Into super or into your home?

SUMMARY: Into your super or into your home? Where do you plough excess savings?

Something left over after all the bills are paid is generally the aim of the game.

It happens too rarely, to too few. The reality is, for most, where excess savings exist, expenditure rises to meet the challenge.

But for those who deliberately achieve excess savings, to create choices, the next concern is usually how best to deal with it.

The three main options are: Paying down the home loan faster; tipping extra into super; or straight non-super investment.

All involve an opportunity cost. But it’s the size of the opportunity cost, relative to your situation, that is where the difficulty in making the right decision lies.

Sometimes it is a function of how much excess there actually is. If there is a significant sum, then a portion into all three can make sense. Sometimes it is about age. Dumping too much into super too young is to assume that you won’t need the money before retirement. Sometimes it is about restrictions, such as the $25,000 concessional contribution limits for super.

For today, I’m going to pay most attention to the battle between ploughing money into home, versus into super. (Investing outside of super is something that should be done, consistently, throughout life.)

So what do you do based on your age?

Approaching retirement (55+):

The tax savings are immediate and considerable, in that you’re potentially swapping a high marginal tax rate for 15% contributions tax on putting money into super. And because super is within your grasp, anything you put in is only years, not decades, from being returned to you.

It is a time also, where people, particularly the self-employed, are often earning the most money.

If you are now earning in excess of $200,000 a year as an employee, the ability to get extra money into super is limited. If your boss is tipping in 9.5% ($19,000 a year), then you are limited to getting another $6000 into super in this financial year.

And if you’ve got excess savings at this point, putting an extra $6000 into super is a near no-brainer – you’re swapping a 47% tax rate for 15%, leaving an extra 32% not being taxed into your fast approaching retirement.

(For today, I’m going to ignore the Division 293 tax that sees those earning more than $250,000 a year being taxed at 30% of super contributions.)

The real questions come for those earning lower amounts, around $70,000 to $150,000.

Getting extra money into super can be a great idea, depending on how much spare there is, often up to the $25,000 concessional contribution limit.

If you’re earning $100,000 a year and can get an extra $15,000 into super (instead of taking it at your marginal tax rate of 39%), then you are saving tax at around $3600 a year into your super (versus your marginal tax rate).

Do that for 10 years before retirement and you have $36,000 extra to use, potentially to pay off the mortgage, plus whatever it has earned over that period, also earned at the low tax rate of 15%.

Another potential option is ploughing extra into the home. Extra money paid off the home mortgage itself is a guaranteed 4% (or whatever your home loan rate is), after-tax, saving each year, as savings in home offset or redraw are not taxed as income.

Unless there is a market crash, it would be hard for that tax-free 4% to beat the tax savings from salary sacrificing into super.

Another short-term bang-for-buck option is to consider the effect of spending extra money on your home. Particularly for those who are considering downsizing in the short term.

If you have an extra $50,000, for example, that you can put into your home for quick fixes that will add $100,000 to your home, then this can also be worthwhile.

Strong note: Not every dollar you spend on your home is going to deliver two dollars worth of capital uplift. And most people won’t have the skill to know what will, and won’t, add more bang for the buck when it comes to renovations. But for some targetted spending, particularly for those about to sell for a CGT-free profit, it can be worthwhile. (Local real estate agents can be useful here.)

We’re still waiting for the detail on the $300,000 top-up to super for downsizers. I wouldn’t plan on that being a great deal. And it will only apply to those who are over 65 in any case.

Middle-age (40-55):

You’re in your home. Perhaps your second one. The mortgage is still considerable. And super still seems a long way off.

Higher income earners still need to have a strong priority towards pumping concessional contributions into super. Unlike previous generations, getting money into super for this generation is going to be harder than it ever has been for this age cohort.

If maxing out your CCs is only going to allow you to get another $5000 to $10,000 into super, then this should be an early consideration. Big income increases from here could mean that it eventually becomes marginal (if you’re in super surcharge territory of 30% super contributions tax) to put further money into super.

Reducing the mortgage is going to be high on the priority list. Even if that is pushing extra money into the redraw account, where it remains available to pay school fees, or to withdraw for other investment. (But it’s saving you a guaranteed and tax-free 4% in the meantime.)

A bigger home is also likely during these years, so too much money put into super is money that can’t be used to help pay down that second, large, mortgage.

But, as a reader told me on my 40^th birthday, “your 40s is when you make it”. She was talking about the big investments in your life being made during your 40s. Investment in shares and property, in your own business, in taking some investment risk, during this period when your income is at its highest, on average, according to the Australian Bureau of Statistics.

Youth (under 40):

This is generally the period of either saving up to earn your first monster mortgage, or having achieved that goal and now struggling under its weight.

Perhaps, for some in their late 30s, you might have started to get it under control a little and be looking at what’s next.

What’s next, absolutely, must include some sort of action for getting more money into super. Your parents generation could shovel money into super once they hit 50, when the kids were off their hands and their own mortgages were paid down. This generation will only be able to put it in by the teaspoon.

So, sacrificing a little extra now, even if you’d rather be putting extra into paying down the mortgage, is critical. Because there will come a point later in your life where you want to, but won’t be able to.

If you’ve got capacity, as a couple, to do something with, say, spare savings of $30,000 a year … then a portion of that, even $5000 or $10,000 needs to go into super, preferably salary sacrificed for the tax savings.

The remainder should be split between two areas. First, getting ahead on your mortgage, so you’ve got a good-sized sum of savings in your redraw account to pay for this expensive period of your life (assuming you have kids). And second, starting your own, proper, investment plan outside of super (largely property and/or shares).

For those saving for their first home, we’re waiting to see the detail on the First Home Super Saver Scheme. And until we see something concrete, I wouldn’t be putting any money anywhere near here. Just wait.

Bank those savings:

For those with the willpower to not spend every cent they earn (and possibly more), making the decisions on how to invest that capacity is what will give you the power to create a real difference to your retirement.

The above points out the rough considerations that might be taken into account at the various age groups. But sit down with a sophisticated financial adviser, who can take you through the processes and benefits, to make sure that you’ve mapped out a plan that will work best for you.

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The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is managing director of Bruce Brammall Financial and is both a licensed financial adviser and mortgage broker. E: bruce@brucebrammallfinancial.com.au . Bruce’s new book, Mortgages Made Easy, is available now.