A major part of pre-retirement planning is focused on growing or increasing retirement savings using available cash flow. Two of the main ways to do this include paying down debt, or contributing to superannuation. To compare these properly we need to look at all of the factors that will affect this decision, such as:
- The interest rate on your debt. Your home loan is likely to only be around 4-5% at the moment, while a credit card could be up to 20%.
- Your marginal tax rate i.e. the rate of income tax you pay on the top portion of your income. For example, if you earn over $90,000 p.a., your marginal tax rate will be 39%. If you only earn $30,000 p.a., your marginal tax rate will be 19%.
- Whether the interest on the debt is tax deductible.
- How much can you contribute to super under your concessional contributions cap. This is $25,000 each year at the moment, and includes your employer contributions. For example, if you receive 9.5% contributions on gross income of $100,000, you will receive $9,500, and as such will be able to contribute an additional $15,500 from before tax income and stay under this cap.
- What is the expected return on investment of your superannuation fund. This will be dependent on the mix of assets you hold inside super e.g. cash, shares, property.
As a rough guideline, you are more likely to be better off paying down debt if one or more of the below is true:
- The interest rate is high
- The debt is not tax deductible
- Your marginal tax rate is low
- You have already maximised your before tax contributions to super
Written by Dallas Davison.
