
“…Many people think they should pay off their mortgage before they save more for retirement. But this rule of thumb is somewhat simplistic, especially when it comes to comparisons with super.
Home loan repayments are usually made with income that’s been taxed at your marginal rate of up to 46.5%. Conversely, you can make super contributions from your pre-tax salary and tax of up to 15% is deducted in the fund.
Pre-tax super contributions can therefore enable you to get more value from your salary and put your cashflow to work more tax-effectively.
For example, if you contribute $1,000 in pre-tax salary into super, a net amount of $850 would be invested. But $1,000 in pre-tax salary would only enable you to pay $615 off your mortgage if your marginal tax rate was 38.5%.
Also, keep in mind that the cap on concessionally taxed super contributions is now a lot lower than it used to be. So, the opportunity to make large, last minute tax-effective super contributions is now a thing of the past.
Our analysis shows many people could be better off making extra pre-tax super contributions throughout their working life – even small amounts – rather than paying off their home loan early and having little time left to build their super further.
But the best approach for you will depend on a range of circumstances and we recommend you speak to your financial adviser before making your decision….”
Ok, let’s pick this apart a bit.
How many people do you know who’ve been laid off their jobs recently? Start counting on the fingers of one, if not two, hands. Add to your count, the freelancers who are struggling to get work. Then, add the number of people who’ve resigned from their jobs recently to seek a more rewarding lifestyle? Self-employment perhaps.
Are you onto two hands or adding toes to the count yet?
Let’s now say that one of your fingers or toes had followed the advice above. They’re sitting at home with no job, owing the bank money and with no cash to put food on the table. However, they have a large chunk of super they can’t touch until oh, about sixty. (It varies depending on your age). The kids may have starved to death by then. Ok, slight exaggeration but you get the point.
If however, they had paid down their debt they’d have a whole lot more choice about the next move. Not only that, but if it’s their family home and therefore principal place of residence (tax office words) they’d be sitting on a tax free asset which can be sold, rented out or drawn down against for future opportunities. No 15% internal tax rate there.
The institution asserts, that to pay down debt first is simplistic. Maybe it is, but it’s real. Tax is not and rarely should be, the driver of core planning strategies. The world economy is not yet free from the trail of debris left by the Global Financial Crisis, and we’re not planning to throw metaphorical tomatoes and run with the bulls back to the days of excess for some time yet. Whatever the pundits say.
Keep it simple, I say, and never let the tax tail wag the investment dog.
You are the driver of planning strategies, make yours fit your real goals and values, not those of the tax office.
Flexibility and smarts are what give you choice in life, not oh-so-cool tax wheezes. Tune into your own goals and values and build your plans from there. Not from the tax office rule book.This information is of general nature only and is not intended as a personal advice. It does not take into account your particular investment objectives, financial situation and needs. Before making a financial decision you should assess whether the advice is appropriate to your individual investment objectives, financial situation and particular needs. We recommend you consult a professional financial adviser who will assist you. As at the date of this article, Sara Lucas was a licensed professional financial adviser, an Authorised Representative of Fitzpatricks Dealer Group Pty Limited ABN 33 093 667 595 AFSL 247429 .