Superannuation strategies

Could your mortgage boost your super?

October 2009
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Making additional contributions into your super might seem a stretch after you’ve met your day-to-day living expenses, and paying off quite possibly your most important asset – your home. There are ways however that you could essentially kill two birds with one stone by altering your home loan arrangements to potentially boost your super balance. The strategies outlined below aren’t for everyone, and careful consideration of your circumstances should be made before committing to any changes to your mortgage arrangements. Plum recommends that you seek financial advice to find a strategy that works for you. As a member of your corporate super fund you have access to Momentum Financial Advice. This service offers general advice over the phone, at no cost to you. You can also attend a face-to-face consultation with an adviser, who will assess your personal situation - the initial consultation, at no cost to you.1 If you would like further information on Momentum Financial Advice call a Plum Member Services Consultant on 1300 55 7586 who can put you in touch with an adviser directly.

Convert to an interest only home loan

Most banking institutions offer members the provision to switch their loans to interest only for a fixed period of time.

What are the benefits? They include:

• repayments are lower than a principal and interest loan; and
• stability of repayments makes budgeting easy (fixed interest only).

How does this strategy work?

An interest only loan requires you to repay the interest only and nothing off the principal. The interest rate can be variable or fixed and often the term is usually short, typically just one to five years. At the end of the loan period you still owe the full amount of the original loan.

Case study

Suzie is 50 years of age and earns a salary of $100,000 p.a. She wants to retire in 10 years. She has a home loan of $120,000 and is currently making the minimum principal and interest repayment of $1,393 per month over a 10 year term. She wants to make salary sacrifice super contributions. But she currently has no spare cashflow.

After speaking to her financial adviser, she decides to refinance her home loan into an interest only facility. As a result, her repayments drop from $1,393 to $700 per month and her surplus cashflow increases by $693 per month. She then decides to sacrifice the equivalent amount of pre-tax salary into her super fund – which is $1,146 per month.

As a result, she will salary sacrifice a total of $13,752 p.a. which, when added to the nine per cent super guarantee contributions she is receiving from her employer, means she will stay well within the reduced transitional concessional contribution cap of $50,000 for the first three years and the reduced ‘regular’ concessional contribution cap of $25,000 for the next seven years.

She continues to do this for 10 years until she retires. At that point she cashes out her super and repays her loan, which is still $120,000, as she has made interest-only repayments over the 10-year period. And because she is aged 60 at that time, she will pay no lump sum tax on her super withdrawal. By using this strategy, she will accumulate an additional $53,153 in super when compared to not using this strategy.

Potential issues to consider

Converting a home loan to interest-only and making additional salary sacrifice contributions can be a powerful strategy. But before you decide to do it, there are a range of issues you’ll need to consider. For example, the results from this strategy will depend on a range of factors, including your marginal tax rate, the interest rate on your home loan, the investment returns you earn from your super and your time horizon. There is a risk the Government could restrict access to lump sum withdrawals in the future. You may need to pay lump sum tax on your super if you withdraw before you reach age 60.

Assumptions: A 10-year comparison. Analysis uses the personal tax rates applying from 1/7/ 2009. Salary sacrifice contributions earn a total pre-tax return of eight per cent pa (split 3.5% income and 4.5 per cent growth). Investment income is franked at 30%. Home loan interest rate is seven per cent pa. All figures are after income tax of 15% in super, capital gains tax (including discounting), home loan interest and repayment of the loan. These rates are assumed to remain constant over the investment period.

Offset your home loan

If you have a home loan, you may want to deposit your salary in an offset account. An offset account is simply a transaction account that is linked to a home loan and the balance is directly offset against the loan amount before interest is calculated.

What are the benefits? These include:

• a reduced term on your loan;
• retaining access to your money; and
• earning a higher after-tax return than a cash account.

How does this strategy work?

If you put your salary in an offset account linked to your mortgage, you’ll effectively reduce the balance on which your home loan interest is calculated. This could enable you to make considerable investment savings and pay off your debt much faster.

Most offset accounts also provide ATM, cheque book and internet access and can be a great place to park funds to meet your living expenses.

Finally if you put your payments in an offset account you can potentially earn a higher after-tax return than a transaction account. This is because offset accounts effectively earn an after-tax return equivalent to the home loan interest rate.

Conversely, transaction accounts pay interest at lower rates and the earnings are taxable at your marginal tax rate (which could be up to 46.5 per cent*). A financial adviser can help you decide if using an offset account suits your circumstances.

* Includes a Medicare levy of 1.5 per cent.

Case study

Wendy, aged 45, has a mortgage of $300,000 and the interest rate is seven per cent. The remaining term is 15 years and she is making the minimum principal and interest repayment of $2,696 per month.

She has been made redundant after six years with her employer and will receive cash payments totalling $50,000 (after any applicable taxes are deducted). She will put the money in an offset account linked to her mortgage and will withdraw money as required to meet her living expenses.

What are the long-term benefits?

To illustrate the long-term impact that offsetting her mortgage could have, let’s assume Wendy starts another job in four months, and at that point has $30,000 left over after meeting her living expenses.

If she keeps the money in her offset account, she will pay off her home loan around two years and five months earlier than if she doesn’t use an offset account saving her $48,651 in interest in the process.

Assumptions: The home loan interest rate is 7 per cent and Wendy makes the minimum loan repayments of $2,696 per month over the entire loan period.

As a Plum member, you can access lending facilities through Momentum Loan Solutions. You can choose from a range of home loan providers including banks and non-bank lenders. Annual reviews are also part of the service to ensure your loan continues to meet your needs.

For more information or to access Momentum Loan Solutions, contact a Member Services Consultant on 1300 55 7586.