Re-mortgaging and pensions

HammersFan

I was wondering:

If I re-mortgaged my house, and lets say i released £30000 in doing so. Then i pay that money as a lump-sum into my personal pension. i assume I get that 'grossed-up' by 22% (6,600). Thus I put 36,600 into my pension in one lump. Let's assume this is less than 100% of my salary.

If my mortgage is at 5.00 fixed (a bit low, but easier on the maths) this will 'cost' me £125 per month in interest (30,000 over 20 years) - which I could save by not paying that same amount into my personal pension if I wanted to. If my pension grows at 6% PA then I would imagine in 20 years time I would be quids in (because of compound interest etc.). I could then take the tax-free lump-sum to more than clear the mortgage (30,000), and have a reasonable amount left for an annuity (90,000) - I rounded the figures for simplicity, but at 6% over 20 years the pension total would be about 120,000.

Do people do this (it looks like a 'free pension)? And have I got this all wrong - is it a mad / illegal idea (I think it might be, sounds a bit too good to be true). I thought it was a way of getting money into the pension sooner rather than later, and I would still go after paying down the mortgage, and put bits and pieces into the pension in the meantime.

Andy_L

Assumptions:
Pension grows at greater than mortgage rate.
Tax free lump sum is still available in 20 years.

As a basic rate taxpayer conventional wisdom on this board is that it's not worth paying into pensions vice ISAs unless:
-there's free money from an employer
-You at a higher than usual risk of bankruptcy
-You don't have the discipline to not raid the ISA & need the pensions lock in.

Browse around and you're see why (ie I'm not going to bother rehashing the same statements that have been done to death on many previous threads)

dunstonh

Andy has covered all the main points.

It isnt illegal and it isnt a bad idea for a higher risk, higher rate taxpayer who understands totally what they are doing and are experienced with investments and has sufficient capital reserves. For everyone else, it should be totally avoided.

The term is called "pension mortgage" and very few are happy with the end result. Only professional investors have done well out of it.

I wouldnt go near it myself and I would be a prime candidate for someone that would be potentially suitable, let alone recommend it to someone else.

HammersFan

Thanks for the info, much appreciated. So the immediate tax-back break is not sufficient compensation because of the risk?

EdInvestor

What's not sensible is to attach a risk-based savings product ( endowment, ISA, pension) to a defined loan repayment deadline.

If markets crash (as they did a few years ago), you end up with a shortfall at the last minute which is not easy to cover. Hence the endowment panic.

dunstonh

You can only take out 25% at the other end though so you need the fund to have more money in it to make up for that.

A number of people had pension mortgages set to pay out at age 50 to clear their mortgage. As from 2010, you cant access the pension until age 55. So these people are having to find 5 more years of borrowing. What if it gets increased again?

What if the 25% is removed or becomes taxable? Its no longer called tax free cash. It is now pension commencement lump sum. There has been discussion and rumour a number of times that the tax free status will go or the whole 25% will go. It may not but its a risk.

If you put £30,000 in over 20 years, you would get this raised to £38,461. if that grew by 7% p.a. it would have a final fund value of £148,830. 25% of that taken back would be £37,207. So thats the mortgage cleared.

The cost has been £30,000 in monthly payments and to show for it you have £7,207 plus an annuity of £6500 a year.

Put it in an ISA/UT (and filter the UT to an ISA over the coming years) and the end result will be exactly the same minus the 22% tax relief but you wont have to purchase an annuity. You will have £116,089 minus the 30k repayment for the mortage and you have £86,089 left over. 30k interest costs leaves you with a £50k profit.

That is called gearing and loads of people do it every day. Not as direct as you suggest but when they have investments and have a mortgage, they are in effect borrowing money and investing.

It can be very successful but obviously, if the investments go down at a point you need the money, you would be out of pocket. If investments go up by more than you are paying in interest, then you make profit. Its similar to buy to let mortgages. Instead of buying a property, you are buying shares/funds.

HammersFan

Thanks for the detailed response - much appreciated. These things take a bit of working out, so I am grateful.