Wealth creation using superannuation – a case study

Back in the days of “normal” interest rates the simple answer to the question “what do I do with any surplus savings?” was “pay off debt”. That’s still a sound strategy for anyone paying high rates of interest on credit cards or personal loans.

But if your only debt is your mortgage, and if mortgage interest rates are at the lowest they’ve ever been, does paying it off more quickly provide a good bang for your buck? And if not, what are the alternatives?

A superannuation vs mortgage case study

Trish is a 55-year-old senior manager and following a pay rise she estimates that she will be able to commit $1,000 per month of her pre-tax income to building her wealth.

She has a mortgage on her home that has 15 years to run. With an outstanding balance of $220,000, an interest rate of 2.25% p.a. and monthly payments of $1,441, Trish examines the outcome of following the traditional advice of adding her new savings capacity to her monthly home loan repayments.

But how much can she really save? Her marginal tax rate is 39%, including the Medicare levy, so after the tax office takes its bit Trish is left with just $610 per month to add to her current mortgage repayments. Even so, that’s enough to see her home loan paid off in 10 years, allowing her to retire debt-free at her preferred retirement age of 65. Knocking five years off her loan will save her a lot of interest, but is there a better alternative?

A super idea

Trish examines the option of letting the home loan take care of itself for a while and to exploit some of the wealth creation opportunities offered by superannuation.

Under a salary sacrifice arrangement, Trish could contribute $1,000 of her pre-tax income to her super fund. The tax office will still take its cut, but at just 15% Trish will be left with $850 per month to actually invest. That’s a handy boost right there.

Then there’s the investment return. Paying down her mortgage provides Trish with an effective investment return on her after-tax savings of 2.25% p.a. With ten years to go until her preferred retirement date, it’s appropriate for Trish to invest her super in a balanced or balanced-growth portfolio with good expectations of significantly higher returns. So let’s see how things turn out if Trish’s super fund achieves a net return of 6% p.a. after fees and tax.

First, the mortgage: after ticking along with minimum payments of principal and interest for ten years it still has an outstanding balance of $81,712 – hardly the debt-free status that Trish was aiming for. But what about the super savings strategy? Due to the combination of tax advantages, higher returns and the power of compounding interest, Trish’s super fund is worth $139,297 more than it would have been if she had opted for the pay down debt strategy. After withdrawing $81,712 tax-free from the fund and paying out her mortgage, Trish is $57,585 better off under the super strategy.

Balancing risk

While delivering lower returns during times of low-interest rates, paying down debt does provide an effectively risk-free return equivalent to the interest rate. Trish’s super strategy comes with a higher level of pure investment risk, and it is important that she is comfortable with the ups and downs that balanced and growth funds are likely to experience.

It’s also important to recognise that our situations are all unique. The same strategy won’t suit everyone, so make sure you speak to your financial advisor about designing a savings strategy that’s right for you.

More like this

If you like this article, you might be interested to know that we share useful thoughts and information like this in our monthly financial insights email. You can subscribe to that email here. All subscribers receive a copy of our e-book: The 5 Key Pillars of Financial Independence.

General Advice Disclaimer

This article contains general advice only, which has been prepared without taking into account the objectives, financial situation or needs of any person. You should, therefore, consider the appropriateness of the information in light of your own objectives, financial situation or needs and read all relevant Product Disclosure Statements before acting on the information. Whilst every care has been taken to ensure the accuracy of the material, Paradigm Strategic Planning or Sentry Advice Pty Ltd will not bear responsibility or liability for any action taken by any person, persons or organisation on the purported basis of information contained herein. Without limiting the generality of the foregoing, no person, persons or organisation should invest monies or take action on reliance of the material contained herein but instead should satisfy themselves independently of the appropriateness of such action.

Paradigm Strategic Planning Pty Ltd is an Authorised Representative of Sentry Advice Pty Ltd AFSL 227748

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top