Use TFLS to pay off Mortgage now or in 5 years - how does the maths work?

michaels

My thinking is that withdrawals from my DC pension are effectively taxed at 15% (assuming I don't go over 256k of TFLS) so I would need the funds in the pension to grow 15% faster than the interest rate on the mortgage (lets call it 4% fixed) for it to be better to keep the mortgage.  So if I can get a nominal return of more than 4.6% in the pension then it wins.  However I would need to invest the funds in the pension with that 5 year time horizon in mind.

To me it seems like it makes more sense to pay off the mortgage - the only down side is that I lose a 'credit line' that currently I can use the mortgage borrowing for unexpected expenditure.

Thoughts?

QrizB

michaels said:

My thinking is that withdrawals from my DC pension are effectively taxed at 15% (assuming I don't go over 256k of TFLS) so I would need the funds in the pension to grow 15% faster than the interest rate on the mortgage (lets call it 4% fixed) for it to be better to keep the mortgage.

That's not really how maths works.

For every £85 of mortgage you need £100 of pension.

If we assume you make no mortgage payments, and the mortgage interest rate is X%, after one year your £85 of mortgage will now be £85 x (100+X)/100 and you'll need £100 x (100+X)/100 of pension to pay it off.

In your example, if your mortgage rate is 4% you need your pension to grow by more than 4%.

michaels said:

To me it seems like it makes more sense to pay off the mortgage - the only down side is that I lose a 'credit line' that currently I can use the mortgage borrowing for unexpected expenditure.

That's entirely your investment decision to make, but if you can invest your pension in "safe" products like gilts or STMM funds and beat your mortgage interest rate, doing so will leave you better off overall.

michaels

I'm not convinced it is simply a matter of comparing the two rates as I think the growth in the pension is effectively taxed at 15%.  If it were ISA funds then it would make sense to compare rates?

QrizB

michaels said:

I'm not convinced it is simply a matter of comparing the two rates as I think the growth in the pension is effectively taxed at 15%.

Again, that's not how maths works.

You're starting with a larger sum in the pension (£100 vs £85) so the same % growth is a larger numerical amount.

QrizB

Here's a worked example.

You have an £85k mortgage at 4% pa interest. You could pay that off today with £100k from your pension - £25k TFLS plus £75k liable to £15k (20%) tax, total £85k.

Instead, you let it roll on for a year. You make no payments. After a year you owe 1.04 x £85000 which is £88400.

Meanwhile your £100000 pension has also increased by 4%, to £104000. If you cash that in, you'll get £26000 TFLS plus £78000 liable to £15600 tax. Total (26000+78000-15600)= £88400.

Pipthecat

To me it seems like it makes more sense to pay off the mortgage - the only down side is that I lose a 'credit line' that currently I can use the mortgage borrowing for unexpected expenditure.

Don't forget you can invest the saved monthly mortgage payments

michaels

QrizB said:

Here's a worked example.

You have an £85k mortgage at 4% pa interest. You could pay that off today with £100k from your pension - £25k TFLS plus £75k liable to £15k (20%) tax, total £85k.

Instead, you let it roll on for a year. You make no payments. After a year you owe 1.04 x £85000 which is £88400.

Meanwhile your £100000 pension has also increased by 4%, to £104000. If you cash that in, you'll get £26000 TFLS plus £78000 liable to £15600 tax. Total (26000+78000-15600)= £88400.

Thanks. I always forget that even if I take the money out of the pension as tfls it still has the cost of using up allowance so the effective tax rate is 15% and I am just deferring the tax. 

However if I breach the 256k limit then the maths does change as it means some money has to come out at 20% rather than 15% and with growth/inflation this is more likely in the scenario where I defer paying off the mortgage.

PropertyGuru_Wannabe

Don’t forget if you actually put £100,000 into your pension pot you would have £125,000.