Paying off mortgage VS High Earnings Tax

[bellymonster]

I've started to build up a nice wedge in the company accounts, over and above what I need for rainy days, but really don't want to extract any more as I'll be paying the high earnings tax on it.

It then occured to me that it might be better put to use for paying chunks off the mortgage. Obviously I will have to pay the upper tax band on it BUT will the interest saved on my mortgage out weigh the tax given to HMRC.

I've tried doing the math but came out with loads of different results.

Anyone else taken this approach?

[BrilloPad]

I've started to build up a nice wedge in the company accounts, over and above what I need for rainy days, but really don't want to extract any more as I'll be paying the high earnings tax on it.

It then occured to me that it might be better put to use for paying chunks off the mortgage. Obviously I will have to pay the upper tax band on it BUT will the interest saved on my mortgage out weigh the tax given to HMRC.

I've tried doing the math but came out with loads of different results.

Anyone else taken this approach?

I was going to but then I got divorced.

[ASB]

[QUOTE=bellymonster;411310Obviously I will have to pay the upper tax band on it BUT will the interest saved on my mortgage out weigh the tax given to HMRC.[/QUOTE]

That rather depends on a number of factors. not least of which is your mortgage interest rate, balance on the mortgage and ther reamining term.

Take 10,000 net. Pay 2.5k in extra higher rate tax.

If you have a 150k mortgage with 20 years to go paying off 10k now, and maintaing the same payment rate will save you about 17k in interest and 2 years on the term. If you had a similar mortgage with say 5 years to go then it would save you about 3k in interest and a few months on the term.

There is a calculator here which allows putting in of one off extra payments.

http://new.egg.com/visitor/0,2388,3_...w_1028,00.html

And here:

http://www.freestylemortgages.com/2.5.html

However on the negative side you need to consider inflation and the fact that you will be losing interest on the 10k since you don't have it anymore. A lot of it comes down to your attitude on debt really.

[bellymonster]

Thanks for the quick calculations, I have 23 years left on a 115k mortgage so it could save me a fair few quid.

I also thought it might be even better to take the lump sum out at the begining of the financial year which would mean not having to pay the tax until the January of the next tax year. Then switch to an offset mortgage and reap the benefit of the taxmans money.

[beaker]

There is no right answer to this, it really depends on you. My current plan is to pay as much off the mortgage as possible while I am still happy contracting, as living mortgage or rent free IMHO is the first step to cutting back on working.

While paying money into your mortgage will not earn you any interest, you can always borrow against the increased equity in your home at a lower rate than most other kind of investment loans. You can then buy other income gererating investments while taking advantage of the tax deduction on the interest.

[minstrel]

I think it depends on your strategy for getting the remaining cash out of the company.

Unless YourCo stops generating income and then you gradually take out the cash as dividends up to higher rate threshold over a number of years then you are probably going to get hit with some additional tax when you take the extra cash out.

If you accept you are going to get hit with additional tax at some point, then you may as well take it out sooner rather than later and pay off mortgage. Paying off mortgage capital will definitely be better than post tax investment income YourCo could make.

If you've got a strategy for getting the cash out without paying higher rate tax, you might be better keeping the money in the company.

If you do plan to take the cash out nowish then you are right it is best to wait until next tax year as you will have to pay the tax in Jan 2010 rather than 2009 (although payments on account will catch you up after the first year).

[d000hg]

Sorry for the slight tangent, but is it possible for my company to own the house I live in? It reminds me a little of the Red Dwarf book where in "Better than Life" Rimmer's body is owned by his company... but is it possible/beneficial? It possible it sees you could build up £200K in your company account and buy a nice house?!

[GreenerGrass]

There is no right answer to this, it really depends on you. My current plan is to pay as much off the mortgage as possible while I am still happy contracting, as living mortgage or rent free IMHO is the first step to cutting back on working.

Agreed. If you have a large mortgage over a long term then restricting your income to 37 odd k to save tax seems to be cutting off your nose to spite your face.
With the exception of keeping a 1 year safety net for salary provision etc, I'll extract the maximum possible from my company until my mortgage is paid off, or at least insignificant.
At that point you will be a huge step closer to financial freedom.
You can then decide whether to still contract most of the year and draw just 37k to build up a big surplus in the company, or limit yourself to 6 months of contracting max and start having a life, a more enjoyable plan B etc.

For those who want to work less way before they reach pension age, I also give paying off the mortgage a higher priority than making wacking great pension contributions. Its no use dropping dead at 65 with the biggest pension fund in the world.

[ChimpMaster]

Belly - How long have you had your company open? If it's longer than a year (and preferably 2) then you might want to consider liquidating it. That way, you can get out all of the funds as a capital gain rather than income, and hence the amount is susceptible to CGT rather than PAYE.

If you do this post April '08 I believe it will work out more beneficial to you as the CGT rate will be fixed at 18%.

My accountant told me that he once wound down a company for a client who had 200k in it!

[moorfield]

Agreed. If you have a large mortgage over a long term then restricting your income to 37 odd k to save tax seems to be cutting off your nose to spite your face.
With the exception of keeping a 1 year safety net for salary provision etc, I'll extract the maximum possible from my company until my mortgage is paid off, or at least insignificant.
At that point you will be a huge step closer to financial freedom.
You can then decide whether to still contract most of the year and draw just 37k to build up a big surplus in the company, or limit yourself to 6 months of contracting max and start having a life, a more enjoyable plan B etc.

For those who want to work less way before they reach pension age, I also give paying off the mortgage a higher priority than making wacking great pension contributions. Its no use dropping dead at 65 with the biggest pension fund in the world.

Very well put, GreenerGrass. With the exception of some contributions into my SIPP I'm lumping all spare cash into my offset mortgage too.