Monday, 10 February 2014

Optimising your First Home Saver Account

Recently I wrote about the benefits of the Australian government mandated First Home Saver Account.  If you did not read that piece I recommend having a look as there are quite a few strings attached to the account and the penalties if you do not meet the requirements are quite harsh (the amount you have saved gets rolled into your superannuation and you cannot access this until your retire).

That being said, if you do qualify for this account and you are thinking about buying a home in the near to medium term (at least 2.5 years away) then there are ways that you can maximise your investment in this account.

The superior returns from this account are due to a combination of a significant government co-contribution and concessional taxation

The beauty of this account is that the superior return comes in 2 separate forms:
  • A 17c co-contribution (return) on the first $6,000 deposited each financial year
    • An incredible return especially given it is risk free
    • This return has the biggest impact in the first year on total returns and a diminishing impact as time goes on
  • A 15% tax rate on any earnings within the account
    • Members Equity has a First Home Saver Account which earns 3.25% p.a. which is a decent return but nothing amazing
    • However if you think about the fact that this is taxed at only 15% you would need a significantly higher pre-tax return on any other account to get the same after tax return as this account.  For this different marginal tax rates (including the Medicare Levy)
      • If your marginal tax rate is 19% (you're probably not paying the Medicare Levy) so you would need a 3.41% pre tax return to get the same after tax return
      • 34% marginal tax rate (32.5%+1.5% levy) = 4.19% pre-tax return equivalent
      • 38.5% marginal tax rate (37%+1.5% levy) = 4.49% pre-tax return equivalent
      • 46.5% marginal tax rate (45% + 1.5% levy) = 5.16% pre-tax return equivalent
The next thing you need to look at is the alternative for your savings and investment dollars.  The first $6,000 each year is a no brainer - I can guarantee you that you will not get a better return of any other investment (other than paying off high interest credit card debt).  

The next thing you need to ask yourself
is "can I get a better after tax return in the short run than this account is offering me".  The returns I outlined above are not huge.  You can definitely do better than shares but you need to remember that shares come with an element of risk.  You can lose your money or a portion of it.  This is a risk free return.  If you are on a lower tax rate, perhaps there are some other accounts which can earn you a slightly better return but if you are on the top marginal tax rate it is getting pretty hard to find an equivalent risk free return.

In fact I just checked my home loan and I am currently getting charged 5.21% p.a.  I am only marginally better off investing in this account (on an after tax basis) as I am in the first home saver account.

Maximising the returns from this account

In order to maximise the returns from this account you need to do a few things:
  1. Work out whether or not you can get a better return outside of this account
    • If you can then all you are putting into this account is the $6,000 required each year 
    • If not then you will be putting away all your savings into this account and you don't really need to worry about maximising your return because it is the best you are going to get anyway
  2. If you can get a better return outside this account, the transfer your money into this account each year at the last possible moment
    • You need to have the account open, but in order to maximise the return on this account you would ideally have your $6,000 earning a higher rate of return elsewhere until close to the end of the financial year
    • You would then transfer the cash into this account towards the end of June in order to qualify for the government co-contribution
  3. You would buy your house as close to the start of the fourth financial year of the account
    • The super returns in this account are driven by the 17c co-contributions on deposits each year which means that as your account balance gets bigger, the impact of the 17c deposit is being diminished 
    • Although technically you could keep the rate of return highest by only putting in the minimum amount each year ($1,000) this doesn't make a great deal of sense because you are forgoing a great return on the remaining $5,000
    • You need to have this account open for at least 4 financial years - you can withdraw money from the account in the fourth financial year so to maximise the impact of the 17c co-contribution you would deposit the money at the start of the fourth financial year, get the co-contribution and then buy your property as soon as possible
If you could time everything perfectly (an impossibility given how hard it is to find a house that you like in an area that you like for the price that you like) you can get an IRR of 26.64%.  

Of course this is an unrealistic return.  It assumes that you deposit the cash into the account on 30 June for years 1 - 3 and then deposit the cash on 1 July in year 4 and then buy the property on 2 July in year 4.  

More realistic assumptions would be to deposit the cash on the 15th of June in years 1 - 3 to give yourself some breathing room, transfer the cash on the 1 of January in year 4 and then buy your house on the 1st of Feb the following year (assumes you take ~6 months to find a house) in which case the return you get on the investment is 16.22% which is still an incredible risk free return.

The reason the return drops so sharply is that the 17% is having less and less of an impact each year.  If you were to take an extra 2 years to buy a house (i.e. buy it in year 6 with the same reasonable assumptions above) then your return would drop to 10.18% which is still a very very good return but much lower than the ones mentioned above.

What would you have at the end?

I have been talking in percentage terms this whole time - but people often like to know how much they put in and how much they are getting out at the end.  So with the minimum reasonable period mentioned above:
  • You will have been saving for 2.5 years
  • You will have deposited $24,000 into the account (if you are buying with a partner double this)
  • You will get $29,265 at the end which is made up of
    • $24,000 in your own deposits
    • $4,080 in government co contributions
    • $1,185 in after tax interest
If you have any questions on my calculations please feel free to send them through.

You May Also Be Interested In
First Home Saver Account - Super return but mind the strings attached
How to get the most out of high introductory bank savings rates
High interest savings accounts are starting to pay very low interest
Investment strategy: all posts

1 comment:

  1. I forgot First Home Saver accounts were even still around! Was never as successful as the Kiwi Saver account it was copied off in NZ.

    Shame I can't open one myself (already have a property), but my Mrs can certainly open one... :)