If you have a couple of thousand dollars surplus cash each month, what is the most effective way to invest it?
You could invest in the share market, repay your mortgage(s) or invest in property.
But there’s another strategy that might be particularly more attractive, especially since mortgage interest rates are ridiculously low at the moment.
You may not want to repay debt or invest in shares or property
It certainly doesn’t cost a lot of cash flow to borrow to invest in a residential property at the moment. However, it is difficult to buy an investment-grade property for less than $600,000, which means you need to borrow a relatively large amount of money. If you already own some direct property, you may not feel comfortable borrowing this amount of money.
Repaying debt at the moment might only save you 3% p.a. in interest costs, which isn’t terrible, but it’s hardly a big return on your investment.
And of course, you could invest your cash flow in shares in your personal name or family trust. But if you are relatively close to retirement (within 10-15 years), investing inside super could be a lot more tax effective.
So, what about borrowing to fund additional contribute into super?
First, let me clarify how you can contribute money into super.
What is a non-concessional contribution?
There are two types of super contributions being ‘concessional’ and ‘non-concessional’.
Concessional contributions are more commonly utilised because these contributions are made pre-tax i.e. you receive an income tax deduction for them. You can make concessional contributions via salary sacrifice or by making a personal contribution into your super account. These contributions are taxed inside super at a flat rate of 15%.
Non-concessional contributions are after-tax contributions i.e. they do not affect your income tax position (no tax deduction). As such, they do not attract any superannuation taxes either (no contribution tax).
If your super balance is less than $1.4 million at the beginning of the financial year, you can make non-concessional contributions of up to $100,000 per year. Alternatively, you can bring forward 3 years of contributions into one i.e. contribute $300,000 in one year and nil for the following 2 years.
Borrowing to make non-concessional contributions isn’t normally a good idea
If you borrow to make a non-concessional contribution into super, the interest in respect to the loan is not tax deductible. This makes it an expensive strategy when interest rates are higher than they are today, and therefore rarely worthwhile.
However, with interest rates so low today, I thought I would consider whether borrowing to make non-concessional contributions is an attractive strategy.
My financial analysis
Assuming an investor has a surplus cash flow of $2,000 per month, they could borrow $200,000 today and contribute the full amount into super (i.e. make a non-concessional contribution). They could then direct their monthly surplus cash flow of $2,000 towards repaying this loan. The loan would be fully repaid within 10 years.
As noted above, interest charged in respect to this loan will not be tax deductible.
I have assumed the investor fixes their interest rate for 5 years at 3% p.a. After the 5-
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IMPORTANT: This podcast provides general information about finance, taxes, and credit. This means that the content does not consider your specific objectives, financial situation, or needs. It is crucial for you to assess whether the information is suitable for your circumstances before taking any actions based on it. If you find yourself uncertain about the relevance or your specific needs, it is advisable to seek advice from a licensed and trustworthy professional.
