Pension or mortgage overpayments?

Babbacheez

Hope someone can help, thanks in advance.

I have also posted this on the mortgage forum, as includes both topics.

Since turning fifty this year I have become obsessed with the thought of paying off our mortgage, we currently owe £150,000, and are in a ten year fixed deal, with nine years to go, at a rate of 2.45%, and have found it fascinating entering different amounts into my lenders mortgage calculator and seeing the debt decrease, we currently overpay £400 a month.
My wife is a 40% tax payer, and from next year will receive an annual bonus of around £20,000, our first thoughts were to use that money each year to overpay on the mortgage, but would get hammered by tax, I mentioned this to a colleague who suggested paying it all directly into my wife’s pension, she has a dc pension, also I am due to start a dc pension in January after being in a db for thirty years, with a pot of worth around £400,000, I currently also pay £350 into avc’s a month. I am a 20% tax payer.

My colleague also suggested stoppping our mortgage overpayments in January and put that into our pensions through our employers and also the £350 that I was paying into avc’s into my pension, then when reach 55 I have the option of using a 25% tax free sum from my pension to pay a very large chunk or even clear the mortgage.

Is this achievable? Do I need to buy my colleague a pint?

Dox

Being obsessed with something never helped clarity of thought! Do some detailed sums and work out what the financial outcome might be (albeit based on a number of assumptions), then see how far your obsession holds...

kidmugsy

At what age do you plan to give up work?

Babbacheez wrote: »

Since turning fifty this year I have become obsessed with the thought of paying off our mortgage, we currently owe £150,000, and are in a ten year fixed deal, with nine years to go, at a rate of 2.45% ... we currently overpay £400 a month.

My wife is a 40% tax payer, and from next year will receive an annual bonus of around £20,000 ... a colleague who suggested paying it all directly into my wife’s pension, she has a dc pension

It's likely to be an excellent idea for your wife to contribute enough to pensions to let her avoid 40% tax.

Babbacheez wrote: »

I am due to start a dc pension in January after being in a db for thirty years, with a pot of worth around £400,000, I currently also pay £350 into avc’s a month. I am a 20% tax payer.

Once you've contributed enough to the new DC scheme to guarantee the max employer pension, contributing more isn't especially appealing UNLESS you can do so by "salary sacrifice" aka "salary exchange", "smart pension".

Babbacheez wrote: »

My colleague also suggested stopping our mortgage overpayments in January ... then when reach 55 I have the option of using a 25% tax free sum from my pension to pay a very large chunk or even clear the mortgage.

That could work if your employer's scheme lets you withdraw your 25% TFLS while remaining an active member of the scheme and still contributing to it. Some schemes allow that, some don't.

Suppose that your scheme doesn't allow that. Suppose further that it doesn't offer sal sac. Then your best bet might well be (1a) your wife contributes enough to her pensions to avoid 40% tax, (1b) you contribute enough to yours to gain the max employer contribution, (2) if you still have spare money every month overpay the mortgage at as high a rate as possible without triggering penalties, and (3) if you still have spare money after that every month, contribute it to your own pension.

ex-pat_scot

A couple of thoughts.


In general, it makes sense to maximise your pension contributions ahead of pension overpayments.


You need to consider each of your circumstances separately, then together.


Firstly - your wife.
What is her current pension value? DC & DB? How old is she? When does she want to be financially independent / retire?
If she is of similar age, and has enough headroom to contribute as much as she wishes and still remain under projected LTA, then she is a prime candidate for pension contribution.
All contributions at HR tax (from April 19 = £50,000) would attract pension tax relief at 40% / 42%.




IF she anticipates being a BR taxpayer in retirement (likely, unless she breaches LTA or chooses to withdraw at an accelerated rate), then her marginal tax she will suffer when accessing the pension will be 15% (20% basic rate, and 25% as tax free element).


This means that, even without employer contribution, getting tax relief at 42% / 32% then paying tax later at 15% is a pretty decent approach.


Secondly - yourself.
Under sal sac, you will get 32% tax relief, then suffer 15% net tax on pension withdrawal (assuming BR taxpayer in retirement). That's a pretty decent benefit, and any employer contribution will also increase it.


