Repay BTL mortgage with pension lump sum or sell?

gunnag

I have owned a BTL house for many years which has an interest-only mortgage of £185k (approx. 45% of the house value). The monthly rent is £1450, and I have very good tenants.

The mortgage is on a 5-year fix, which ends in 12 months, so I will need to remortgage at a much higher rate next year, so I'm now considering what to do. 

I'm 63 and have a final salary pension from a previous company, which I have to take at 65, or I could take now with slightly less income. 

I'm still working and will continue to work for the next few years, I'm a 40% tax payer so I'm paying as much as I can into another pension. In future I hope to work less days to take me out of the 40% tax bracket.

One option is to take some or all of the 25% pension tax-free lump sum and pay off the majority of the BTL mortgage; the only other option I see is to sell the house and re-invest the profit (minus CGT tax) elsewhere, perhaps put it into my current pension.

Currently, my BTL profits are suffering because I'm a 40% tax payer but this would change if I reduced my hours.

Any thoughts or ideas on how best to proceed would be appreciated. I guess I should really talk to an accountant/financial advisor, and will do that later after gathering as much info as I can.

xylophone

You have checked your state pension forecast?

https://www.gov.uk/check-state-pension

In view of the fact that you have generous DB provision and other pension provision, and assuming that you are happy with being a

landlord, using the PCLS to pay off the mortgage seems to me well worth consideration.

You intend to continue to work at least up to SPA  and could be entitled to tax relief on pension contributions up to age 75.

See https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm044100

It would be a relief to be free of an interest only mortgage?

Marcon

gunnag said:

One option is to take some or all of the 25% pension tax-free lump sum and pay off the majority of the BTL mortgage; the only other option I see is to sell the house and re-invest the profit (minus CGT tax) elsewhere, perhaps put it into my current pension.

Have you checked that your DB scheme pays 25% as a tax free lump sum? Some do, but unlike defined contribution schemes it isn't automatic - it's down to the rules of each individual scheme.

I don't know how much your earnings are and/or what you envisage the profit will be if you sell, but are you sure you'll be within the appropriate contribution limits to obtain tax relief? You may be able to use carry forward https://www.moneyhelper.org.uk/en/pensions-and-retirement/tax-and-pensions/carry-forward but remember that you'll need to have enough 'relevant earnings' to cover ALL your pension contributions in the tax year you make a bumper contribution. More info: https://www.litrg.org.uk/pensions/paying-pensions/tax-relief-pension-contributions

Hoenir

gunnag said:

The mortgage is on a 5-year fix, which ends in 12 months, so I will need to remortgage at a much higher rate next year, so I'm now considering what to do. 

If interest rates were to remain in the ball park they are today.  Would they have a significant impact on your after tax return? 

What's the net yield on the property after all expenses , tax is accounted for. I assume that you've a sinking fund put aside for longer term expenditure. 

If you sold the property now you've still time to recycle some of the capital back into your pension scheme. 

gunnag

Thanks for the comments, as I have a young teen daughter to support, its more than likely that I will be working up to and beyond SPA and paying off some or most of the interest-only mortgage seems like an attractive option.

My final salary pension provider has an online calculator which presents me with various options, including taking the full 25% lump sum with a reduced monthly payment, or a smaller lump sum with a bigger monthly payment. I'm also able to choose between monthly payments which have a reduced yearly pension increase or the full RPI/CPI increase.

If I sell, I envisage the net profit after CGT, mortgage repayment etc. would be around £160k, I will have to check the rules to see how much of this I could pay into the current pension over the coming years.

What I'm trying to work out is how to get the most tax efficient income in the coming years using a combination of working, BTL investment and pensions etc. Its all very complex, I wish there was a spreadsheet I could just enter everything in and see what outcome the various scenarios generate !

Hoenir

One non financial factor is do you want the hassle of managing the property into your retirement years. Your existing tenants may well move on at some pont in time. 

gunnag

Agreed, one factor in my decision is that the tenants are a family and have been very good over the last 6 years, and the managing agent seems to do a good job as well.

I think if the current tenants were to move, then that would would likely mean I would sell up.

Albermarle

I'm 63 and have a final salary pension from a previous company, which I have to take at 65, or I could take now with slightly less income. 

Sometimes you can defer these pensions beyond the Normal Retirement age and the pension will revalue upwards for each year you delay ( the opposite of taking it early and having a smaller pension). 

However AFAIK this is not the norm and normally if you do not take the pension at 65, you will lose out. It will increase by inflation or similar but you will still lose out. Anyway worth checking what the rules of your scheme are. 

poseidon1

gunnag said:

Thanks for the comments, as I have a young teen daughter to support, its more than likely that I will be working up to and beyond SPA and paying off some or most of the interest-only mortgage seems like an attractive option.

My final salary pension provider has an online calculator which presents me with various options, including taking the full 25% lump sum with a reduced monthly payment, or a smaller lump sum with a bigger monthly payment. I'm also able to choose between monthly payments which have a reduced yearly pension increase or the full RPI/CPI increase.

If I sell, I envisage the net profit after CGT, mortgage repayment etc. would be around £160k, I will have to check the rules to see how much of this I could pay into the current pension over the coming years.

What I'm trying to work out is how to get the most tax efficient income in the coming years using a combination of working, BTL investment and pensions etc. Its all very complex, I wish there was a spreadsheet I could just enter everything in and see what outcome the various scenarios generate !

An important issue that currently decimates your net profit after tax from your BTL investment is the effect of section 24. As a higher rate tax payer you are restricted to just 20% of your mortgage interest payments as tax relief against your property income. 

As you say, once your current fixed mortgage expires , a new one would likely be at a noticeable higher rate, with even greater impact on your net profit as a result of section 24.  Paying off all or a large chunk of your mortgage would mitigate substantially the injustices of section 24 whilst you remain a 40% taxpayer.

Perhaps a way to look at your options is to compare what bank interest income you could generate on potential net proceeds of sale of £160,000 ( say £160k at 5% = £8k) , compared to your increased rental profit by  retaining the property with a much smaller or zero mortgage. Yes, you are still paying 40% income tax in each scenario, but if your net rents are noticeably higher than what you could earn risk free on bank deposit, than that seem to favour hanging onto the property.

Also bear in mind retaining the property going forward, any gains are erased on death for cgt purposes, although iht maybe in point depending on the  overall value of your estate.

Finally for completeness, selling the property would free up cash to  maximise funding of ISAs ( if you are not already doing so), and the ability to generate a growing tax free income from that option is worth a thought. Perhaps a half way house of mortgage reduction and isa funding might be worth considering?

gunnag

Thanks for that insightful comment, I used one of the online BTL tax calculator tools and worked out the following scenarios:-

- sell house and realise £160k profit, invest in ISA or similar @ 5% = £8k profit as already mentioned

- keep house, increase rent to £1450 next year (Agent is already doing this), pay off £160k from BTL mortgage using the pension lump sum, new mortgage would be approx £25k at around 3.5% (I estimate next year).Still working annual income £65k, BTL net Profit = £7939.

So there's not much difference between the two options, although BTL does require maintenance, etc. At least I keep the house, which has been in my family since 1968, and I'm kind of attached to it.

Luckily, my residential property is mortgage-free, and I don't need to worry about paying off any mortgage on that which is a relief.

Qyburn

gunnag said:

- sell house and realise £160k profit, invest in ISA or similar @ 5% = £8k profit
...
BTL net Profit = £7939

BTL profit should be roughly linked to inflation.

Option A, remember it would take eight years to move all that sales profit into an ISA. Have you factored in Capital Gains Tax?