HRT dividend and pay off mortgage

[No2politics]

Hi,

With the introduction of the Dividend Tax approaching, I am considering taking a large dividend which will push myself and spouse into the higher tax bracked thus incurring tax at 25%. My intention is to use this money to make overpayments on my mortgage. I would like to ask the forum what things should be considered when making such a decision, and check I haven't overlooked anything.

Figures to work with

• Retained Profit: 125k
• Outstanding Mortgage 230k
• Mortgage Interest: 3.59% fixed until August 2017
• Over payments of 10% allowed a year. The clock resets on 1st April so I can make a 23k and 21k overpayment approx
• Shares split 50/50 with spouse, paying myself minimum salary of 10. Make 8k personal pension contributions a year which allows me to declare dividends that maximises both mine and spouses Higher rate of tax allowance.
• Personal Savings- 20k
• About to start a three month gig on best ever rate.

Assumptions

• 0% Interest on business savings
• I will find enough work in the next 6 years to pay myself dividends to take advantage of my basic rate allowance and cover all running costs of the business.

Considerations
Taking an immediate hit of 25% for a saving in mortage interest seems to balance out after approximately 6 years. i.e. doing 1.0359 to the power of 6 gives 1.235 and 1.0359 to the power of 7 gives 1.28. Is this the correct way to assess this?
The alternative would be to max out on employer pension contributions and put in a pension (low cost tracker). I was initially thinking of going down this route, but with the way Osbourne is playing around with pensions and how they will be taxed in retirement I don't like this option much. You also have to consider the variable performance of a pensions investment return, vs the guaranteed cost saving of a mortgage.

What would you guys do?
1) Max out on dividends and make 2 overpayments then when mortgage comes up get an offset
2) Max out on dividends and make only one overpayment, just in case you need the money then get an offset
3) Don't take any more dividends but just load up on company pension contributions
4) Leave the cash in the company but get aldermore bonds for 1 year?

I'm currently thinking about going with option 2, and depending on when my first invoice gets paid on this next gig potentially doing option 1.

Thanks

N2P

[northernladuk]

Yes

HTH

[syrio]

Avoid paying any higher rate tax.

Maximise company pension contributions.

Reduce the mortgage with personal savings.

Company savings into Aldermore 1 year bond at 1.9%.

You worry too much about pensions being played around with.

[WordIsBond]

You've left out two important pieces of information.

1. Do you have any personal savings you could use to reduce the mortgage?

2. Assuming maxing out the basic rate band for you and your wife each year, how much of that do you spend each year, and how much of it could you use to overpay your mortgage?

Key point relative to #2 -- if you can make the max overpayment (10%) each year out of basic rate dividends, why would you take higher rate dividends to do it?

If you are actually living on £80K a year (basic rate band for two of you) with a £230K mortgage, I'd suggest spending less of that £80K and use some of it to reduce your mortgage, rather than paying higher rate tax.

[No2politics]

You've left out two important pieces of information.

1. Do you have any personal savings you could use to reduce the mortgage?

2. Assuming maxing out the basic rate band for you and your wife each year, how much of that do you spend each year, and how much of it could you use to overpay your mortgage?

Key point relative to #2 -- if you can make the max overpayment (10%) each year out of basic rate dividends, why would you take higher rate dividends to do it?

If you are actually living on £80K a year (basic rate band for two of you) with a £230K mortgage, I'd suggest spending less of that £80K and use some of it to reduce your mortgage, rather than paying higher rate tax.

Good points. Usually we have approx 20-25k a year surplus which we could use for mortgage overpayments.

However next year we are getting an extension costing circa 60k which is going to eat up my current personal savings of 20k (includes this years surplus) and next tax years surplus of 25k.

Since i require an additional 20k to pay for extension I will be taking HRT dividends this year.

Given that im taking some dividends anyway this year I wanted to explre whether it is worth taking more divies now to cover the two overpayments of 23k and 20k, vs paying into company pension.

[WordIsBond]

I wouldn't even think about doing this. If you are going to be able to start overpaying it by £20K a year in a couple of years, there's no way you recover the extra tax you'll be paying.

As noted, you can get 1% or more a year on company savings without too much trouble, or you can look to invest more aggressively within your company if you want.

If you have to build the extension this year, yeah, go ahead and take the dividend, pay the tax, and build. If not, I'd wait another year. But either way, you should be able to start taking big chunks out of that mortgage in a year or two without paying any HRT.

Thing is, the rules on IR35 could change drastically in a year, dragging almost everyone inside. If that happens, you'll probably want to be maximising your pension contributions to wipe out as much as possible of the deemed payments, and if so you'll be drawing down your reserve at the basic rate pretty rapidly.

You're sitting pretty right now, with funds to draw and the ability to draw them far in excess of what you need without paying a lot of tax. I'd stay the course.

[Lewis]

Ok, not sure if this maths is correct, but £1 profit from company via HRT dividend means 25p to tax man and 75p in your mortgage. To get the 75p back to a pound (to balance out, as you say) you'd need to multiply the 75p by 1.33 not 1.25, because the mortgage interest is only on the 75p not the full £1. So I think it would be more like 8-9 years to balance as 1.0359 ^ 8 = 1.3259. Meaning 75p paid into mortgage now saves you 25p in interest after 8 years.

[Syntyrion]

Ok, not sure if this maths is correct, but £1 profit from company via HRT dividend means 25p to tax man and 75p in your mortgage. To get the 75p back to a pound (to balance out, as you say) you'd need to multiply the 75p by 1.33 not 1.25, because the mortgage interest is only on the 75p not the full £1. So I think it would be more like 8-9 years to balance as 1.0359 ^ 8 = 1.3259. Meaning 75p paid into mortgage now saves you 25p in interest after 8 years.

Though you may want to consider possible impact of difference in rate in, for example, years 4-6, or going from a fixed rate to an SVR. If the rate then is 5% the breakeven point will be earlier.

[No2politics]

Thanks for all the comments guys. Really useful to get a different perspective and im going to follow the advice to keep below the threshold.

[CaptainDanger]

I am in a similar position but not without so much sitting in the company bank account. I have about £25k surplus this year after taking divis and salary to the higher tax threshold. I am thinking a lot simpler in order not to cloud my head with too many thoughts. I either put into the pension or I take out divis and pay the higher rate tax.

I didn't want to labour over the maths too much as in the past I have always payed down my mortgage when I have savings which will hedge against SVR and rate increases which helps me sleep at night hence why I don't labour over the maths too much as peace of mind is more valuable to me, but I have decided to do a 50/50 split as one thing we all know for certain is that tax on divis will be higher from next year so it makes sense to pull at least some out now unless you can be 100% sure you are going to stay within the basic rate tax band for the next few years. The remainder I wil put in my pension.

Something else to consider; Personal Savings Allowance helps with interest paid on divi income sitting in the bank.

Lastly we don't know what is going to happen with pensions, but the signs are something will and it is more than likely going to hit the higher rate tax payer which is very disappointing as Osborne made a smart move relaxing the annuity rules, now it looks like he might do a Gordon Brown on us.