Should we use our inheritance to pay off our mortgage?

We have a house in Canberra worth approximately $1.2 million against which we have a fixed loan of approximately $500,000 and a variable rate loan of $100,000, the latter offset by $70,000. We are around 50 years old with approximately $900,000 super combined. Our financial situation has changed recently due to a generous inheritance. Next year, we could discharge our mortgage with funds from the estate. However, does this make sense? By allowing the loan to continue, in the future, we would have more options available to us as we could change our current residence to an investment property and use the estate funds to buy a more suitable house for our future needs.

You have a point in that, if you plan to buy another main residence, then there may be advantages to retaining a large loan on your current house so that interest will be deductible when you move out. This will also allow you to put as much equity as possible into your new home where any mortgage would be nondeductible.

If you plan to buy another main residence, there may be advantages to retaining your loan.Credit: Peter Rae

The trick is that if you were to pay off your current mortgages with the inheritance, and then raise a new loan to buy a new house, the interest would be non-deductible as you will be investing the money into a non-income producing asset.

However, by placing money into your current mortgage offset account, it has the same mathematical effect: no interest, but now the money remains yours and can be withdrawn without creating a new loan. In this way, once you withdraw your money to buy a new home, and rent your old one, the interest on the old home loan then becomes deductible.

While you can offset your variable loan, many providers of fixed loans don’t allow them to be linked to offset accounts, nor allow early repayment without a hefty break fee. In such a case, ask about an offset and get a quote for the break fee. But you may find it cheaper to wait until the fixed loan matures before transferring it to a variable loan and offsetting it until you buy elsewhere.

My partner has reached her super preservation age of 59, having been born in the second half of 1963. She has a Vic Super account of $280,000 and a Commonwealth Super account of $90,000. She plans to stop work to complete her PhD within about a year, then recommence work. She wishes to access $250,000 of her super to pay off most of our joint mortgage. This way our living expenses will be minimal, and she can finish her research full-time for about a year since she no longer receives scholarship payments from her university as the PhD is in its 7th year. As her parents both died recently, she will inherit approximately $250,000 as her share of their property. When she inherits this, she plans to contribute it back to her super using the three year ‘bring forward rule’ as a non-concessional contribution. What are the rules about withdrawing super after you have reached your preservation age?

Basically, after reaching one’s preservation age (which phases up from 55 for anyone born before July 1960 to 60 for anyone born after June 1964) you can retire and withdraw your super benefits. But there are a number of potential traps.

Until you reach 65, you will need to confirm that you are retiring permanently, although you can change your mind later, which makes the affirmation rather pointless.

Withdrawals at age 59 are not untaxed, as they are from age 60. At 59, you can withdraw a lump sum up to an amount known as the ‘low rate cap’, currently $230,000, and which is taxed but at a zero rate. Anything above that, e.g. a further $20,000, is taxed 15 per cent, plus Medicare.

“Taxed at a zero rate” sounds stupid but was originally designed to allow low-income earners to withdraw their super as a lump sum without paying tax. The problem today is that the $230,000 is still regarded by the ATO as taxable income and can thus affect your HECS/HELP payments, or family tax benefits or anything that is determined by your taxable income.

It doesn’t sound as though your partner is desperate for money and, if the above problem affects her, she might do better to wait until she turns 60.

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

If you have a question for George Cochrane, send it to Personal Investment, PO Box 3001, Tamarama, NSW, 2026. All letters answered. Help lines: Australian Financial Complaints Authority, 1800 931 678; Centrelink pensions 13 23 00.

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