Dilemma: Pay off mortgage or salary sacrifice into pension?

GazzaBloom

Hi,

I am 53 and I am faced with the classic dilemma, pay off mortgage or salary sacrifice extra money into pension then pay off mortgage with tax free lump sum when I start drawing down pension.
I am fortunate enough to have surplus income to allow me to pay off debts early and I am clearing higher interest loans first and from February 2021 will be able to overpay my last remaining debt, the mortgage, which I could clear in March 2022.

Through 2021 I will overpay £22K and through 2022 I will overpay £13K to clear the mortgage. However, if I salary sacrifice that money I will have 1.53 times that amount paid into my pension as I'm a 40% tax payer and my company will pay the 13.8% NI contributions into my pension too. I calculate that the pension amounts paid in would be £34K in 2021 and £20K In 2022 but I would have a mortgage balance of £35.5K and the end of the same period.

I pay 1% above base interest on my mortgage so 1.1% currently, it's peanuts in interest, balance of mortgage today is just over £44K and house value is circa £220K. My pension is in 100% equity/stocks mutual funds that have annualised average returns of around 12-14%. The pension is still down this year due to the March/April stock market downturn but has mostly recovered but still around 6% down on end of 2019 value even after regular monthly payments totalling £7K to date. I'm confident the pension will fully recover and go on to make gains either later this year or next year.

So, my dilemma is, do I pay off the mortgage and be guaranteed debt free in March 2022 or pile into the pension via salary sacrifice, benefit from the extra 53% that will be paid in and let the stock market do it's thing, hopefully fully recover and make gains on the extra money I put in? The unknown is how much gains or losses will be incurred in the pension during 2021 and 2022 but if the pension funds perform to historical average I calculate I could be £23K better off by paying into my pension...if the funds perform. They would have to perform extremely poorly to lose all the extra 53% paid in.

So, it really comes down to the surety of being debt free in 20 months time and then have plenty of surplus income that I can shovel into my pension thereafter until I have enough and then hopefully retire early, or, pile into the pension from next year, leave the mortgage, carry the debt and pay off whatever the balance is by taking a tax free lump sum when I decide to retire. I'm targeting retirement in 4-5 years, at age 57-58 and should hopefully have enough in the pension by then either way but may be better off if I target the pension now rather than the mortgage.

Instinctually, I really like the idea of being 100% debt free in March 2022, it will feel like I have gained a lot of financial freedom and be a lot less dependant on my current salary level but financially it seems to make more sense to carry the mortgage debt.

Are there any other angles I haven't considered here? Any thoughts?

 Cheers

mark55man

you have basically summarised (very well) a long standing debate on here
* The financial view is that especially as a HRT, not very far from being able to access pensions so not locking anything away for too long the pension is the thing to do by a clear margin
* Others would say the joy of being totally debt free, not just CC an loan free but mortgage fee is worth paying

I believe in the saying time in the market not timing the market so I am mainly in the former camp, but when I remortaged last I did shorten the term a little so a little in the second.  I do find hardcore MFW a little unbalanced - its not the only thing by a long way you should focus on

Only you can choose - how much free money are you happy to give up to achieve your MFW goal early??

Bemma

I think you've done your SS a disservice, by calculating the 53% benefit incorrectly.  It's larger than that.

£1 gross SS into your pension: Cost: £1 - 40% Tax - 2% NI = 58p

Add 13.8% employers NI contribution: £1.138 costs you 58p net. So 96% immediate uplift.  So nearly double!

You need enough 40% tax head room otherwise part of the payment will only save you 20%Tax/12%NI, but even then:

Cost: £1 -20% Tax - 12 % NI = 68p

£1.138 cost 68p net.  So 67% uplift.

So even if you SS down to the 20% tax bracket, the benefit of your SS is still larger than your 53% calc.

Over paying your mortgage may give you a physiological boost, but increasing your SS will give you a financial boost.

I'm strongly in mark88man's first option camp, particularly if you have SS and get employers NI

GazzaBloom

mark88man said:

you have basically summarised (very well) a long standing debate on here
* The financial view is that especially as a HRT, not very far from being able to access pensions so not locking anything away for too long the pension is the thing to do by a clear margin
* Others would say the joy of being totally debt free, not just CC an loan free but mortgage fee is worth paying

I believe in the saying time in the market not timing the market so I am mainly in the former camp, but when I remortaged last I did shorten the term a little so a little in the second.  I do find hardcore MFW a little unbalanced - its not the only thing by a long way you should focus on

Only you can choose - how much free money are you happy to give up to achieve your MFW goal early??

