Trying to pay off mortgage - interest only ideas?

Dithering_Dad

I agree with James on the S&S ISA. If you're going the investment route then you need to go the whole hog and commit to it by using your whole 7k ISA entitlement. Putting using a cash ISA won't give you returns that much more than just paying down your mortgage directly.

I also agree with James and the other posters about endowments, they're not the same as investments because you never got to control where the money went, you can't move them and people never increased their contributions when the market was down (to gain more when the market recovered).

If you use the maximum entitlement of 14k for you and your wife for shares/fund investment and then any left over you can use to overpay the capital of the mortgage. This would be the ideal scenario because I'm assuming you're a high rate tax payer and so once you have used up your ISA allowance it's difficult to get savings plans or investments that beat mortgage repayments once you've deducted tax/capital gains.

I'm starting to wonder if I should add an S&S ISA into my own MFW strategy. Mrs Dither and I were given Standard Life shares and will shortly be receiving some more free ones. I was considering just cashing these in and then putting the cash onto the mortgage, but my pension is doing that well that I think it's worth a punt to combine the SL shares into a Self Select ISA in my wife's name (she's a basic rate tax payer so dividends are untaxed), and then add some more shares up to the 7k limit and then see how they do.

peterg1965

the last three responses are very interesting. Initially I would only have £10,500 to invest pa. Therefore, I would split the money 50:50 between myself and my wife in S&S ISAs, increasing as and when surplus money was available to the max 14K pa.

A further matter. I have an unfunded Scottish Equitable PPP. Contains all PR money, currently valued at £18K and aggressively invested in mostly higher risk SE external funds. I undertand that I cannot touch this until I am 55 (currently 41). Can I also use this in my MFW strategy? What can I do with this money to help reduce the mortgage? Do I have to wait till I am 55 to drawdown 25% of the fund to assist in paying off the mortgage capital?

Should I/Can I invest the £10,500 pa into this pension fund, thereby getting 40% tax relief (I am a higher rate payer) making £17,500 contribution per year. At a 10% annual growth this would net me £533K at 55, so what could I do with this to pay off the mortgage?

Edit. The only sticking point is whether I can opt to go for an Interest Loan on my Nationwide Mortgage now, whilst 6 months into a two year fix. Anyone know if this is possible before I call them?

jamesd

You would have to wait until you're 55 to touch the pension money. Then or at any later time you could take 25%, 133k, as a tax free lump sum and put the rest into drawdown, though you don't actually need to take an income from it. Then the other 400k would give you (at 5%) 20k of extra income, much of which would be taxed at 40%.

The drawback of using the pension is that it's taxable in retirement. You're already expecting 31k of pension income in your own name (perhaps plus state pension?) so you're in age allowance reduction (elimination) territory already. Close to being a higher rate tax payer in retirement. That strongly favors tax free income like that from an ISA. So using the ISA allowances fully and putting the 100k lump sum from the work pension into the mortgage repayment pot looks reasonable.

I'd probably first go with fully using the ISA allowances, assuming that your income will continue to rise and you'll be able to make the pension contributions later but won't be able to catch up on the unused ISA annual allowances.

Assuming that you can do it cheaply and predict the end it's not necessarily a bad idea to borrow for a few years to get the full ISA allowances now. It'll probably cost 5-10% but returns will probably be greater and you'll get the tax break long after the borrowing is repaid. Given 40k income and 3% increases each year the borrowing would last three years before salary increases due to inflation made it unnecessary and the borrowing would be repaid over the next few years.

If your wife doesn't have a pension yet I'd also probably go with contributing to hers before yours, until she has enough to expect to get 10,000 a year in pension income (about 200,000 needed). Most of that won't be taxable and allowances and income just above the allowances is less likely to be upset by future taxation changes than basic or higher rate pension income.

The ISA is far more flexible than the pension so it's good to have a substantial amount of it.

peterg1965

This is all very interesting. To answer some of James' questions, the £31K pension is at age 53 and at todays money. It doesnt include State Pension at 66 and I will hopefully generate another small pension after I retire from my current career at 53/55. There is a chance that promotion could get me £39K (£120K lump sum) at 55. I cannot bank on this. My wife has a nurses final salary pension (£4K at the mo) she is 44. My £100K lump sum (todays money) will be £135K in 12 years time at a 2.5% pa increase (presuming my salary goes up at that rate).

