pay off or invest?

WaxiesDargle

Hi

I am about to receive £30,000 that is owing to me from my final salary pension that was originally miscalculated in 2006. I have an existing repayment mortgage of just over £27,000 which I pay £197 a month @ 4.0% interest

I am just in the 40% tax bracket from my pension payments and my salary from the job I do now combined

I don't have any other debt

I'm just wondering what is the best course of action...pay the mortgage off or invest

Thanks

dunstonh

I'm just wondering what is the best course of action...pay the mortgage off or invest

no-one can answer that as its down to your personal risk profile and the potential of the investments you use and how they grow and only time will tell how the investments will grow.

For example, invest two years ago and you would be around break even or slightly down on the amount invested. If you invested in March you would be around 25-30% up. So, in one period you would have been worse off and in another better off. The future is unknown.

Short term expensive debt should nearly always be cleared first. Longer term cheap debt is not so clear cut. So, the answer will depend on your risk profile, where you invest and for how long.

WaxiesDargle

Thanks dunstonh

Yes you are right...I suppose I was just 'thinking out loud' and asking for ideas

DiggerUK

WaxiesDargle,
As a high rate tax payer it seems that a mortgage @4%, if cleared, comes to the equivalent of nearly 7% gross. Plus you would have the extra cash each month.

The debt has to be cleared, why not do it the cheapest way and cut out all the interest you would be paying.
Trust me, when you clear the mortgage things start to happen. It just seems hard to hand over 27K.

Best of fortune.

Reaper

I would certainly pay off the mortgage, but I'm very debt averse. The rest I would put in a cash ISA if you don't have one already.

Nosht

Depending on your attitude to gambling its great fun to play about with the Stock Market especially when you do not really need the money. This enables you to take more risks than usual & to have the POTENTIAL for higher returns than normal.



Regards,


N.

sabretoothtigger

Get a fixed rate mortgage so you arent burning the candle at both ends. High rates I would assume lesser returns elsewhere

Otherwise pay off the mortgage and put the payments into investing gradually, especially good if you dont know what you'd invest in yet

jamesd

WaxiesDargle, ignoring your own risk tolerance, you're likely to do better from investing than from paying off the mortgage, with the degree depending on how you invest.

One middle road is to have a medium risk set of investments including lots of corporate bond and equity income funds and use the income to overpay the mortgage. That way you have a fair chance of keeping the capital growth on the investments while the income reduces the mortgage. Though doing this with the income will reduce the likely gain from investing a fair bit.

When you see lots of talk about a boom market that won't ever end, a couple or five years from now, that's a good time to be taking money out of the investments and clearing the mortgage, hoping to get in before the next market downturn. Or wait until the investments are say 50% up and then start taking out 10% of them each year for the mortgage so long as they remain 50% up. That's effectively creaming off the profit from the good times and waiting for recovery during the bad ones.

Unless you need the income you should probably be making pension contributions to eliminate your higher rate tax liability. Getting the higher rate relief is a good deal and I assume from your current income that extra taxable pension income won't put you into higher rate income tax once you're no longer working.

DiggerUK is correct that things start to happen when you clear the mortgage. You become less credit-worthy because the regular on time payments from the mortgage repayments cease making you look good in your credit record.

The after tax comparison that DiggerUK used to make paying off the mortgage seem more attractive is bogus because most investments you could usefully make will not be taxable at higher rate even if you're paying higher rate income tax. They will be almost completely free of income tax. Corporate bond funds held inside a stocks and shares ISA have no income tax on their income and those should have first priority for going into the ISA. Many other investments deliver most of their gain via capital growth and your capital gains tax allowance will probably eliminate all of your tax liability on the growth. In three of four years all of the investments can be expected to be inside an ISA if you're single, in two if you have the allowance of a spouse to use.

DiggerUK would be right if you were using taxable savings accounts instead of investing. That would favour paying off most of the mortgage, just leaving a few thousand to keep the credit reporting going and have access to the mortgage facility in the future so you can borrow cheaply via a mortgage advance instead of a personal loan.

In addition to your higher rate income, you might consider paying 17,500 of the 30,000 as a lump sum contribution to a pension. 17,500 because that is no more than 1% of the lifetime allowance and that avoids any chance of you being affected by the lump sum anti-recycling rules.

The advantage of the pension contribution route for basic rate income is that you get an immediate 25% gain on the amount you contribute and it's hard for other ways of using the money to match that immediate bonus. Income you take will be taxable but you'll get to take 25% as a tax free lump sum and keep the benefit on that. The main disadvantage is loss of access to part of the lump sum and if you're short of capital it may be best to use the ISA route instead. I'm assuming here that your pensions mean that you will be a basic rate tax payer in retirement and won't have a taxable income above 22,900 in retirement, or that your taxable income will be above 29,230, so it's unnecessary to consider the effect of age allowance reduction.

WaxiesDargle

Thanks all for taking the time to reply

jamesd...very comprehensive advice there, thank you

DiggerUK

jamesd wrote: »

DiggerUK is correct that things start to happen when you clear the mortgage. You become less credit-worthy because the regular on time payments from the mortgage repayments cease making you look good in your credit record.

I've heard this story before about being less credit worthy, after clearing off debts and mortgage.
Being debt free means we don't have a great need for credit anyway, and in nearly 10 years we have been mortgage free, have never had a problem.

All our credit references show, are that bills are paid on time, and there are no late payments. I think it's more an old wives tale than for real.

If you want to pay interest when you don't need to, go ahead, it's your money at the end of the day. We just don't like giving the banks a penny more than we have to.

dunstonh

If you want to pay interest when you don't need to, go ahead, it's your money at the end of the day.

Its not as simple as that though is it. You could pay 4% interest on one hand and get 7% income on the other.