Thirdly - what's the long term game plan?
If you are both going to retire simultaneously, convert all money to DC pots, and draw down at BR, then clearly there's a greater benefit in maximising the employer matching, then taking full advantage of wife's HR relief.
(if she's contributing down to below the HR threshold, then you both would be getting the same tax relief, so it would then be better to fill up the pot of whoever has the smaller pot).


What if your strategy might be to keep the DB scheme?
In this case, if you want to retire early then the penalty (actuarial reduction factor) is quite costly. This means that a sensible strategy is to use DC money first and leave the DB untouched until normal retirement age. This would thus require a good amount in DC funds to bridge the gap between 55 and scheme NRA.
For you, if you stop at 55 and have a scheme NRA of 60, and want to keep your DB pot, then you will want a DC pot of at least £62,500 (in today's money) by age 55. This would allow you simplistically to withrdaw £12,500 a year ie to use up your personal allowance ie you would pay no tax on it at all. In this example, you would get 32% tax relief on contributions and pay no tax at all on withdrawal.
Your challenge would therefore be to focus the next 5 years on building a DC pot up to at least £62,500. That would be (very roughly) £800 per month gross contributions.


Finally - what to do about the mortgage?
I understand the desire to free yourself from the burden / risk of £150,000 outstanding.
Traditionally, the 25% tax free cash element to your pension can be used to this effect.
Current thinking is that paying off the loan might not necessarily be the "no brainer" - if your pension investments are growing at 5% pa long term and loans are running at 2.45% then financially there's no sense in rushing towards paying off.
Clearly rates may not remain at that level; your ability to borrow in later life might be limited; other life events may change your world. Once you get to 55, then you can access your pension (and its tax free element) at any point, so you have a built in hedge.


What are the risks?


the main ones are political. You are still 5 years from earliest access to pension. That might change. Unlikely, but it's a possibility.
The tax free cash element 25% might go. There would be outrage, but again it's a possibility.
NI might start to be chargeable on pensions. Again unlikely.
Pension tax relief is more likely to be a target - and would be more of an impact on your wife's HR tax relief. It might also restrict the amount you can save.
Lifetime allowance may well change again. You might end up being over the LTA, in which case there would be fixed protection for your existing funds and you could then choose to divert the money against mortgage rather than pension.


I've made lots of simplifications and assumptions, but you should take away the general picture that HR tax relief is really valuable over the mortgage payments, and even BR relief under sal sac can be very valuable to you.

saucer

Having just turned 50 myself I am in a very similar position to you. Similar mortgage, though lower interest rate. We have decided to completely prioritise pension contributions over mortgage repayment for the reasons outlined above, particularly by ex-pat scot . I am happy to go with not running down the mortgage capital on the basis that we will have TFLS, some investments and other pension savings to cover it when the time comes. This will be, like you on top of DB schemes and the security these bring.

Kit_Katt

If you are A HR tax payer and in a steady job id max out on pension contributions looking at both you and your wifes situ.

If job security is uncertain take a view on how much cash you have to see you through a rough patch till landing the next job. Id throw money at pension but get mortgage to a manageable level that doesnt hurt you if you were out of work.

Take a look at health forecast over the next 10 years. This is a long ride and have an eye on when you might want to exit the working world .

MEM62

Kit_Katt wrote: »

If you are A HR tax payer and in a steady job id max out on pension contributions looking at both you and your wifes situ.

If job security is uncertain take a view on how much cash you have to see you through a rough patch till landing the next job. Id throw money at pension but get mortgage to a manageable level that doesnt hurt you if you were out of work.

Take a look at health forecast over the next 10 years. This is a long ride and have an eye on when you might want to exit the working world .

I am sure the OP came to a decision a long time ago since this post is nearly 6 months old.

atush

It doesnt make sense to me to use her bonus to overpay. AS you would pay at least 40% tax on that money.

But if you pay basic rate, after maxing your pension contributions to get the most from your employer- overpay with that.

And/or do a full MSE and any savings made use to overpay.