Pension or pay off Mortgage?

Pound-Of-Flesh

Hi,

Can anyone give me some basic advice on how to prioritise my finances?

I am mid 40s, self-employed, earn a good amount (£60,000).
BUT over the last few years, i have been very disorganised with money, had huge credit cards debts etc. (The more you earn the more debt you can get!)

In the last few months I have started to turn my life around, using the good advice on this site (plus a hefty loan from a relative). I now have all the debts on zero % balance transfers & am paying off as fast as possible. Then will repay my relative. I am also living on a sensible budget.

For years I have not made any contributions to my private pension plan. Suddenly retirement age does not seem so far away, so I want to start doing whatever I can to rectify the situation.

But I also have a large interest-only offset-mortgage. (£200k) When I took the mortgage I intended to use the flexibility to pay it off fast. Instead I have done the opposite - borrowing back money I put in. I reckon - if I tighten my belt, and do some stoozing - now I am free of all the credit card interest every month, I could pay it off in about 10 years.

So here is my question -
I know MSE says it makes sense to pay off debts before saving - because generally debts have higher interest. But does the same principle apply to Mortgage vs Pension??? Because pension contributions are tax-free, that means they are a great 'investment' according to MSE. So which is the best use of my money - pension contributions or mortgage payments???

Thanks!

dunstonh

I know MSE says it makes sense to pay off debts before saving - because generally debts have higher interest

That is correct when it comes to short term higher interest debts.

But does the same principle apply to Mortgage vs Pension???

No. mortgage interest rates are lower and retirement planning is a cost you have to meet. Its not something you can choose to do or not. Especially for you as you are self employed which means you dont qualify for the full state pensions.

I have said this before (so apologies to regulars) that asking whether you should pay more into the mortgage or pay towards retirement is a bit like asking whether you should pay the gas bill or the electric bill. You dont choose you do both.

Because pension contributions are tax-free, that means they are a great 'investment' according to MSE.

I dont know where it says that because that wouldnt be correct. They have certain tax advantages in certain circumstances and from an income provision only point of view they are the best option. However, they are certainly not the only option and there are some negatives with it as well.

So which is the best use of my money - pension contributions or mortgage payments???

Retirement planning.

Reason being that you are only going to get £4700 a year state pension as you are self employed. You currently earn around £60,000. You earn more per month than you will earn per year in retirement. So, your lifestyle is going to be decimated unless you start providing for your retirement.

If you want a £30k a year income in todays money then say £5k of that comes from the state meaning you need to fund £25kp.a. That needs you having to save up a pot of around half a million pounds by your state retirement age of 66 (earlier retirement is unlikely to be an option for you given your current funding).

Assuming age 45 and retirement age of 66 getting 7% p.a. growth. To get a pot of £500k will cost you to put aside £895.13pm gross. Thats a net cost of £537 with a pension.

If you put it off for another 8 years and started then, it would cost you £1993pm gross (plus an allowance for inflation).

So, the question you should be asking is, do I want to live on £4700 a year or not?

Pound-Of-Flesh

Thanks for the answer.

Actually I do have some pension provision besides the state basic pension - but let's leave that aside. And no, I don't want to live on £4700 per year!

Your response starts by saying I should pay both pension & mortgage - but that simply side-steps the question. If I have to make a trade-off, which is best? In fact you then go on to answer that question .


The figure of £895.13pm gross (£537 net) is presumably monthly. So what you seem to be saying is don't try to pay off the mortgage - go for big pension contributions instead.
In fact I can pay £537 less each month off my mortgage and get £895.13 worth of pension investment [That's the tax advantage I was referring to by the way - the mortgage is paid out of taxed income, the pension out of untaxed income].

I guess I am just trying to be extra sure I get maximum benefit from my money. So the pension option gives more bang-per-buck than paying off the mortgage?

EdInvestor

Pound-Of-Flesh wrote: »

Actually I do have some pension provision besides the state basic pension - but let's leave that aside.

Not a good idea as tax allowances come into the picture.

So the pension option gives more bang-per-buck than paying off the mortgage?

Add together your state pension entitlement and your existing pension entitlement, deduct the result from 10k. Saving an amount which will provide an income of that remaining amount (eg 50k pension pot = income of 3k, roughly) will give you more bang for the buck as a basic rate taxpayer now and later.

An HRT who would pay BRT in retirment would get additional bang for investing more.