Offset account + tax deductions

[Futurist]

Offset account & tax deductions

Hi All,

I've been going through the topic of mortgage repayments and tax deductions, and I wanted to get opinions on what you believe is the best situation.

If I have enough savings that out weighs my home loan - should I go with an offset account, and pay no interest. Or scrap the offset account and pay the interest repayments (for a tax deduction)?


Detailed Scenario:

Loan = 250,000
Savings = 300,000
(250k can fill the offset account, with 50k savings remaining in an interest bearing account)

TOTAL Taxable Income = 120,000
(Salary + Rental income + Interest via Savings accnt)

The tax bracket I am in will be: 80k-180k bracket ($17,550 + $0.37 for every $1)

Now, this is the part that I am confused about...
If my TOTAL expenses range from 0 to 40k -- lets say it is just 35k in tax deducible expenses (repairs, interest repayments, etc) - are they still worth deducting ?

I understand if my total expenses are OVER 40k, which brings me to a lower Tax Bracket then its a great thing.

However if my total expenses keeps me in the same bracket - would i be better off NOT paying interest on the loan (by putting the 250k savings into an offset account) ? Thus instead of having 35k of expenses (as above) only have 15k of expenses to tax deduct (20k would have come from interest repayments to the bank)

 

[Rolf Latham]

An important consideration on this cash flow analsyis is what can you get for your money while not in an offset, ie..........can you margin it and get say 10 % net, or are u talking an at call acct of 6 % or so.

Also, Id assume u have no owner occ home loan ?

ta

rolf

 

[buzzlightyear]

With regards to the exact tax position in the second part of your example, we would need to confirm the tax paid for the fy. However, for illustrative purposes, of you earned $120k as a PAYG earner, and were paid monthly the example would be as follows.

$10,000 gross pay with $2,886 deducted by your employer. This equates to $34,632 in tax paid in the fy. With $35k worth of deductions, your tax refund, inclusive of medicare & flood levy would be $13,782.

The advantage of offset account is this is an effective net after tax return of your mortgage rate. Let's say that is 6.5% interest, at 37% marginal tax rate, you would need to earn 10.3% gross from another investment to equal your current 'return'.

 

[Futurist]

...Also, Id assume u have no owner occ home loan ?

Hi Rolf - thats correct, no occ loan - this is my first IP.
And have savings that outweighs the loan that i'll be getting.

I was originally thinking just putting the extra savings into a standard savings account earning at best 6% interest these days. However i might be considering term deposits and see if that gives a better overall interest

 

[Rolf Latham]

Hi Rolf - thats correct, no occ loan - this is my first IP.
And have savings that outweighs the loan that i'll be getting.

I was originally thinking just putting the extra savings into a standard savings account earning at best 6% interest these days. However i might be considering term deposits and see if that gives a better overall interest

I bet you are grateful you have those choices

ta
rolf

 

[Futurist]

The advantage of offset account is this is an effective net after tax return of your mortgage rate. Let's say that is 6.5% interest, at 37% marginal tax rate, you would need to earn 10.3% gross from another investment to equal your current 'return'.

Hi Buzzlightyear,

Thanks for your reply.!

I understand what you said in the first two paragraphs.
However I didn't quite get your third paragraph (quoted above)

Can you please elaborate a bit more to see if i can understand it..? I work well with figures and examples if that helps

 

[jroth]

By offsetting 6.5%, you are effectively earning 6.5% tax free - by saving interest that would have been payable.

To earn it from other investments you would need to earn 10.3% to be left with 6.5% after tax assuming 37% marginal rate.

 

[buzzlightyear]

jroth has explained it well.

You have 'earned' or avoided in paying the interest rate on your mortgage. On a loan of $250k, at 6.5% this is $16,250. If you are looking to invest your money to earn an after tax return of $16,250, you will need to earn $25,793 gross return (10.3% on $250k). After you pay your marginal rate of 37% on this amount, you pay $9543 in tax taking you to a $16,250 after tax return

This is a simplified example and doesn't take into account other tax effective investments or capital growth. So it may be better described as the risk adjusted after tax yield.

 

[Ed Barton]

jroth has explained it well.

You have 'earned' or avoided in paying the interest rate on your mortgage. On a loan of $250k, at 6.5% this is $16,250. If you are looking to invest your money to earn an after tax return of $16,250, you will need to earn $25,793 gross return (10.3% on $250k). After you pay your marginal rate of 37% on this amount, you pay $9543 in tax taking you to a $16,250 after tax return

This is a simplified example and doesn't take into account other tax effective investments or capital growth. So it may be better described as the risk adjusted after tax yield.

you should look at the OP again, i believe your answer is based on the OPs cash offset as non deducible debt, which it is not.

 

[Futurist]

If you are looking to invest your money to earn an after tax return of $16,250, you will need to earn $25,793 gross return (10.3% on $250k). After you pay your marginal rate of 37% on this amount, you pay $9543 in tax taking you to a $16,250 after tax return

Right.. Gotcha!

I updated my spreadsheet and looked at the possible circumstances and results.
And basically found 3 possibilities (from worse outcome to best):

WORSE:
a) Put the $250k into a standard interest bearing account to earn say 5% interest. Which is then tax deducted to produce an overall smaller net value.

MID:
b) Put the $250k into an offset account, 'saving' me the 6.5%-7.5% interest repayments for the mortgage.

BETTER:
c) Put the $250k into a high interest investment that would produce an overall bigger net value than that of .

 

[alexlee]

MID:
b) Put the $250k into an offset account, 'saving' me the 6.5%-7.5% interest repayments for the mortgage.

BETTER:
c) Put the $250k into a high interest investment that would produce an overall bigger net value than that of .

The offset account is effectively as safe as a high interest bank account. Your option c would have more risk. Higher return isn't necessarily better because you have to take risk, liquidity, etc into account.