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Using pension to pay off mortgage at retirement...

Journalist: Rachel Mortimer, The Times and Sunday Times

ended 25. July 2023

We are running a piece in The Times this weekend on whether households should direct any surplus funds towards paying down their mortgage or into their pension.

One alternative that has been suggested is going interest-only on your mortgage deal to keep repayments low amid higher interest rates and increasing your pension contributions instead. Then when you reach pension age, using the 25% tax-free lump sum to clear the mortgage debt. 

Would be very grateful for your thoughts on this - good idea? Any risks? 

Thanks very much. 

8 responses from the Newspage community

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Editor
Samuel Mather-Holgate
Independent Financial Adviser at Mather and Murray Financial
Good financial planning is a balance of objectives. Paying money into your pension gives your cash an immediate boost in form of tax relief, but overpaying your mortgage will create opportunities before retirement age like upsizing or freeing up cash for other projects. Many clients use their tax free cash to clear the balance of the mortgage when they retire, but it’s a moving feast and their priorities have changed throughout their working life and adapted to suit their needs at the current time.
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Ranald Mitchell
Director at bad credit mortgage specialists Charwin Mortgages
Anyone who is in an occupation pension scheme will likely stick to that. Outwith such schemes, private pensions are sadly lacking and people would be well served to utilise any opportunity to boost retirement provisions. Who wants to be broke in retirement?

Interest-only mortgages cost more over the term, with the interest applied on a level balance. Yes, the payments are cheaper and are suited to some higher-income earners who have cash and resources to exit. The prospect of using a 25% tax-free lump sum in retirement is ill-considered and highly impractical for most. To repay a £300,000 mortgage, you would need a fund size of £1.2M, something that is rare for private pension holders and accept a reduced pension pot. That coupled with varying fund performance, leaves the customer exposed to potential shortfalls.

Repayment mortgages all the way. You are guaranteed to have your mortgage paid off at the end of the term subject to all scheduled payments being made.
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Ross Lacey
Director & Independent Financial Adviser at Fairview Financial Management
This is a common question we get asked by clients and many variables are unique to each situation so there's no definitive right or wrong answer here.

Generally, interest-only mortgages on residential properties are much harder to get now than they once were. They tend to be the domain of high earners and/or those with significant equity already in their property.

There are certainly some big tax benefits to paying money into a pension; for a basic-rate taxpayer £100 in the pension costs £80, whereas for higher-rate and additional-rate taxpayers, it costs only £60 and £55 respectively.

It's important to consider the realistic return that may be achieved by investing money in a pension compared to the mortgage rate and also planning for what happens if there's a negative period in stock markets that coincides with when the interest-only mortgage needs to be paid off.

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Stephen Perkins
Managing Director at Yellow Brick Mortgages
This very much depends on the interest rate on the mortgage compared to the expected investment gains from paying into a pension or other investment.

With mortgage rates increasing and stock investments not obtaining returns equal to safe easy access savings accounts at the moment I would think for most on mortgage rate of 5% or above would be better to pay down their mortgage. Better yet may be an offset mortgage, so you still have access to the money if you later need it for something else.

Relying on any investment or pension to repay your mortgage will always be a higher risk than most borrowers will be comfortable with, especially with memories of the endowment shortfalls still being fresh in the public consciousness.
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Jonathan Burridge
Founding Adviser at We Are Money
Your pension is there to give you money when you retire. True, there are tax advantages to saving into your pension, but, the money is tied up until you reach pension age and there is no guarantee that the money will be sufficient to repay the debt. If a borrower goes interest only they will pay considerably more interest over the lifetime of the mortgage. There is no "right" or "wrong" answer it will be dependent on the borrower's circumstances and attitude to risk, but, a very simplistic starting point is that pensions are designed to provide income in retirement not to repay a mortgage.
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Gary Bush
Financial Adviser at MortgageShop.com
The scenario of focusing on overpaying your mortgage during your working life OR making contributions to your pension is one that needs close bespoke advice - there simply isn't one answer to fit all. It's true that pension savings are on the whole tax efficient, it's also true that the UK is now enjoying (NOT) a higher mortgage interest rate environment that is threatening a lot of household budgets. If we are talking about high earners who are able to cope with maintaining higher mortgage repayments and make sizable contributions to their pension then the balance is there. If however, you are struggling in working life and have minimal pension arrangements it would probably be better to focus on reducing your mortgage debt as the government has a safety net position for lower earners in retirement. This isn't a perfect scenario, there hardly ever is, but if you'd repaid your home finances it would have freed up some of your monthly budget to focus on living, rather than mortgage cost
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Joshua Gerstler
Chartered Financial Planner at The Orchard Practice
"We find that for a lot of families there is a strong emotional desire to be mortgage free sooner rather than later. It is normally to provide comfort that whatever happens, you can have a secure roof over your head. I would not normally advise taking out an Interest Only mortgage and contributing to a pension instead. This is because there is a possibility that when the time comes, the value of the pension is not sufficient to clear the mortgage, leaving you with the possibility of having to sell your home. Ideally we would try and encourage families to have a repayment mortgage and be contributing to a pension at the same time. The end result should be that they are able to live mortgage free at the end of the term, and have built up a pension pot to be able to provide an income in retirement."
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David Robinson
Co-Founder at Wildcat Law
A number of companies provide pensions for their employees where they will match pension contributions up to a certain level. For those lucky enough to have such a scheme maximising contributions with a view to using your tax-free cash lump sum (PCLS) to pay down part of your mortgage may be a very good idea. Not only will the member benefit from a 100% uplift in contribution from the employer, but they will also receive tax relief on their contributions.
The big catch though is that you have to accumulate a sizeable DC pension pot for the 25% tax-free lump sum to be large enough to cover a mortgage. Assuming a mortgage of £200,000 - you would require a pension pot of £800,000, this is far greater than the current average pension pot. However whilst it is unlikely to work for most mortgages it could be used to cover part of a mortgage or allow a mortgage to be repaid earlier as most pension pots can be accessed at 55.