Surely Pension always beats overpaying mortgage

Wellgood

Want to check my logic here....may have got it completely wrong

So imagine I have £1000 and have to decide whether to pay into Pension or pay off mortgage

If I pay the £1000 into Pension AVC I have saved 20% Tax and 12% NIC as do it via salary sacrifice so in effect £1000 has cost me £680. This £1000 will then be invested and lets for arguments sake say yield 4% p.a = £40
(Note - I can take out AVC tax free as part of 25% TFLS)

Or instead I use this £1000 to pay off my mortgage (currently at 2.5%) then I would only have the £680 to pay off the mortgage as I will have been taxed on it. and I would save 2.5% on £680 = £17

Surely I am (£40-17) £23 better off paying into Pension AVC?

kidmugsy

Depends on whether your investment prospers or not. It's not remotely guaranteed to yield 4% p.a. Then when you draw the pension you get 25% tax-free (if that still exists) and pay tax on the other 75% - and there's no guarantee that basic rate tax will be as low as 20% in the future.

In other words, the pension option carries investment risk and legislative risk that the mortgage option doesn't. It's still tempting, of course, but you need to be aware of those risks.

bigadaj

So on your calculations you are around 0.25% per year better off, so compounding this should make a significant difference.

There's no guarantees, you won't make 4% every year even though that is a fairly conservative long term average, and your mortgage rate might rise in the future.

marlot

You can't get to your pension until 55.

You can lose your job. You can lose your home and get evicted. Decide to move somewhere else, perhaps for that next job. Perhaps when mortgage rules have just changed, making it hard to get that next mortgage.

Three of four the above happened to me, and it was useful to have the freedom of a small mortgage - it prevented the fourth.

I'm not saying don't invest in a pension - I've done that too - just make sure you have a balance.

[Deleted User]

Just to add...

Overpay the mortgage if you are...

Within sight of a better LTV rate
The mortgage outgoing is high e.g. pushed yourself to afford
Consider the impact of job loss, could you survive on one income
On a high interest rate
Will not clear mort by planned retirement date
How close to retirement

Although we have always paid extra to pension it was only once we were comfortable with the mortgage level did we divert the overpayments to the pension instead...

Cheers

AnotherJoe

As posts 4 & 5 point out, consider the flexibility. With a pension, your money is locked up. Much less likely to be so with overpaying on a mortgage. So it may end up being a mixture of both depending on your age.

Over62

Halve your lump sum and pay £500 off your mortgage and £500 into your pension. That way you have always done the right thing with half the money!