Thanks for the reply - what is HRT and MFW..??

GazzaBloom

Bemma said:

I think you've done your SS a disservice, by calculating the 53% benefit incorrectly.  It's larger than that.

£1 gross SS into your pension: Cost: £1 - 40% Tax - 2% NI = 58p

Add 13.8% employers NI contribution: £1.138 costs you 58p net. So 96% immediate uplift.  So nearly double!

You need enough 40% tax head room otherwise part of the payment will only save you 20%Tax/12%NI, but even then:

Cost: £1 -20% Tax - 12 % NI = 68p

£1.138 cost 68p net.  So 67% uplift.

So even if you SS down to the 20% tax bracket, the benefit of your SS is still larger than your 53% calc.

Over paying your mortgage may give you a physiological boost, but increasing your SS will give you a financial boost.

I'm strongly in mark88man's first option camp, particularly if you have SS and get employers NI

Yep you're right, just looked at that again using a little model I built in a spreadsheet. If I salary sacrifice £1600 per month of take home pay, my calculator shows £3,273 going into the pension per month.

Paul_Herring

what is HRT and MFW..??

Higher (40%+) rate taxpayer.

Mortgage Free Wannabe

Thrugelmir

How secure is your employment? 

GazzaBloom

Paul_Herring said:

what is HRT and MFW..??

Higher (40%+) rate taxpayer.

Mortgage Free Wannabe

:-)

GazzaBloom

Thrugelmir said:

How secure is your employment? 

That's a great question. I started on this debt free journey after being made redundant for the 2nd time in my life in February 2017. Luckily, I was offered alternative employment and after a year of being fed up decided to really knuckle down and try and get debt free so should it ever happen again I would be less dependant on this salary level, as I'm well paid and would struggle to find anything like this salary locally.

The business contracted globally and sold off a large portfolio of overseas assets, hence my redundancy as I was in a global position at head office. Now I am employed in the UK division and they are doing well and I feel relatively secure for the next couple of years at least.

Being bitten by redundancy previously is why my instincts tell me to pay off the mortgage and get debt free but the salary sacrifice numbers are tempting and there is huge benefit to shovel it into the pension. £1600 a month off the mortgage vs £3200 into my pension

I guess March 2022 isn't that far away and if I stick with paying off the mortgage and getting debt free, I can pile in even more into the pension thereafter.

Bemma

It is possible to do even better, but depends on other factors.

Are you paid the same every month, i.e. do you get occasional bonuses etc?

Do you claim child benefit?

 

It is possible to pay 40% and 12% NI, if for example your bonus pushes your annual salary sacrificed pay into HRT, but your non bonus monthly pay is below £50k/12.  Also, If you salary is greater than £50k, there is a claw back on child benefit (10% first child 8% subsequent children, roughly).

I trigger both of these things, adding this all together with 2 children and 7% employers NI (I don't get it all):

40% tax +12% NI + 18% = 70% effective reduction.

£1.07 in my pension costs me 30p == 257% uplift, so for £1 SS I get £3.57 in my pension.

Only part of my salary fits this amazing uplift window, but it would be silly for me to use this money to over pay my mortgage.

GazzaBloom

Bemma said:

It is possible to do even better, but depends on other factors.

Are you paid the same every month, i.e. do you get occasional bonuses etc?

Do you claim child benefit?

 

It is possible to pay 40% and 12% NI, if for example your bonus pushes your annual salary sacrificed pay into HRT, but your non bonus monthly pay is below £50k/12.  Also, If you salary is greater than £50k, there is a claw back on child benefit (10% first child 8% subsequent children, roughly).

I trigger both of these things, adding this all together with 2 children and 7% employers NI (I don't get it all):

40% tax +12% NI + 18% = 70% effective reduction.

£1.07 in my pension costs me 30p == 257% uplift, so for £1 SS I get £3.57 in my pension.

Only part of my salary fits this amazing uplift window, but it would be silly for me to use this money to over pay my mortgage.

No child benefit claimed. Kids are 17 & 18 now anyway. I agree that SS make the most financial sense but as Thrugelmir mentions above job security has to be a consideration, also health.