Interest Only Mortgage with a Pension

DrGronod

We have just been offered the following as a "tax efficient" way of setting up a new mortgage but also budgeting for school fees over the next 14 years. We are just about to buy a new house with a new £150K mortgage (with over 50% equity on the house) and have a 4 year old starting school in Sept (may go to fee-paying school now or in 3 years).
My wife had this offer from a "specialist" school fees IFA (I hope I have this right - it is a bit 2nd hand and therefore may have missed something):
- have an interest-only mortgage
- start a pension fund at something like £1000 a month
The school fees are then paid from the pension fund I think (can you do this?), but this has the advantage of getting tax back and therefore boosts the fund and makes an overall saving. And also makes the payments more even over time (ie just going up with inflation etc rather than any big jumps when going up to senior school etc).

I'm a bit unclear as the whole process and all the whys and wherefores, but all I can find on pension-linked mortgages are problems from a few years ago.
Apparently there are new pension rules (w.r.t. tax rebate) from this year which make this now an attractive proposition. But how come no one has mentioned this that I can find? Is it too good to be true?

The alternatives are to stick with the repayment mortgage I have provisionally arranged, and sort out various savings plans to budget for greater future expenditures. Or maybe set up an offset mortgage in future (doesn't seem right not but may have extra income from another source in the future (all a bit vague that though!)??).

Any advice greatfully received!

Thanks
DrG

Andy_L

I feel it's been garbled.
I don't see how you can pay school fees out of the pension fund as its locked up till you're 50/55 & then you can only take 25% as cash anyway
I can see using the 25% lump sum to pay of you mortgage might be better than using an ISA as an investment vehicle to repay the interest only mortgage but it depends heavily on you age & attitude to risk & if your happy to tie up £1k/month into a pension with all the associated swings & roundabouts that entails.

dunstonh

For higher rate taxpayers, there are some advantages to a pension mortgage. However, it should be treated as a high risk transaction and I personally wouldnt do one now.

To get money out of a pension, you need to be within the right age group (55 to 75).

You also have the double risks of investment returns and legislation changes. There are rumours that the Govt is looking what used to be known as "tax free cash" but now called pension commencement lump sum. It's quite possible that they would remove the 25% lump sum option from pensions. Indeed, the early information on the new NPSS (national pension) has no mention of any lump sum entitlement.

To me, if this is a route you really wish to take and understand the investment risk, then ISAs would make more sense because under post A day rules, you can always pay the money from the ISA into the pension later, if the rules havent changed. If they have changed, then you havent commited yourself to an option which no longer suits your goals.

Apparently there are new pension rules (w.r.t. tax rebate) from this year which make this now an attractive proposition. But how come no one has mentioned this that I can find? Is it too good to be true?

There are new rules on pensions but I dont see how this would impact on pension mortgages apart from perhaps income drawdown being used to pay the school bills.

The transaction being discussed is high risk and sophisticated. It could pay off big time but it also has significant risks and would need ongoing annual reviews. Some of the risk could be reduced by using ISAs in the interim period and leaving the switch to pension later.

DrGronod

Thanks for the detailed replies so far - looks like quite a few things to think about. I may have to find out more as to how the fees would have been paid. I'm normally a "low risk" sort of person - but can't resist a good deal! But working out what is or isn't a good deal is another matter.........
The stats presented did look good on paper as things stand, but the associated risks just weren't clear at all.
My gut reaction is to stick with my 3 year-fixed I have currently arranged and re-assess when that is up. Things may be clearer then (or not!).

Cheers,
DrG

dunstonh

Another way of looking at this is that the bigger the potential for gain, the larger potential for loss. This is big gain potential and big loss potential and not something that should be undertaken by anyone other than someone with a medium high/high risk investment nature. It also requires you to be pretty switched on or have an IFA that is an investment specialist and you know is going to be there for the term. You are looking at partner/director IFAs and not salesforce or employee IFAs (in general).

If it works to a low critical yield and the payments are comparable with repayment mortgage, then the risk is much reduced.

I'm a higher rate taxpayer and and an IFA and I wouldnt do this. I do, however, use ISAs against my interest only mortgage and currently massively above target. The investment principle is not a bad one but I wouldnt want to use a pension tax wrapper for the long term.