Overpay mortgage like mad & work on pension later?

Westminster

Hi

I'm married, 37 with 2 young kids (2 and 4) and have recently moved to a house which 'should' be more than sufficient space-wise until the kids move out. The house is worth 425k and I have a 240k mortgage (1.79% fixed offset till July 2017).

I've got a 34k Group Personal pension pot from an old job which has had no payments for the last 10 years.

I am just starting a 60k job in January where the employer will match contributions up to 5% which seems like a no-brainer to me so I'll stick my 5% in too.

This job will have CPI-linked annual rises and I should be looking at a promotion in 4-5 years to a salary in the region of £105k

My query is - I'm planning on trying to over-pay the mortgage like made to get rid of it in 6-7 years (we have around £2600 spare per month after all outgoings). Once that is gone then I will look into investing for retirement.

My thinking is that I would REALLY like to be mortgage free and I would anticipate that the penalty in lower pension are offset by reduced housing costs etc.

Any thoughts?

dunstonh

The issue is one more to do with behaviour and feeling than financial benefit. Although there are some financial benefits. Some stronger than others.

Chances are the returns on your pension will exceed the mortgage interest. Maybe not a lot depending on your risk profile but the longer the term, the better monthly contributions get averaged out. (the average returns over 15 years (so through the credit crunch) are over 5%. So, you would be clearing a debt costing you 1.79% by not paying into something that has a long term average of around 5%)

As you are a higher rate taxpayer then you get 40% tax relief. That may not always be the case as a single rate of tax relief or even complete removal of tax relief have been mooted as possible future options. They may not happen but if they do, you would have missed out on that by delaying. So, currently, every £100pm of pension contribution is costing you just £60.

You also mention you have children. As you are earning over £50k, then the child benefit is reduced. Pension contributions reduce your income and this could increase the amount of child benefit paid to you.

Cost of delay. Every year you put off paying into a pension (or pay less than you should be) means that when you do start, the monthly cost will be higher.

When you get your income just above £100k, then you want to be looking at pensions due to the personal allowance reduction. You can use the pension contribution to bring your income below £100k and prevent your personal allowance from being reduced/removed.

Onto behaviour... It is very easy to say that you will be £2600 better off and that you can increase your pension. However, how much of that would you allocate to the pension? The delay may mean you have to pay a big chunk of that for the next 20 or so years to hit your target. Will you be prepared to pay that?

Remember that in future years you are going to have a lifestyle that is used to an income of over £100k. So, by the time you get to retirement, you are going to want an income to support that lifestyle. That means putting more aside. It is highly unlikely you will need anything like £100k but you will need more than typical if you dont want to take a lifestyle hit. Will you be prepared to pay for that?

Either method works. You just need to be disciplined and realise that of that £2600 you will save, you are likely to have to put a fair chunk of it into the pension and not just a token amount.

Personally, I have spent the last 8 years (since credit crunch) heavily overypaying the mortgage at the expense of my pension which has had a much lower amount than I should be paying. I will be mortgage free in two years. I was a higher rate taxpayer for most of that period. I am now switching to a limited company and will shortly no longer be a higher rate taxpayer and my pension contributions will only get 20% relief (and no NI). So, financially and with hindsight, I would have been better off paying more into the pension. My pension returns have been higher than the 2.5% interest on the mortgage. However, psychologically, I feel a lot better having the mortgage cleared.

The best financial option is not always the best option. The option that makes you most comfortable can be the best option.

Westminster

Thanks for the insight - clearly personal attitudes to risk etc play heavily on what may or may not be a 'good' decision.

I hadn't appreciated that pensions contributions could lower your effective income for the purposes of child benefit eligibility.

I had formulated this plan before the new pensions freedoms were announced so perhaps making more use of the 40% tax relief would be sensible.

As far as lifestyle is concerned - its very tricky to say what my/our future attitudes will be. I've been remarkably (well remarkably to myself at any rate) restrained on spending what I earn. I do get close - particularly window shopping on autotrader etc - but I still buzz around in my 12 year old car which does the job and sails through its annual service at the local garage so until that dies I am trying to restrict myself just to looking at new cars rather than splashing out.

I've previously had pretty heavy issues with debt which, while hard at the time, do seem to have instilled a long-term change in attitude towards money and generally being used to spending only what we need and seeing all my excess money going towards paying down the debt. I was able to successfully transition that to overpaying my current mortgage to the point where I am now and I don't ever want to be in the position again where I stop opening my post, don't answer the phone or worry about being repossessed etc.

