Australia’s economic situation has changed dramatically in recent times and you’d be forgiven for wondering how to put your money to best use. If you have surplus cash, you will no doubt be considering whether repaying debt, contributing to super or building your investment portfolio is right for you. Tax will also be a significant consideration for high income earners in the mining and resources sector.
Taking an overall approach to wealth accumulation may provide better financial outcomes than focussing on one particular aspect of your financial life and be more suited to adapting to ongoing economic fluctuations and changes in your personal circumstances.
Repay Debt v Contribute to Super
When you pay down private debt you use after-tax money. For mining and resources high-earners with incomes over $200k pa, this generally means a marginal tax rate of 47% (inclusive of 2% Medicare Levy).
For an income of $200k your super guarantee payment at the current rate of 9.5% is approximately $19,000. This provides opportunity for using $6,000 of surplus income to top up your concessional contributions to the $25,000 cap limit. Used in this way, your surplus will be taxed at just 15%.
Scenario #1: Paying down home loan debt
At the marginal tax rate of 47%, income of $6,000 is approximately $3,180 after tax or $265 per month for you to reduce your debt.
Scenario #2: Contributing to super
*The above examples do not include any potential additional tax from division 293A.
For younger people who are many years from retirement and who can both comfortably manage their home loan and additional contributions to super, there is opportunity to enjoy a valuable tax savings boost to super and benefit from compounding interest over the years.
Now, here’s the trade-off.
You won’t be able to retrieve your money from super should you need the extra cash. If having access to cash is a priority, then paying surplus income to a home loan offset account rather than directly to your home loan or super would likely be your solution.
An offset account is linked to, but separate from, your home loan and works to ‘off set’ interest payable on the home loan balance, while providing the flexibility for you to access cash if required.
As discussed in our earlier article “Home loan redraw or offset account? ”, the key benefit is flexibility. For example, funds may be accessed from the offset to purchase a new home when the existing home is retained as an investment property. The existing loan becomes tax deductible. Whereas funds redrawn using a loan redraw facility for the same purchase, are not tax deductible.
Repay Debt v Invest
Record low interest rates for those with a home loan are a boon, but for those with money sitting in a savings account, it’s nothing but gloom.
Reducing your home loan debt reduces your risk, however increasing your debt to take advantage of the low capital cost of money and using it for to invest in shares that could return 7% or 8% in returns, may be worth considering rather than using cash to invest.
Home owners in a strong low net debt position or with a large amount of surplus cash in an offset account have additional opportunities from a tax position. If for example you were considering using cash to invest, a separate loan account against the house could be established (rather than using the same home loan or cash). Using it for tax deductible investments such as purchasing an investment property allows you to claim a tax deduction for interest on the new loan.
To illustrate this example, let’s consider Jill who has a home loan with $400,000 owing and $300,000 in an offset account. She is considering investing $50,000 of her surplus cash over the next 12 months. Rather than using the cash to invest, she could increase the facility limit by $50,000 on her home loan and establish a $50,000 loan “2” account on her home and use that to invest. The interest on loan “2” is tax deductible as it is used for an investment purpose. Jill is then free to add surplus cash to the offset account. At the end of the year, she will have $350,000 in offset to her $400,000 non tax-deductible home loan with $50,000 drawn from loan “2” which is tax-deductible. As opposed to $300,000 in an offset account and an equivalent $50,000 investment, which has no tax-deductible debt.
Here’s the trade-off.
The trade-off in this situation is that borrowing extra money or drawing surplus funds from your home loan redraw facility or offset account will increase your risk. There are no guarantees when it comes to return on your investment. Market volatility is an expectation and there will be times of negative return.
History shows, playing the long game has resulted in general upward trends, however personal circumstances and the need for ready access to cash, must also be considered carefully when investing.
Your next steps
Your first step is simply to commit to taking action so your money is put to the best possible use for your situation.
Consider your short and long-term goals which may include your lifestyle needs, when you plan to retire, and your approach to home ownership in context of your career which may include the need for future relocation. Consider your tax position. Are you paying the highest tax rates, and would you rather be the beneficiary of your labour than the Tax Office? If you have surplus money sitting in a low interest savings account, then it’s time to get advice on the best options for your circumstances.
To discuss your personal needs, the risks you’re willing to take and the upsides and downsides of this balancing act between debt, super and investment options, please contact Brett Cribb on (07) 3007 2000 or email@example.com to determine your next move.
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Stratus Financial Group and its advisers are Authorised Representatives of Fortnum Private Wealth ABN 54 139 889 535 AFSL 357306. This information does not consider your personal circumstances and is of a general nature only. You should not act on it without first obtaining professional financial advice specific to your circumstances.
*Please note: As advice and services relating to this matter are not offered under the Fortnum Private Wealth AFSL, in accordance with our collaborative advice model, when required, such matters are referred to appropriately qualified professionals.