05 Dec First priority: pay down non-deductible debt
We are often asked by clients whether it’s more important to reduce non-deductible debt or whether building wealth and investments outside of the family home is more beneficial. The most common compromise to paying off non-deductible debt is making concessional super contributions instead.
What’s the most common non-deductible debt?
Personal home loans are a form of non-deductible debt and probably the most common debt. Non-deductible debt makes wealth creation difficult. A person paying tax at 47% (including medicare levy), with a home loan of $500,000 charging 4% interest, must earn $37,736 before tax just to pay the interest of $20,000 after tax. Looked at another way, paying off non-deductible debt achieves the equivalent of a 7.5% pre-tax return. As a guaranteed return on investment 7.5% is pretty good.
Stay ahead of the game
Because of its expense, reducing non-deductible debt should be step 1, 2 and 3 of any serious wealth creation strategy. Despite that, many clients do not think to prioritise the repayment of non-deductible debt. Reducing non-deductible debt will have a flow on effect. Take the same example above, and in comparison, to making concessional super contributions, paying an additional $25,000 in after tax dollars off a traditional 30-year home loan, of $500,000, at 4% interest will take 14 years off your home loan and $178,000 of interest savings. This means that after 16 years, you have the next 14 years to invest $25,000 into other investment vehicles such as superannuation. Compound this for 14 years at an average of 6% return gives you an additional $525,377 of assets.
Can you achieve the best of both worlds?
In this day and age, most of our clients are driven to not only pay down non-deductible debt but also a need to build wealth outside of the family home. The question is whether it’s possible to achieve both.
We encourage you to contact us to arrange a time to formulate a plan.