Fixed interest rates: Know the facts before you lock it in

The bank got it wrong. Today's inflation is not being driven by households going on a spending spree; it is being fuelled by surging construction costs and a spike in oil prices caused by the conflict in Iran - forces well beyond the control of ordinary Australians. The Reserve Bank is using the only lever it has, but it is hitting the wrong target.

Yes, inflation was already running hot before the conflict began, and a rate rise was always likely. But common sense suggests the better course would have been to pause for a month and see how events unfolded. If they had done that, they would have found that an energy crisis hits the economy much harder than six rate hikes.

Higher interest rates will not bring down global oil prices or ease construction costs, but they will hit households hard.

Of course, this has triggered a flood of headlines about how much more borrowers will have to pay - and many of them were wrong. The maths is simple: a quarter per cent rise in interest rates adds about $5 a week for every $100,000 of debt. So if you have an $800,000 loan, each 0.25 per cent increase costs roughly $40 a week.

This raises the obvious question: is it time to fix your interest rate? Historically, fixing has rarely paid off, and in this case the horse may already have bolted, because banks have lifted their fixed rates ahead of these moves.

A typical variable rate for owner-occupiers is around 5.84 per cent to 6.4 per cent, depending on the lender and how sharp a deal you have negotiated. Five-year fixed rates are generally in a similar range, often around 6.0 per cent to 6.49 per cent, and in many cases sit slightly higher than variable rates.

The key point is that fixed rates are no longer the bargain they once were. Banks are pricing in the expectation that rates may stay high for the long term, so locking in for five years usually means paying a premium for certainty rather than securing a lower rate.

In simple terms, fixing today is less about saving money and more about buying peace of mind if rates rise further. The trade-off is loss of flexibility: fixed loans may carry significant break costs if you need to exit early. There can also be a rate lock fee before you even get the loan. This is a fee to guarantee the rate at settlement.

Some banks say the rate lock starts when you apply; others only lock it in once you have unconditional approval, which can take weeks. By then, the banks may already have moved their four- and five-year fixed rates higher.

Also before fixing you must understand break costs: the price you pay to exit a fixed loan early. This is where many borrowers come unstuck. It's a minefield, and good advice matters.

Fixing can provide certainty and peace of mind, but it is not for everyone. A variable rate offers flexibility and the chance to benefit if rates fall. The key is to think about your future: your income, your job security, and whether your circumstances might change. If you can't see clearly five years ahead - and few of us can - a shorter fixed term may be a wiser course.

Some borrowers also hedge their bets with a cocktail loan: fixing part of the loan and keeping the rest variable, giving them both certainty and flexibility.

Remember, in the end the best strategy is not about picking the perfect rate - it's about putting yourself in a position where you can sleep at night, whatever happens next.

Question: An individual receives a $100,000 windfall and decides to contribute the full amount to superannuation. He is still working and, under the carry-forward rules, has sufficient unused concessional cap to treat the entire contribution as concessional and claim a deduction for the full $100,000. The super fund deducts 15 per cent contributions tax, or $15,000.

However, a deduction of only $50,000 would have been enough to reduce his taxable income to nil. By choosing to treat the full $100,000 as concessional, has he unnecessarily paid contributions tax on amounts that delivered no additional tax benefit?

Would it have been better for part of the contribution to be treated as non-concessional, and if so, how is a taxpayer meant to determine this in advance? Is there any mechanism in the tax or super system that alerts a taxpayer when claiming the maximum possible deduction is no longer optimal?

Given the strong emphasis on tax-deductible super contributions, is there a risk people assume the largest possible deduction is always the best outcome, when in some cases it may not be?

Answer: Certain deductions that would normally be allowable cannot be claimed if they create a tax loss - personal super contributions fall into this category. If a deduction for personal super contributions exceeds taxable income, the ATO will deny the excess. That portion of the contribution is then treated as a non-concessional contribution and counted against the non-concessional cap, which can create problems if that cap has already been used.

Before claiming a deduction, it pays to step back and look at the bigger picture. There is usually no tax advantage in making deductible super contributions that push taxable income below the effective tax-free threshold. This is why many people wait until late in the financial year to make personal contributions, when they have a clearer idea of their taxable income and the optimal amount to claim. Ultimately, the responsibility rests with the individual to understand and comply with the rules. But given how complex the tax and super systems have become, working with a competent tax adviser or financial adviser can make the difference between a smart strategy and an expensive mistake.

Question: We are considering whether our adult son should be nominated as a direct beneficiary of our superannuation, or whether it would be better to direct our super death benefits to our estate and then leave the money to him under our will.

Our financial planner has advised that directing the benefit to the estate is preferable because our son would not incur the Medicare levy, whereas he would if he were a direct beneficiary of our super. I would like to confirm whether this is correct. I understand the Medicare levy is generally 2% of taxable income, but how does it apply to superannuation death benefits?

Answer: Where a superannuation death benefit is paid directly to a non-dependent adult child, the taxable component is subject to tax at 15% plus the 2% Medicare levy. Note that where the death benefit contains life insurance proceeds, a higher tax rate of 30% (plus Medicare levy) may apply to a portion of the payout.

If the same benefit is paid to the estate and then distributed to the son, the Medicare levy does not apply, but the 15% (or 30%) tax on the taxable component is still payable.

A much simpler alternative is often for a member who has reached their senior years to withdraw the entire superannuation balance tax-free during their lifetime and leave the proceeds to their estate. In that case, no tax is payable by the beneficiary.