Nick Bruining Q+A: The math behind why using superannuation to clear the mortgage works out

Question

Last week, you explained how to use superannuation to clear a mortgage.

When I explained this to my husband, he pointed out that we were making more money leaving the money in super, generating a return higher than the mortgage was costing us.

I am interested in your thoughts on this argument?

Answer

While not wanting to instigate a domestic dispute, there are some complicated yet important concepts to understand.

The recent good returns in super are due, mostly, to excellent share market increases. Repeatedly touching all-time highs, we have no real idea what happens next.

This introduces the very important concept of risk and return. That is, high returns on investments can only come with high risk. Scammers try to promise otherwise, but that is how the world works.

A share market correction would easily drag those spectacular returns into negative territory and your super would fall in value. A low-risk investment in super would generate a lower return than the cost of your mortgage.

An unexpected fall cannot happen with a mortgage. The balance of your mortgage only decreases because it has been repaid. There is no risk to the bank because it would simply sell your home if you defaulted on your mortgage.

There is no risk repaying the debt early, other than an opportunity risk achieved by exposing your money to higher-risk investments.

Your mortgage is probably costing you about 6 per cent a year, which you pay with after-tax money. If your income is up to $135,000, you are paying 32 per cent in tax and the Medicare levy.

To “match” the after-tax interest cost of the mortgage, the investment return you would need to “earn” is 8.82 per cent pre-tax, again high risk. Above $135,000 a year, the required pre-tax return could be as high as 11.32 per cent.

Of course with the mortgage repaid, the extra cash-flow could be redirected to superannuation.

Question

In last week’s Your Money, you explained how to use super to pay off a mortgage.

I am a 62-year-old member of an older Commonwealth super scheme and my wife, who is 61, has three funds. There is a sizeable employer scheme and a private super fund purchased through a former friend many years ago.

My wife stopped one of her part-time jobs late last year and has a small amount in that employer’s scheme.

My question is, which super fund should we use to start a transition to retirement strategy?

Answer

Your circumstances present options which you may not be aware of. I would be very reluctant to do anything that upsets your existing Commonwealth scheme. Older public service schemes typically offer a generous lifetime pension which would revert to your wife if you die before her.

As your wife “ceased gainful employment since reaching 60”, she has satisfied a condition of release, meaning she could access all of her super to pay off the mortgage. The freed-up cash flow from having no mortgage could then be redirected to her super to replenish the fund and gain a generous tax deduction as well.

As she is over 60 and these are taxed funds, no tax is payable on the withdrawal. Assuming life insurance is not an issue, there is no reason to hold multiple funds. She is almost certainly duplicating some fees holding multiple funds.

The older, private scheme might also have hefty fees attached to it, so you may decide to close that fund completely and apply the money to the mortgage.

Your wife could chose between the remaining funds but most employer schemes are generally low-fee anyway.

Other things to compare might be the historical returns over at least three years, but make sure you are comparing apples with apples. One fund’s high-growth option may be another fund’s balanced option.

Also see how much choice is available and how efficient the fund is at dealing with queries and changes.

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