Save for pension or overpay mortgage?

Ab1ga1l

Hello,

I am wondering whether it's better to overpay my mortgage at max (£500 p/m) for the next two years, which is currently fixed until Feb 2013 at 5.6% or whether I should pour my money into a pension?

I am 30 and have only just started a pension :eek: . My employer does not contribute to the pension. I have seen on this forum that a guideline is to have approx £35000 by 35 :eek:.

My question is; Should I concentrate on over paying my mortgage in case of a scary % rise in two years time or, should I be putting my money into my pension pot ASAP instead?

Just wondering if you financially savvy people would mind providing some guidance?

Thanks

kidmugsy

If you think asset values - e.g. the prices of shares and bonds that your pension money would be invested in - are rather high, and likely to fall, you might prefer to pay down your mortgage now, and invest in the pension later in life. That might be particularly true if at present you got only 20% income tax relief, while expecting to get 40% relief later.

I'm a fan of flexible mortgages, where you can pay them down now, and borrow the money back again later if you need it. If yours isn't flexible, then you might prefer neither to invest in a pension nor to pay down the mortgage. Perhaps you'd find it better to save in an ISA? Anyway, have you done the rational thing and cleared expensive debt, and checked that you've got sensible insurance cover?

Ab1ga1l

Thanks for your helpful reply Kidmugsy,

Fortunately I do have my emergency savings and my only debt is my mortgage and it is flexible - are you suggesting paying it down now then taking that money back and reinvesting it later into the pension?

I have checked my pension with Legal & General and I can change payments without getting charges.

Sounds like a good plan :j

Just wondering what you mean regarding the 'insurance cover'?

Thank you!

kidmugsy

"Insurance cover": I had in mind (i) if you have dependants, you might want life cover, and (ii) some people like health cover or unemployment cover - I never had those myself, and am pretty ignorant of them, but if I were in the middle of my working life I might check on them. I have memories of being incapacitated and depending on the NHS - eventually I paid for treatment out of my savings.

jamesd

Do you think that your mortgage interest rate will rise to 10.5% plus inflation a year? That's the average return of the main UK stock market from 1977 through 2003. It may be lower in the future but that makes the point pretty well: overpaying on a mortgage makes you poorer if you're willing to invest instead.

Since your employer isn't helping you might consider investing within a stocks and shares ISA instead of investing within a pension for the extra mount. The ISA has the advantage that the money can be taken out at any time and any level of income can be taken, while the pension income is limited in the 55-65 range to below the level of income that investments can produce long term. So the ISA lets you draw faster if you retire early.

Things like £35,000 at 35 are only very rough guidelines to get people thinking about it and doing something. A better way to go is to work out what level of income you want to have when you retire and decide when you'd like to do that. Then you can use pension calculators to work out what you'd need to invest to have a good chance of reaching that target.

Instead of overpaying on the mortgage you can invest the money and then during boom years in stock markets you could take say 10% of the investments to use as an overpayment. That locks in some of the high market gain.

One of the most efficient ways to pay off a mortgage is to use the pension tax free lump sum, available from age 55. You get the tax relief on the way in but no tax on the way out, so in effect you end up getting tax relief on your mortgage payoff. Then the other 75% of the pension pot can provide an ongoing income, or just be left invested until actual retirement.

If you think that at some point you'll be earning enough to pay higher rate tax that's an ideal time to make pension contributions to get the higher tax relief. Or if you have an employer which uses salary sacrifice for pension contributions that's a good time for basic rate tax payers because you save the NI as well as the income tax on the contributions.

Overpaying on a mortgage is a great option for people who aren't willing to invest, who just want the mortgage gone or who want to do a bit of several different things.

Ab1ga1l

Thanks JamesD that's very helpful.

I've taken a look at the stocks & shares ISAs and also multi manager funds. This is all very new to me so I think I'll take some time to pour over those options.

Thanks to both of you

Loughton_Monkey

At 5.6% fixed, the decision is much more marginal than the more normal poster who tends to ask the same question when they are only paying 1.37% on their mortgage.

Irrespective of which option to take, I would echo the recommendation already given: When your mortgage rate expires, you really should look at an "Offset" mortgage. These offer excellent flexibility and I don't know of a negative with them. Mine was fully offset but I took it all out again to earn much more elsewhere.

Long before I ever took out the 'Offset' mortgage, I always had endowment mortgages. I tended to think that saving for retirement was always a bigger priority than paying off my mortgage. In fact I quite brazenly used the bulk of my endowment policies for significant home improvements. NOT to pay down the mortgage. I simply relied on inflation to 'manage' the mortgage debt and eventually offset it using 'petty cash' and not my remaining endowment policies - four of which went into retirement savings, and the final one matures next month and is earmarked for ISA's and more pension contributions.

If you feel the same, then I would suggest a Stocks & Shares ISA. If there are two of you, you have up to £21K+ annual limit and you can invest in funds that are virtually the same as you would have used in the pension. This gives you exactly the same growth as putting it in pension. But importantly gives you options in a couple of years. You can then make a decision based upon the real 'climate' at the time when your fixed rate ends. You could either pay down the mortgage, or drip feed the money into pensions and get the tax relief - same effect as if you'd started the pension now. i.e. best of both worlds.