Nick Bruining: Transition to retirement a tax-effective hack to clear your mortgage before you retire

While your superannuation fund continues to generate double-digit returns, knocking off the mortgage seems counterintuitive.

“l can make more money investing than I would save by paying off my debts” is a common response.

Financial planners often face this argument, sometimes pushed by others who are trying to sell investment products to their clients, but more often when clients look at their continuing healthy super returns.

It’s all to do with the risk return trade-off.

As a starting point, your super returns are not a guaranteed outcome. The value of your super varies on a day-by-day basis. Sure, it’s been a while since the market has experienced a major downturn, but rest assured, the next one is coming.

Unfortunately, no one knows exactly when that will be, and to what degree. But when downturns do occur, they tend to be sudden and severe. If that just happens to be close to the time you plan to retire, then the money you earmarked to knock off the mortgage might not be there.

A super fund that’s benefited heavily from shares over the past few years could easily see a fall of 20 per cent or more in value overnight.

Your mortgage’s interest rate and monthly repayment is a rock-solid expense of 6 per cent-plus, and probably going higher in the next few weeks. If only your outstanding mortgage varied up and down each day like your super account balance.

Your mortgage interest also needs to be paid with after-tax money.

A better way to compare the two is to calculate what pre-tax investment interest rate you would need to generate to pay the after-tax amount, representing the interest component of your monthly mortgage repayment.

The same philosophy applies whether you are 36 or 66.

Let’s assume, for example, you are paying the bank 6.2 per cent a year on your mortgage and you earn $140,000 a year before tax. With the Medicare levy included, that puts you into the 39 per cent tax bracket.

To earn 6.2 per cent after tax to cover the mortgage interest costs, you’ll need to find an investment that pays 10.16 per cent a year. Anything paying anywhere near that rate of return is guaranteed to be ultra-high risk.

Paying off a non-tax deductible debt is always the most tax-efficient and safest way of using extra income.

As an alternative — and if you’re over 60 — you could use your super to start knocking off those non-tax deductible debts like a mortgage or car loan, even before you retire.

Using a technique called a “transition to retirement”, you can transfer most of your super into a special account-based pension fund.

These transition to retirement ABPs are funds that will pay you a completely tax-free payment from your super of up to 10 per cent of the account balance per year. Do this over a few years to knock off the mortgage, and you can then top up your super again with the money you used to pay off your mortgage.

Even better, these payments might also be tax-deductible concessional contributions to super — something your monthly mortgage payment never was.

And while it might be comforting to “keep the facility open” — in other words, have a small outstanding balance on the mortgage into retirement — think carefully.

If you have set things up correctly, there should be no need to borrow money in the future. Similarly, many banks have a not insignificant annual fixed charge they will continue to charge.

I have seen many retirees a few years down the track — and having paid out thousands of dollars in fixed “maintenance” fees — only to finally close off the mortgage having never used it.

Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association