Money
Why you SHOULDN'T pay off your mortgage before you retire
If retirement is less than 10 years away for you, Nicole Pederson-McKinnon has 2 very good reasons why your mortgage shouldn’t be your first priority right now.
By Nicole Pedersen-McKinnon
Are you busting your butt to obliterate the mortgage… so you can stop busting your butt and finally retire?
Because the common wisdom is that you need to pay off your mortgage before you stop working – a home to live in and money to live on is the recipe for retirement success.
Well, I dispute that you should pay off your mortgage first. In fact, retiring and then paying off your mortgage could help you bust out of debt far easier and cheaper.
What’s more, I don’t even advocate paying it entirely off…
Before we get into it, there’s an important caveat to my strategy: it only applies if you intend to retire in fewer than 10 years. If your retirement window is greater than that, this is probably not going to be the right approach for you.
But if retirement is less than 10 years away, here are 2 excellent reasons for retiring with a mortgage.
Reason 1: Keep flexibility and emergency access to money
The prospect of mortgage-freedom is so sweet you can probably almost taste it.
But if your loan term is not yet up, keeping just $1 of debt owing on your mortgage* should be even more delectable – because doing so means real freedom.
With a mortgage still active and accessible, you retain the ability to dip into the money: as a deposit if you suddenly decide to move somewhere new; to use for emergencies; even just to short-term fund a holiday.
You need – for safety – to keep your mortgage overpayments in an offset account, so you can get at them without your lender’s permission.
But here’s the thing about a mortgage: once you retire, and even in the years prior to that, you’re very unlikely to get approved for a new one. Banks value ‘earned’ income over all else… as in, earned via a job, not from investments.
Retaining it just gives you ultimate flexibility and fast access to cash, which you might later replenish from the sale of your house or other assets, or from your super.
So, forget any thoughts about a mortgage being psychologically uncomfortable – it’s seriously smart.
Think of it as an insurance policy for your lifestyle.
Reason 2: Clear your debt for less!
This is the part where keeping your mortgage alive becomes relevant only when you have 10 years or less until retirement.
With 10 or fewer working years left, you are close enough to getting at your super.
You are also far enough away from retirement to weather any fluctuations in the sharemarket if that super ends up needing to recover from a few bad years.
But drum roll please… the clear-your-debt-for-less strategy is to pay only your minimum required mortgage repayments then shovel any extra payments you were intending to make straight into super.
Money you pay into super in this way (called a concessional contribution) is before tax – instead of the money being taxed at your marginal tax rate, you pay 15 percent in contributions tax. (You can now put in up to $30,000 a year but are also able to ‘mop-up’ any unused allowances going back five years.)
Meanwhile, for every $1 extra you put into your mortgage, you’ve already lost up to 47c in the dollar (depending on your marginal tax rate of potentially up to 47 percent).
The bottom line is that super is pre-tax and your mortgage is post-tax, and the maths very-much favours putting money into super rather than into your mortgage. Think of it as being able to save 85c into your super versus 53c onto your mortgage. You can see how quickly the super-strategy adds up…
Of course, the risk you run is getting poor super returns, rather than the guaranteed ‘pay off’ of repaying your mortgage. But with super, because of the initial tax perks, you start way ahead anyway.
And with 10 or fewer years until you can get your money at retirement, you could imminently simply withdraw a chunk of your super tax-free – which has also grown in a tax-advantaged environment – to pay off your mortgage.
So, the key is to (almost - see above!) pay off your mortgage just after you retire.
But what about the other part of the successful retirement equation: having enough money to live on?
The income side of retirement
The Association of Superannuation Funds of Australia calculates what this would set you back on a weekly and annual basis, and updates these figures quarterly.
The current annual cost of a comfy retirement is $52,085 for a single person and $73,337 for a couple. Weekly that is $998 and $1,405, respectively.
A ‘modest’ retirement is costed out too, but let’s not aim there as what it affords is not much by comparison… for example, forget dinners out or much of an annual holiday, or anything fun, really…
(As an important side note, there are also some unappreciated benefits of renting in retirement, so do read that one, too.)
Vitally, these calculations assume you have paid off your mortgage (to be clear, owing $1 won’t matter!). So, in order to meet these figures, you’d need to have either paid off your mortgage prior to retirement, or used a portion of your super to pay it off after.
However, whether or not you use your super to make it easier to pay off your mortgage, there is still a way to use your home to take your super stratospheric…
Take the super strategy stratospheric
As a way of encouraging Baby Boomers and Gen X-ers into downsizing and freeing up some properties to fix the housing crisis, several years ago the government introduced a ‘super’-sized incentive.
Each individual can contribute up to $300,000 into superannuation from the sale of their primary residence.
That means if you sell a house and move into a unit as you approach retirement, with a mortgage paid off or not, you could drop a lazy $300,000 into your super fund… and up to three years’ worth of non-concessional contributions at $120,000 per year. (Note that both members of a couple could do this, if there were enough money left over from the sale and repurchase.)
So your super would be turbocharged, tax-free, by $660,000. Remember, investment returns are taxed favourably in the super accumulation phase (at only 15 percent) and not at all in the pension phase (when you can also withdraw money tax-free from the tax-free component).
Of course, you have to be happy to downsize but – if you are – know that the system is loaded in favour of doing so.
Super is a powerful way to either pay off your home more cheaply or shelter the proceeds of its sale in a lovely little tax haven. Or both.
* You don’t even need to keep $1 owing on your mortgage if you make your extra repayments into an offset account; you can simply fill up the offset account until it equals the loan balance. You won’t pay a cent more in interest as your net debt is $0; you will have to still make your minimum loan repayments but can just take these from the full offset account, as they become due. This is what I did and I’ve written the book on it – How to Get Mortgage-Free Like Me.
Feature image: iStock
Nicole Pedersen-McKinnon is the author of How to Get Mortgage-Free Like Me, available at www.nicolessmartmoney.com. Follow Nicole on Facebook, Twitter and Instagram.
This article reflects the views and experience of the author and not necessarily the views of Citro. It contains general information only and is not intended to influence readers’ decisions about any financial products or investments. Readers’ personal circumstances have not been taken into account and they should always seek their own professional financial and taxation advice that takes into account their personal circumstances before making any financial decisions.
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