The importance of a plan when paying off your home loan

The loan repayments are a form of compulsory saving; a well-located property should give you tax-free capital growth over the long term and when the house is paid off you will own an asset that gives you free rent for life.

If you are buying a home, a big question is how quickly you should pay that loan back.

The answer will depend on your own financial situation, but if you are serious about becoming financially independent your goal should be to get that debt under control as quickly as possible.

Because of the way compound interest works, the amount of interest you pay increases exponentially as time passes. Most loans are written over 30 years these days, to minimise the repayments, but it makes the interest cost horrendous. It's a good strategy to aim to pay that mortgage back in a 15 year term.

Think about two couples, aged 30 - I will call them the Browns and the Greens - who both borrow $400,000 at 5 per cent to buy their first home. The set loan repayments are $2147 a month over 30 years.

The Browns are not particularly interested in finances, so they plod along making the set monthly payments. After 30 years, when the loan is paid off, they would have made total payments of $773,000, including $373,000 of interest.

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The Greens are more financially aware and they focus on paying the loan back in 15 years. This requires them to make payments of $3163 a month.

Fast-forward 15 years: the Browns still owe $260,000 on their home, while the Greens are now free of debt. Because of their ongoing mortgage commitments there's not much the Browns can do to improve their position.

However, a new world of opportunity has opened up for the Greens. They are used to the financial discipline of paying $3163 a month, so they now start investing that $3163 into an index fund that matches the All Ordinaries Accumulation Index.

Fifteen more years pass and both couples have turned 60. The Browns have just made their final mortgage payment and have resigned themselves to retiring on the age pension.

The Greens, however, are set for a very comfortable retirement - their investment may now be worth $1.1 million and should be on track to reach $3.26 million in a further 10 years, when they turn 70.

Of course, this is just one of several strategies. Some people will prefer to slow down their mortgage repayments and focus on borrowing to invest in property or shares sooner rather than later. Others, especially if they are older, may be better off to salary sacrifice to the maximum.

The main point is that everybody who is serious about becoming financially independent should focus on optimising their finances at as early an age as possible.

It's like playing Monopoly - your goal is to get as many assets on the board as possible. Remember, because of the way compounding works, the highest growth comes at the end of the investment period. The quicker you start, the longer you will have to benefit from the miracle of compound interest.

Question

My wife and I are both 61 and effectively self-funded retirees. Can we move our accumulation super funds into pension mode and make additional lump sum contributions into the funds once a drawdown commences? Having done that are we still allowed to work occasionally once we start to draw the pension from our super fund?

Answer

You can certainly continue to make contributions to superannuation until age 75, but they cannot be made to a pension account. Therefore, you will need to have an accumulation account and a pension account inside your fund. This is a very common situation for many retirees.

There are no limitations on what work you can do irrespective of whether you are drawing an account-based pension are not.

Question

I am thinking of retiring at the end of the year as I will finish a contract role with not much prospect of extension. I will reach my preservation age of 59 in December. I am thinking of transferring my accumulation fund to an account based pension.

I have. $1,600,000 in my super account. I understand that withdrawals from super are tax free once I reach age 60. However If I draw an annual income of $80,000 from the fund before I turn 60 how much tax will I pay until I reach 60?

Answer

Until you reach 60 the pension income payments will be taxable at your marginal tax rate but you will be entitled to a rebate of 15 per cent which will reduce the tax.

If your super fund contains both taxable and non-taxable components, that proportion of the income stream which comes from the non-taxable component will be tax-free. For example, if your balance was $1.6 million which included $400,000 of non-taxable component, 25 per cent of your income stream would be tax-free.

Question

We both have binding nominations lodged with our super fund directing the full amount of our superannuation to each other on the death of either of us. My wife's accumulation account has a current balance of about $1.79 million and my accumulation account has a balance of about $1 million.

My understanding is anyone who has more than $1.7 million in super is not allowed to make any further contributions, age limits notwithstanding, but I am unsure if this applies to receiving a superannuation inheritance from your spouse.

If I was to die tomorrow and my binding nomination is to my wife, will the $1 million from my accumulation super account be allowed to go into my wife's superannuation fund tax free as she is over her general transfer balance cap of $1.7 million? If not what would her options be?

Answer

A binding nomination binds the trustee of your fund as to 'who" to pay in the event of your death, but not "how" to pay it. There are two payment options upon death.

The first involves your wife electing to receive a tax free lump sum as a death benefit. A death benefit cannot be rolled over into her accumulation account.

With the second option, your wife may elect to take the death benefit as an income stream, and the amount that can be taken in that way will then depend on whether your wife has used up, or not used up, her pension transfer balance cap, which is the maximum she can have in pension phase (currently between $1.6 to $1.7 million). This is quite complex and I suggest that you would benefit from seeking financial advice on this matter.

Question

Can you can explain to me the difference between positive and negative gearing and when each one is more suitable. We are looking at buying a rental property for our son to rent from us on the Gold Coast due to the high rents there. He has a disability so this would be a long-term plan as he will never be able to buy his own place.

We own our own home after downsizing and have a large sum in our bank doing nothing, but not enough to buy a property for him outright. We are in our early 50s and both work full time although one of our positions is only casual. Should we use all our money for the deposit or just what we need to and put what's left into superannuation? We don't really want to get a loan using our own home as equity as this feels unsafe.

Answer

The word "gearing" means to borrow. A property is positively geared when the net income exceeds the total outgoings, and is negatively geared if the net income is less than the outgoings.

If you intend to rent the unit to a family member and to claim the normal tax deductions that a rental property gives, the rent will need to be a fair market rent. It need not be a high market rent and may be discounted a little because of the strength of the tenant.

I think the best way to finance it would be to have a deposit which would be sufficient so that the net rents covered the outgoings. The property would then be "neutral" geared. There would still be some tax deductions available because outgoings such as depreciation a tax-deductible but do not require an outlay of cash. I assume you will leave the property to your son when you die.