So in theory, I can say that I am used to not having that £2600 burning a hole in my pocket so yes I will be willing to put a substantial chunk towards a pension - who knows if I will stick rigidly too that though ;-)

It's certainly all food for thought.

xylophone

I hadn't appreciated that pensions contributions could lower your effective income for the purposes of child benefit eligibility.

http://www.aviva-for-advisers.co.uk/site/public/tech-centre/tech-article-detail/child-benefit-charge-planning

http://www.moneyobserver.com/opinion/how-to-avoid-child-benefit-charge

Have you looked at the charges on your old pension? Are they cheaper on the new? If so, would you wish to consider transferring the one into the other, if possible?

Westminster

Indeed I have looked at the charges and they seem pretty favourable in my old scheme.

I did try to get my current auto-enrolled employer contributions to be paid into that one (they are both with Standard Life) but didn't seem to get anywhere with HR. No idea yet if the new employer will be more accommodating.

The auto-enrolled fund is SL MF Mgd IIIP which has total annual charges of 1.334%

The older pension (unsure on fund - should have asked) is 1.02% but has a discount of 0.272%: so total annual charges 0.748%

I will be transferring what little has accrued in the auto-enrolled pot into my older / lower fees pot.

dunstonh

I did try to get my current auto-enrolled employer contributions to be paid into that one (they are both with Standard Life) but didn't seem to get anywhere with HR. No idea yet if the new employer will be more accommodating.

To do that would require you to be classified as an opt out and for the employer to face additional administration and cost to them to pay into your individual scheme.

The auto-enrolled fund is SL MF Mgd IIIP which has total annual charges of 1.334%

That would indicate that you have chosen a higher charged fund. The defaults would be lower than that with the 0.75% cap. So, you are probably not comparing like for like.

Happier_Me

Hi Westminster

I'm 40, married, kids older than yours but still primary school age. I became mortgage free for a short time at 31 then upsized.

I very much like the idea of being mortgage free again and have for a number of years been overpaying my mortgage. I know I could probably earn more by investing.

My aim is to be financially independent and have the option to retire early. I stopped overpaying when it occurred to me that once I become mortgage neutral (mortgage - savings = zero) I would then have to save an emergency fund, spend some serious money on the house (it's been a little neglected), upgrade the car (unfortunately my husband will not drive round in a 12 year old car), etc etc etc. Put simply my hard work is far from done at the point I could become mortgage free!

I still pay more than I need to on my relatively small mortgage and so I will be mortgage free by May 2020 in a house worth around £350k. But by that time I will have a six figure sum saved too. I contribute to a good pension scheme.

I do not pay 40% tax (I now work 4 days a week) but I came close to that bracket last year. Had I continued in that job I would have paid as much as I needed to into a pension to avoid paying ANY tax at 40% and to safeguard my child benefit.

I would seriously consider doing the same in your position. Let's say you need to pay an extra £4k to take you below the 40% tax threshold (it's probably closer to £12 to £14k) - that would reduce your monthly take home pay in simple terms by £200. Yet your pension gets a £4k boost! £3k + £4k into your pension reduces your earnings from a child benefit point of view to £53k so you would benefit here also. I'm sure someone will come along and 'tinker' with my figures!

With £2600 spare a month I would lose some of that into a pension to avoid higher rate tax.

Linton

The answer to any financial either/or question is often "both". Pay more than you need to into your mortgage if it makes you happier but also put as much 40% taxed income you can into a pension.

mgdavid

What overpayment regime does your mortgage allow? Any extra amount at any time, or maybe just one lump sum per year, or something in between?
For as long as it's available I'd be maxing pension contribs to get the 40% HRT added to it. It's effectively FREE MONEY.
If the tax rules change a few years down the line (as rumoured) then you can re-evaluate the maths and change your strategy then.
If your mortgage rate for some unforeseen reason goes up a lot after July 2017 then also re-calculate at that time.

Westminster

Its an offset so unlimited overpayment (and drawdown) so we use it like a savings account with 6+ months of outgoings sitting in the offset account.

Westminster

So playing around with http://www.listentotaxman.com/ - can someone confirm if I have this right.

With £124pm childcare vouchers and a 60k salary I would net £3438.75 pm

If I then contribute £1000 pm, I only lose £600 from my net income (making it £2838.75) and HMRC adds another £400 to make a total monthly contribution of £1000?

Can all this get done as PAYE or do I have to do some kind of self-assessment claim at the end of the financial year?