Just as most Olympians work and struggle with the goal of achieving gold on the international stage, so it is with ordinary Australians in their quest for retirement gold. The 2 big retirement goals most of us have - retire with enough wealth to support your desired retirement lifestyle and retire debt-free. Sometimes it may seem that these two goals conflict - i.e. if I have an extra $500 a month is it best to go onto the mortgage or should I salary sacrifice it into super? - Let's shed some light on this question.
But first up, we should try as best as possible to compare apples with apples. Within your super fund you will probably have an extensive range of investment choices (Australian shares, balanced fund, cash, etc). Your mortgage, however, goes into the one account and is effectively a negative to a risk-free liability (i.e. When you give the bank $10, your liability is reduced by $10 and there's no real chance at all that this won't be the case). Thus mortgage principle repayments are effectively a risk-free asset. The only comparable asset in super would be cash. So for our comparison it would be appropriate to assume that any monies going into super are invested 100% in cash. Also, we will only be referring to a mortgage attributable to your principle residence (i.e. not investment property loans - a whole different story). So let's now look at some of the key areas of difference between the two.
CONTRIBUTIONS TAX
Super has a contributions tax. It is currently 15% for any deductible contributions (including employer mandated contributions, salary sacrifice contributions, etc). But does money going into your mortgage have a contributions tax. Not directly, but if the source of your money is from taxable income, any money going onto your mortgage will effectively be taxed at your marginal tax rate before it pays down your home loan. This could be up to 46.5%, but is generally around 34%-38.5% (incl. Medicare Levy). That is a big jump from the 15% tax to put money into super and is the big reason for super to be considered.
NET EARNINGS RATE
When you put money into your superannuation fund's cash option you generally earn somewhere around the RBA's official cash rate, less admin fees. Some funds do give you access to higher bank rates through term deposits and the like, but they generally have higher admin fees. Also, earnings are taxed at 15% in super. The net earnings rate (rate less fees and taxes) can tend to be rather subdued and a little lower than what you'd get in a bank's savings account (which usually is fee-free). But your mortgage doesn't earn any money does it? Well not directly, but effectively it does. It earns the rate of your mortgage. Why? Because, the interest you owe every month is calculated on the total amount you owe, which if you make an extra repayment means that you have saved (read: earned) interest at your mortgage rate. And most extra repayments can be made fee-free. Also, the interest saved (earned) through extra mortgage repayments is not taxable. As mortgage rates are generally above cash rates, the mortgage wins out when comparing net earnings rates.The results change when super is invested and achieves higher returns. At current morgage rates, the crossover (or breakeven) rate of return for the average taxpayer is around 5% pre-tax returns in super.
ACCESSABILITY
As you know, once you put money into super, there it shall stay until retirement is achieved (in general). This could mean some will have to wait over 40 years before being able to touch their retirement savings. An early repayment onto your mortgage, however, does not need to have this same restriction, though depending on the bank and repayment type their may be some redraw restrictions imposed. So in regards to accessability, the mortgage does win out again.
INVESTMENT FLEXIBILITY
For a fair comparison between super and a mortgage we've looked at super investment into cash options only. However, one big difference between putting money onto your mortgage as opposed to contributing into your super fund is the question of investment flexibility. Your mortgage account will only earn the effective rate of your mortgage interest rate and is thus effectively invested 100% in cash. You do have the ability to perhaps reborrow to invest in other asset classes, but this may not always be the possible. You superannuation does not have this same predicament, with most super funds allowing switches between different securities and asset classes in a quite fluid and easy manner.
CAVEATS
Two big things to consider before even wondering which option may be best for you is contribution limits and early repayment penalties. If you are already close to maximising your deductible super contributions of $25,000 (current level) than there's no real point in figuring out which option may be most worthwhile as the super question is virtually off the table. Also, if you have a fixed or otherwise restrictive home loan, you may not be able to put much more onto your mortgage anyway.
Like with most investment decisions, diversification can be a useful ally. So instead of choosing between the two and putting all of your eggs into the one proverbial basket, perhaps you would be best suited to considering a measured and balanced approach. Super or Mortgage... perhaps for you it will be Super AND Mortgage.