How will you pay off your mortgage before you retire? Vanguard’s advice for Australians

When all the property commentary in recent months has derided the post-Budget drop in prices, you could be forgiven for thinking that’s no longer an issue but it will take more than a couple of months to bring affordability anywhere close to historical levels.

More likely, there will continue to be a greater number of Australians needing to figure out how to deal with their mortgage when they reach retirement. That’s certainly what Vanguard’s How Australia Retires 2026 report found.

Unsurprisingly, almost half of Gen Z expecting to retire with a mortgage was right at the top of my colleague Vishal Teckchandani’s list of shocking charts from that report.

It marks a fundamental shift away from the long-held model for retirement. As Vanguard Managing Director of Asia Pacific Daniel Shrimski puts it: “A fully paid-down home has always been the foundation of retirement security.”

“More people are saying they're going to be taking a mortgage into retirement. If you think of when people are actually buying their home for the first time, they're in their late 30s on average. So it's no surprise that people are taking mortgages into retirement."

The super dilemma

The question once you hit retirement is: how are you going to deal with the debt? The most obvious options are either continuing to pay the mortgage as normal using income from super or pulling out a lump sum to clear the outstanding balance.

“It's a real dilemma and I think that's a worry when it comes to Australians living a dignified retirement, which they've worked hard for, which they deserve,” Shrimski says.

“When you've got to pay down a mortgage and, all of a sudden, you lose a chunk of your super to pay down that mortgage. That's a concern.”

Factors that matter:

• Super investment return and mortgage interest rate - If your super fund is consistently returning well above the interest rate on your mortgage, the compounding effect of maintaining the higher balance could be the better decision. The inverse is also true.
• Mortgage term remaining - The longer the term remaining on the mortgage, the larger the total interest bill, which raises the hurdle for the investment returns. In this scenario, a lump sum payment may make the most sense, while a short remaining term could mean reducing the super balance could hurt long-term returns.
• Access to other income - Age pension entitlements, rental income, part-time work or a partner's income can reduce reliance on super drawdowns, making it easier to service the mortgage without eroding the balance quickly.
• Age pension asset test implications - Superannuation is counted under the assets test for the age pension, while the family home is generally exempt. Reducing super to pay off the mortgage effectively converts an assessable asset into an exempt one, which can increase age pension entitlements.
• Risk tolerance - Markets falling while you still owe money on the mortgage can create a strain on both finances and emotions. The ability to handle that scenario without panicking should be weighed against the comfort of being debt-free.

The above is just a small sample of the factors at play. The complexity is why Shrimski strongly advocates for greater access to financial advice.

“There has never been a time, I believe, where people need more financial advice than they do today,” he says. “Whether it be the tax settings, whether it be more people reaching those critical retirement ages; financial advice and guidance has never been more critical.

"What happens is people will end up working longer. People won't exit the workforce entirely, they will maybe work part-time, maybe work casual. They're telling us through the research that that's what they plan to do.”

Why complexity is a “ruiner”

The retirement challenge does not sit in isolation from the broader investment landscape and the mortgage-into-retirement problem is part of a wider issue of Australian investors being unable to make good decisions in a system that makes good decisions unnecessarily difficult.

“Complexity is just a ruiner. The simpler the system is and the easier it is for investors to digest, the better results we're going to get.”

When it comes to retirement there are some simple questions that Shrimski says can help putting together a plan:

• How long are you going to work for?
• Are you going to have debt in retirement?
• What do you want your retirement to look like?
• How much income are you actually going to need to fund that retirement?

That simplicity argument extends to the investment product landscape, which has expanded rapidly. The Australian ETF market was worth $65 billion in 2020, while today it is $360 billion and growing faster than Vanguard's own forecasts anticipated.

More ETFs means more choice, which sounds positive until you factor in what excess choice does to investors who lack the framework to navigate it.

"When you've got sometimes so much choice, what happens is you actually don't do anything," Shrimski says. "You just lean out as an investor because you don't know what the right answer is and it's easier just to do nothing."

Doing nothing, when markets have compounded at 9 to 10% per annum over the past decade in Australia and 15% per annum in the US, is one of the most expensive decisions an investor can make.

“Markets generally will go up. Having exposure to the market through a product like an ETF with broad-based diversification at low cost is what we think of as a very smart way of investing.”

The generational shift

The other force reshaping the investment landscape is demographic, though in the opposite direction to retirement. A new cohort of younger Australians has discovered capital markets via social media, low-cost apps and the lived experience of watching markets compound through their early adult years.

Vanguard's research puts the contrast in stark terms. Among Australians aged 18 to 28, 45% say they are somewhat or very familiar with ETFs. Among Australians over 60, that figure is just 18%.

“Younger Australians are saying, ‘I want to be a part of that’. The simplest way of doing that is through an ETF. It's certainly the most cost-efficient," Shrimski says

To build further on this momentum, Vanguard is advocating for an Australian equivalent of the UK's Individual Savings Account through its MyInvestment proposal: a tax-incentivised investment account for investors who cannot or do not want to wait until they can access superannuation.

"We've seen tremendous uptake in the UK with the ISA, and in Japan with the NISA," Shrimski says. "We want Australians to be able to invest in these accounts without having to wait until they're 60 or 65 to get the benefits. It can help them earlier on in life to invest in a tax-efficient way, up to $20,000 per year."

The proposal is designed to complement superannuation as a medium-term wealth-building vehicle for goals that sit between the everyday savings account and the locked-up super fund. For younger Australians saving for a home deposit, education or healthcare costs, it offers something super cannot: access before retirement age.

Under the proposal:

• Eligible Australians (for example, under 45) could contribute up to $20,000 per year.
• Investments held for a minimum period (such as two years) would benefit from tax-free returns on capital gains, dividends and interest.
• Regulated accounts would have rules around investment options (such as low-cost, diversified and liquid investment options designed to support medium- to long-term investing).
• Funds could be used flexibly, for goals such as a home deposit, education or other life milestones.

“We think it sits as a real compliment to the current tax reform package that the government has announced, where we do worry about younger investors maybe not having the same opportunity as those that have gone before them in terms of the tax settings,” Shrimski says.

“We want Australians investing in capital markets for two reasons. First of all, it's great for our economy and it will help from a productivity standpoint. That would be the macro reason, but from a more individual standpoint, investing in capital markets has proven to be a great formula for people to build wealth and work towards financial wellness.”

The $360 billion ETF market will keep growing, the cohort entering retirement will keep expanding, and younger investors will continue to look for entry points.

Whether the system around all of them is simple enough to let them do it well is, in Shrimski's view, the most important question in Australian financial services right now.