Drawing down 25% of Pension to Pay Off Mortgage

[Amy Shrotersfield]

Asking this on behalf of my partner. Basically, he soon hits an age where he can draw 25% of his pension tax free. We're thinking of doing it to pay off the mortgage. He will continue working and will more than repay the money taken over the next 5-8 years.


Just wondering if anyone else has done similar? We're not basing the decision on any figures, pure finger in the air stuff really but it seems he can make a big contribution this year (£30k or so) and immediately claw it back next year along with enough to pay off the mortgage.

Can anyone point out any pros and cons of doing this that aren't immediately apparent?

[fiisch]

Not sure why you're asking here - you'd be better off asking on the Money Saving Expert Forums.

Without knowing exact pension situation and mortgage rates it's impossible to say, but my expectation is financially you wouldn't be better off by doing this. Your husband's pension will likely return a better rate of interest over the next 5-8 years than you are paying on your mortgage, so will grow by a larger amount than the level of interest you will be save by paying early.

Obviously, if you're on a ludicrously high mortgage rate, this may not still be the case. There is also the psychological aspect - some may argue having the roof over their heads paid off is more reassuring than having a larger pension, although I wouldn't necessarily agree with this.

[Amy Shrotersfield]

Not sure why you're asking here - you'd be better off asking on the Money Saving Expert Forums.

Without knowing exact pension situation and mortgage rates it's impossible to say, but my expectation is financially you wouldn't be better off by doing this. Your husband's pension will likely return a better rate of interest over the next 5-8 years than you are paying on your mortgage, so will grow by a larger amount than the level of interest you will be save by paying early.

Obviously, if you're on a ludicrously high mortgage rate, this may not still be the case. There is also the psychological aspect - some may argue having the roof over their heads paid off is more reassuring than having a larger pension, although I wouldn't necessarily agree with this.

Yes, his rationale is that having the mortgage paid of would provide peace of mind. There's £140k outstanding and that equates to approx £900 pcm over a 12 (or 13) year term . Interest rate is 1.9%.

[northernladuk]

Mortgages are the cheapest way to borrow money and have been for a very long time so with rates at sub 3% I can't see paying it off with other savings is going to be beneficial at all.

That said you need to look at how your pension is growing and compare that to your mortgage rate. Also compare other savings possibilities like ISA's and the like to see if you can beat your pension rate. If you can't then I'd think about leaving it where it is.

Obviously if you are comfortable enough want to either just be mortgage free, look after the kids or have enough to splash out on a dream car then it's a great opportunity.

I'd be getting professional advice, and not from a bunch of contractors.

[ContractorBanking]

My advice would be to pay off the mortgage.

Sure, mortgage rates are low and you may be able to get better savings rates / investments elsewhere but there are some things you don't gamble with and one of them is your main residence. Pay it off and enjoy being debt free.

PS this advice is personal and not based on financial economics.

[WordIsBond]

Quite a bit of good advice above. It may make sense to pay off the mortgage even if it doesn't make pounds and pence. It's not always the best move financially but the security is worth something, too, especially as you get older.

Beyond that general statement, it does make sense, as noted above, to compare the interest cost on the mortgage to what your pension is earning.

The comparison is not straight across. Mortgage interest is paid out of take-home / after-tax income. So if you are paying tax on investment income, you have to use the after-tax investment return to compare to the mortgage interest rate. With a pension, three quarters of your pension investment income will be taxable when you withdraw it. So if you decide to keep the funds in your pension, you'll need to get a little bit higher rate of return on it. As an example, if your pension is likely to earn 5% going forward, 3.75% (3/4) of that is going to be taxable when you pull it out, and at 20%, that's going to be 0.75% in tax. So that's roughly equivalent, financially, to a 4.25% mortgage. So if your mortgage is lower than that, you are better off from a strictly financial perspective leaving it in the pension, if higher, you are better off paying off the mortgage. Change the numbers around for your own situation.

One pitfall: I believe once you start taking funds out of your pension, there is a much lower annual limit on contributions thereafter. That may mean this isn't worth it for you. You definitely need to check into the rules on that and understand how they relate to your situation before doing anything like this.

[Amy Shrotersfield]

One pitfall: I believe once you start taking funds out of your pension, there is a much lower annual limit on contributions thereafter. That may mean this isn't worth it for you. You definitely need to check into the rules on that and understand how they relate to your situation before doing anything like this.

Thanks - we will definitely check on that one as the plan is to keep contributing at current levels for the next 5 - 8 years or so.

[Fred Bloggs]

Thanks - we will definitely check on that one as the plan is to keep contributing at current levels for the next 5 - 8 years or so.

As long as you only take the 25% and NOT A PENNY MORE, then you are fine. Your partner can continue to pay in upto GBP 40k a year from his Ltd Co. However, be warned, a penny over the 25% lump sum and you trigger the annual pension contribution allowance. You really do not want to do this, otherwise go right ahead. I'd pay the mortgage off ASAP and put the 900 quid a month (and more) into my pension fund instead.

[IR35 Avoider]

A possible advantage of getting the tax-free 25% out of the pension as soon as possible is that it minimises the proportion of the lifetime allowance it uses up. The mortgage is a good place for it to earn a non-taxable return, and although the return is low, it is secure.

[Lance]

A possible advantage of getting the tax-free 25% out of the pension as soon as possible is that it minimises the proportion of the lifetime allowance it uses up. The mortgage is a good place for it to earn a non-taxable return, and although the return is low, it is secure.

Once you start to draw down, the amount you can save in your pension reduces.
So this suggestion is oversimplyfing a complex situation.

If the OP already has £1M in the pot then drawing don £250k at age 55 would allow another £250k to be added but at much less than £40k per year.
If the pot is less than £1M then the suggestion is moot.

And the rules may well (read that as quite likely) change under the next government.
This one is for the 'seek professional advice' bucket.