Invest or pay off mortgage

colesy

I moved house just under 4 years ago and borrowed an extra £100k to move up the ladder. I've just paid off the extra borrowing 6 years early. That leaves me with the original mortgage that I ported to the new house, which is just over £80k with a little over 6 years left on an old Nationwide 2.5% SVR.

My pension is now being fully funded and I have about £1.5k every month left over. I have adequate rainy day funds and am a 45% taxpayer. So, invest the £1.5k or continue with mortgage overpayments?

atush

How is your pension fully funded? What do you mean?

The state pension (ie you have 35 years) or you have put 1.2 million into your pension fund? Or you have put enough years into your FS/DB pension that you can't gain more? Avcs maybe?

If you aren't talking no2 above, i'd be paying enough to take myself out of higher rate tax. Then i'd be putting half of what is left into pension and the other into S&S isas.

jamesd

By your pension being fully funded do you mean that you are now hitting the lower of £40,000 or earned income in a year limit on pension contributions that qualify for tax relief, or that you will hit the lifetime allowance if you make more pension contributions?

If you're not already hitting those limits then pension contributions seem like a good idea since once you reach 55 you can use those to clear the mortgage, having gained from the pension tax relief.

Paying off a mortgage isn't very attractive given that the long term average return of the UK stock market has been around 5% plus inflation, perhaps 8-9% total.

Given your apparent income and ample resources, have you considered using some VCT investing? You'll get 30% tax relief from HMRC, claimable through a higher personal allowance after you've bought, or via self-assessment if not in PAYE. Tax relief is capped at the income tax actually paid in the year. The 30% must be repaid if you sell within five years. Income is tax free and no CGT. Incomes in the 7-9% range can be had after allowing for the effect of the 30% reduction in purchase price. You can usefully run a fair part of your income through VCTs with a plan to take out the money in perhaps 8-10 years. Not five years because much of the returns from the lower risk types comes from income and there's a fair chance of a capital loss or break even if you sell as early as possible

Given your tax bracket the untaxed income may be of particular value to you once you've invested enough so that it can meet your spending needs.

Do pay attention to diversification, though, both within VCTs and among other investments. No more than 20% of your assets in VCTs is likely to be appropriate, and no more than 5% in any one VCT.

Investing within an ISA is another option but somewhat less attractive on the tax relief side provided you have sufficient diversification already. If you don't, make use of the ISA as well as more limited VCT use, perhaps.

colesy

By fully funded I mean that I'm putting £40k net into my pension and have no carry over to use up. Although I have a small amount in a S&S ISA, my focus over the past few years has been on the pension and the mortgage and investing in my business. While the business has always given me a decent income, it's only in the last few years that's it's taken off big time and allowed me to have significant excess funds.

Daniel54

If it is possible or likely that you will be a higher rate tax payer in retirement,I would put any any surplus into an S & S ISA ,on the basis that you are sheltered from CGT and from income tax when you came to draw down on it .Also well worth thinking of an ISA for your wife,if you have one.

I hesitate to disagree with Jamesd ,who provides valuable advice,but I have always avoided VCTs as have felt they are too much the tax tail wagging the investment dog,unless you really understand the underlying investment

jamesd

OK. Given the level of pension contributions and limited ISA use so far I don't think that you have enough diversification yet to fully use the VCT route for all of the money.

Total annual investments look like £40,000 pension plus this £18,000, so £58,000 total.

What I suggest you consider is £5,000 into one VCT and the remaining £13,000 from the £18,000 into a S&S ISA and invest within that to get a good amount of diversification. You'd get £1,500 tax relief from the VCT initial tax relief and you can then put that £1,500 into the ISA to raise that use to £14,500, close to the ISA limit. Your split then would be:

Pension: £40,000, 69% of the £58k
ISA: £14,500, 25% of the £58k
VCT: £3,500 (after the tax relief), 6% of the £58k

I'm assuming that in future years your income level may increase and you'd then find it useful to use more VCT investing so I'm somewhat interested in you starting to get some experience with VCTs now so you can consider whether you do or don't like them.

A higher risk approach would be more VCT use and only the VCT tax relief going into the ISA. That would look like this:

Pension: £40,000, 69% of the £58k
ISA: £5,400, 9% of the £58k
VCT: £12,600 (after the tax relief on £18k of purchases), 22% of the £58k

I think that's too high for initial VCT use so even if you're keen I think that you should really start with no more than £10,000 before tax relief split between at least two VCTs or £15,000 split between three.

Overall, though, I suggest you go for the first mix to get some VCT experience while mostly using the ISA limit. Then you'll be better placed to possibly increase the VCT use in future years if your income allows.

jamesd

Daniel54 wrote: »

I hesitate to disagree with Jamesd ,who provides valuable advice,but I have always avoided VCTs as have felt they are too much the tax tail wagging the investment dog,unless you really understand the underlying investment

They certainly can be that but they are fundamentally very small company investments probably not unlike colesy's own business now or in a few years. Along the way they transform capital into tax free income. Still something to only use at an appropriate level in a well diversified mixture, though. I'm most hesitant about the limited diversification here.

colesy

jamesd wrote: »

I'm most hesitant about the limited diversification here.

Jamesd - I appreciate your comments but I'm a little confused about the use of the term 'diversification'. Could you clarify? In my perhaps rather naive way, diversification suggests having an appropriate mixture of investments, in your pension fund for example, but I'm not sure that's exactly what you mean here.

jamesd

That is what I mean by diversification here.

VCTs by their nature invest in micro sized companies, below the small company size that features on stock markets, with a maximum of £5 million received from VCT funding by each company. There's only so much of your investments that can be in that part of the company size distribution without becoming excessively focused there.

Personally, given my own investment risk tolerance, 20% or 25% wouldn't bother me if I thought the investments were OK but I don't know your own risk tolerance.

I don't know the total size of your pension pot so far but I've assumed it's not much larger than a few years of £40,000 a year. So I worked out the percentage split based on ignoring the existing pension investments. You could do the same calculation based on the real size of your pension pot to see what the VCT percentage would be at various investment levels.

kidmugsy

jamesd, you've obviously thought a good bit about VCTs. Do you have any views on EIS and SEIS investments?

jamesd

The CGT relief can be useful and maybe the potential returns from really carefully selected companies for investors who understand that perhaps one in three will fail with a total loss.

Mostly, though, those are so far beyond what would be meaningfully useful to me or most posters here that I just haven't looked enough at the qualify of the underlying investments so it'd be foolish for me to write much. Both at work and personally I try to remember that one secret to appearing to know everything is to know when to say nothing.