I’m often asked whether it’s best to pay off your mortgage first or salary sacrifice money into superannuation. With interest rates at a historical low and the average balanced super fund returning just under 10% in the 2013/14 year* it’s an important question.
The answer to this question is never the same; your age, your income and ability to take a disciplined approach to this strategy will all play a part in whether it’s right for you.
It’s not really a sacrifice
Salary sacrifice means arranging for your employer to pay part of your salary into superannuation instead of paying it to you in cash. It can be tax-effective because most of the personal income tax rates are higher than the 15% superannuation tax rate.
To explain, the table shows the difference for three people who invested $10,000. The top row is someone on the highest tax rate. They would have $3,400 extra invested – a whopping 66% more by using salary sacrifice. The other rows show people on lower tax rates – you can see all scenarios show more invested by “sacrificing”.
|Income||Marginal tax rate||Invested after tax||Invested by salary sacrifice||Difference|
* Includes 2% Temporary Budget Repair Levy on taxable incomes over $180,000 p.a.
Salary sacrifice is made even more attractive as superannuation payouts for people aged 60 and over are tax-free.
If your employer allows salary sacrificing, it’s best to have a chat with us before implementing this strategy. You need to be sure you will still have sufficient income for everyday living; you won’t need that money before you retire; and other employment conditions are not adversely affected.
Should I pay off the mortgage or pay more into super?
The easiest way to show the difference is by using a case study.
Consider Jess who earns $100,000 a year. She is aged 50 and plans to retire at age 60. Jess is worried about paying off her $175,000 mortgage. The mortgage interest rate is 7.5% and she is paying $25,495 a year so it will be paid off in ten years.
An alternative strategy is to pay interest only on the loan and salary sacrifice into superannuation so her disposable income remains the same. Jess’ accumulation in super will grow faster and she can pay the loan off when she retires. The table compares the cash flows of the two strategies.
|Pay mortgage||Maximise super|
|Tax and Medicare||$26,947||$18,974|
|After tax income||$73,053||$60,526|
With her current strategy she pays tax of $26,947 and has $47,558 left over after paying the mortgage.
As Jess is over 49 years of age she has a temporary upper limit of $35,000 on the amount of concessional contributions she can make into super. This includes the total of her employer’s Superannuation Guarantee contributions and any salary sacrifice amount.
Assuming Jess’ SG contributions are $9,500pa and she sacrifices an additional $20,500 from her salary, which is within the maximum allowed amount, and pays interest only on the mortgage, this is what she will achieve:
- She will have only $157 less disposable income but will pay $7,973 less tax.
- She will have $20,500 extra per year going into superannuation.
- The super fund will pay 15% tax so $17,425 will be invested. If the fund earns 7.5% per year after tax, her super will grow by an additional $246,000 in 10 years.
- When Jess retires at age 60 she can cash out $175,000 from her super tax-free to pay off the loan and be more than $71,000 ahead of her current strategy.
It is important to note that the outcomes for different people will vary, and will depend on such factors as interest rates and investment returns. To find out what will work best for you, give me a call for a chat.
*Chant West, 14 July 2014
Note: all tax calculations include Medicare levy of 2%