We are often told to make concessional contributions to superannuation to save tax and build your superannuation savings for a good retirement. However, does it make sense to make additional concessional contributions to superannuation if you still have non-deductible debt such as a home loan?
To answer this question, I will look at an example of a couple who are both earning an average income of $66,575.601 per annum. I’ll assume that they have an outstanding home loan of $400,000 at an interest rate of 3% with 16 years remaining on the term of the loan. All repayments are principle and interest made monthly. For the $400,000 owing to the bank, over the next 16 years they will actually pay back to the bank $504,141 via principle and interest repayments. However, these loan payments on a home loan are made with after tax dollars. Thus, they will need to earn $769,681 before tax in order to pay out their $400,000 home loan. In simple terms, they will need to earn $1.92 to pay each dollar of home loan debt outstanding today.
Now, what about the scenario where our couple make additional concessional contributions to their superannuation via salary sacrificing their income? The maths is easier with this scenario. If $1 of earned income is paid to their personal bank account, the tax man currently collects 34.5 cents in income tax and Medicare levy. That leaves 65.5 cents in their pocket. If they were to make concessional contributions to their super via salary sacrifice arrangement, the tax rate is only 15% on those contributions. Thus, the tax man gets 15 cents and they get to keep 85 cents in their superannuation fund to help build wealth for retirement. A good tax saving of 19.5 cents or 19.5% for this example.
Making additional concessional contributions to superannuation in this instance saves 19.5 cents in the dollar of earnt income. However, this couple still need to earn $1.92 before tax in order to pay off one dollar of home loan debt. If they do not make additional concessional contributions they have 65.5 cents left to pay down home loan debt via additional home loan repayments. Making the additional home loan payment with their after-tax income will save them in future principle interest loan repayments and pre-tax income that is needed to repay their non-deductible debt.
In summary, it can make more sense to focus on paying down your home loan first before you start to make additional contributions to superannuation. However, this will depend on your marginal tax rate, age and outstanding home loan balance. A good financial adviser who focuses on strategy will be able to help you determine what the most appropriate path for you to choose is.
1. AWOTE RBA Economic Snapshot July 2021
Read more from Andrew Zbik on the CreationWealth website.