NAME: Paul and Leanne Lynch
STATUS: Married with a four-year-old daughter, Matilda.
QUESTIONS: We are paying off our mortgage and building up our superannuation – are we on the right path? Should we also look to invest in property, buy a holiday house or perhaps borrow to invest in shares?
ANSWERS: Reduce the mortgage quickly and pay it off by the time Leanne retires. Fix part of your home loan to interest only. Consider using the equity in your home to buy other properties. Forget about buying a holiday home and opt for renting one.
With the rules about contributions to superannuation changing, it is a perfect time to ask the question about whether to pump up your retirement savings or pay off the mortgage.
The government is cutting the concessional contribution cap from $30,000 ($35,000 for the over 50s) to $25,000 from July 1, making it harder for people to build up their super balances through tax-effective salary sacrificing (15% compared with a marginal rate up to 49%).
Weighing up between super or the mortgage is Paul and Leanne’s main question. They are building their dream home in an idyllic spot on the NSW Central Coast and their philosophy is to pay off the mortgage as quickly as possible. They are almost at the halfway point and ideally they want zero debt in the next 10 to 12 years.
At the same time they have their eye on the future and want to boost their super so that they have enough to do all the things they have dreamt about, such as travel widely. They both salary sacrifice but with lower contribution rates boosting low balances later will be harder. While they plan to retire from full-time work, they are happy to work part-time if necessary.
Are they on the right path or should they concentrate on the mortgage while rates are low? They have a mortgage with variable interest rates. Should they lock in at these low rates?
Is it a good financial move to have a holiday home in retirement? Paul and Leanne would love to get a unit at Shoal Bay, their favourite part of the NSW coast. A one-bedroom apartment costs around $350,000, rising to $500,000 for two bedrooms.
Would this be a sensible investment now, in the hope that it would be paid off by the time Paul retires, or would it be better to borrow and invest in shares, using the balance to purchase a holiday apartment once Paul retires?
Unlock equity to invest in property, says Margaret Lomas, founder and director of Destiny Financial Solutions and bestselling author of property investment books
I’m glad that you are looking to the future and asking some really valid questions.
There is a 10-year age gap between the two of you and at this stage I’d like to see Leanne investing more into super than Paul. Uncertainty about future legislative changes isn’t really a reason to hold back, and Leanne’s time frame is reducing.
If she can afford the maximum contributions, it’s a good idea to make them, as she will reach the age where she can access these contributions while Paul is likely to be still working and not needing to access his own super.
He has a good 20 years to go and his strategy could be to contribute more to the extra repayments on the mortgage, rather than those extra super contributions just yet. It’s definitely a great time to be doing that – while rates are still so low, more of your repayment can be paying off the principal.
If you can have this paid off within the 10-year mark, the repayment amount can then be diverted to Paul’s super about the same time that Leanne would be drawing down hers.
In reducing the mortgage, the equity in the family home is being increased, even without growth in the market.
While you’re both working, I feel that it is a great time to unlock that equity by leveraging against it into some strong property investments, which have the capacity to grow in the short term.
The dual income puts you in a great position to borrow, and the right investment properties will improve your net worth, which must happen now as I don’t count your own home as being an asset, since you have to live in something.
Which brings me to my final point. Investing in a holiday home is the bad idea in a bunch of pretty good ones.
The areas where most people like to holiday rarely have strong growth drivers, and even if you can get enough rent to cover its costs, a holiday home is unlikely to grow well enough to add to your net worth.
Most people use the excuse of “investing” to get into a holiday home that they can use now but it’s rarely a good idea and can have negative tax implications if you use it yourself.
You’re far better building a nice little portfolio of, say, six to eight properties (which you can actually do now given the level of equity you have) that all grow well and improve your asset base, and later sell one to swap it for the holiday home you desire.
This portfolio of properties can then sit untouched all the way until Paul retires, as it’s likely that his wage, combined with Leanne’s super drawdown, would be enough to cover personal expenses that no longer need to support a personal mortgage once Leanne is out of the workforce.
Then when Paul is ready to retire, there should be a good amount in his super plus a portfolio of properties that has had 20 years to grow, at which time you can either continue to hold and live off the rents or sell each as you need to get at the money they have made for you.
Get rid of the ‘bad’ debt first, says Claire McKay, director of Quantum Financial, and a qualified chartered accountant, self-managed super fund expert and lawyer
You are definitely on the right path by taking control of your retirement plans now while time is on your side.
Reduce that mortgage
For most clients the best strategy is to focus with religious-like zeal on reducing the mortgage as soon as possible. You know with certainty that you have to pay interest on this debt and that the debt is bad (that is, non-tax-deductible).
Reducing the mortgage will take a huge financial load off your shoulders in retirement, and provide certainty and opportunity.
Try to push yourselves to pay off your mortgage well before Leanne retires, as this will put you in a great position in the years before retirement.
Locking in an interest rate is always a bit of a gamble when rates are decreasing but it gives you certainty when they are increasing.
Comparing the variable and fixed rates gives you an idea if banks think interest rates will move. Lock in some of your debt and leave some variable – this can be a good way to hedge your bets.
Turbocharge your savings
It is great that you each salary sacrifice to your retirement savings in a tax-effective manner. Assuming you continue to do this, with 5% annual growth in super and 9.5% compulsory contributions you should have combined super of just under $2 million when Leanne intends to retire aged 65.
If over time you hit the new $25,000 concessional cap, consider making personal (or non-concessional) contributions as a top-up. Once you have paid off your mortgage, then you can consider making additional contributions to super or investing outside super.
Review your super
You both have accounts with NGS, a reputable low-cost industry fund. Check to see if it offers any low-cost insurance to protect your family while you still have debt and Matilda is young.
Leanne is in the relatively safe balanced option. Given her super will be invested for at least another 13 to 14 years before retirement, she may consider the growth option.
If you pay off your mortgage earlier than expected, well before Leanne’s retirement, then consider investing outside super.
While a holiday home sounds wonderful, in retirement you need a portfolio of assets that gives you a tax-effective income stream to support your dream lifestyle.
A holiday home needs to be managed and rented year round and will regularly need maintenance and improvement. It may be cheaper to factor the cost of renting a holiday house in your budget each year.
You have the basis for a sound financial plan that will give you security and support your dream retirement. With a few tweaks I’m confident that you’ll be celebrating the rewards of all your hard work!
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