The pension investment is appealing because of the size of the sum generated (potentially) in comparison to the ISA funds. However I know it will be taxable at 40% or the prevailing 'high' rate in 14 years time. However my £135K Lump sum and the £130K drawdown tax free sum will pay off my mortgage capital and leave me with a pension pot of £400K to take when I needed it. The great unknown here is of course how pension legislation will change over the next 14 years together with taxation rules! I can only base decisions on todays rules and hope that will not change to penalise me in the future.

I think I am erring towards the ISA route, but these are only guaranteed until 2012 (I think) it would be a brave Govt to get rid of them! I have looked at the H-L Vantage ISA which is the way I would go to maximise fund choice and flexibility. Question now is whether I am actually 'brave' enough to go for it!

jamesd

If the Nationwide mortgage can't be switched to interest only another option might be using repayment holidays. If you're allowed three months a year that will get you the equivalent of 6.5 months interest only.

The previous time limit for ISAs has been removed. They now last until some future government decides to eliminate them.

peterg1965

I have contacted Nationwide and I can switch to an interest only mortgage at any time, even within the 2 year fixed rate deal that I am now on. That means I can now invest £850 per month from whenever I decide to switch over. I think I can reasonably increase this by £50 per month each financial year, so £900 (£10800- 08/09) and £950(£11400- 09/10) etc. is there a compound interest calculator which works out the total sum with increasing annual investment?

Now to decide whether to go down the ISA route or utilising my Scottish Equitable Personal Pension Plan (or would it be better to start a new SIPP with H-L?).

Before I actually take the plunge please tell me I am not completed mad!

jamesd

You're entirely sane and past and likely future results suggest that you will be significantly wealthier at the end of the exercise than if you stuck with a repayment mortgage. You will see significant ups and downs along the way.

I don't know of a calculator that handles monthly investments increasing each year, particularly not with a limit to the maximum investment. Spreadsheet time.

Whether the pension option would be best with the SIPP or PPP would depend on the availability of the investments you want, the quality of those available and the charges in each case. The SIPP would probably offer better options but at a higher price than the PPP from a discounting IFA and the IFA could offer SIPPs that are cheaper than Hargreaves Lansdown. If you like higher risk the SIPP is probably best; for lower risk, the PPP which can be had with lower AMCs and that matters more at lower returns.

Hargreaves Lansdown's ISA has lower charges than their SIPP, perhaps 0.25% a year, 4% over 16 years. If committed to using Hargreaves Lansdown that favors using their ISA until the later years, then if you want to use the pension, putting up to your annual salary into the pension each year to get the pension tax relief.

peterg1965

OK. If I went down the pension route and stuck with my Scottish Equitable PPP (for now anyway - I would review if/when the PR rules change to permit access to a SIPP) I think I could invest £1000/month Net. I would then pay and £1068 interest on my £255K mortgage. The pension funding would be £20,000 a year Gross. (I am a high rate taxpayer). Using a compund Interest calculator I would have a fund of £683,000 at age 55 with a 10%/year average increase. My PPP current value is £18,000 (PR) and is unfunded. At 55 I would use my tax free company pension lump sum (£126K (estimated) to pay down the mortgage capital) and part of the 25% PPP drawdown to pay the rest. That would leave me a large sum in my PPP pot as well as a very good occupational pension at 55.

Question is will be exceed the Lifetime Allowance for pensions and hence incur punative tax rates on the excess? If I dont, this scheme appears very attractive to me, although where does it leave my wife? I assume that if I died the PPP pension pot would be an additional 'life insurance' for her?

getmore4less

The other thing to think about with pensions is the spouse pension and the fact that the money dies with you. Also any draw down is coverd by rules.

With ISA income not only is it tax free but it continues after you have gone or if you desire/need to you can control your own draw down rates.

jamesd

peterg1965, calculating with 1666 per month for 16 years (until 55) I get 790,000 at 10%, 1.5 million at 16%. The test happens when you start drawing your benefits and I assume that includes when you take the lump sum, so at least you know what the target to avoid is.

My own inclination looking at the numbers is maximum ISA for each of you each year, 600 a month twice from next year, the excess into your pension. Then review actual investment performance in 5 years and decide where to go from there. By then the ISA use has added about 5% to the pension return needed to go over the lifetime allowance and getting over 21% return is unlikely, since that requires matching Warren Buffet's Berkshire Hathaway's 21.4%.