With pension freedoms just around the corner which includes the over 55’s having access to pension funds, the question for many is; should the pension be used to pay off their mortgage?
As with all financial decisions what you do depends on personal circumstances. For example if you have an interest only mortgage and don’t want to move in the future but have no other means of paying the mortgage off, then perhaps using the pension fund may be the best option.
However, when considering using the pension fund to pay off the mortgage early you need to think about what impact this will have on your long term income and also if you take more than the 25% tax free lump sum your pension contributions will be restricted to £10,000 per annum. In addition if you do take more than the 25% lump sum you will be taxed at your highest marginal rate. This means that the amount over the 25% is added to your annual income and in many cases it could mean people paying 40% tax on the pension.
As you can see from the above, paying off your mortgage by using your pension is not straight forward but there are other considerations when thinking about this course of action that relate to your mortgage. There are questions that need to be asked about your mortgage and whether or not your scheme allows you to pay unlimited amounts off your mortgage. Most mortgages allow you to pay no more than 10% per year off the balance and any extra payments can incur penalties of up to 6% of what you pay. Clearly there could be problems in this area but you could delay eating into the pension until the tie in ends on the mortgage.
Alternative strategies may involve using your pension to pay off expensive debts such as credit cards and increase your mortgage payments with the savings made and shorten the term. Alternatively you could wait until your mortgage tie in finishes and just make a partial repayment to bring you down to a low loan to value that should translate to a much lower rate that again could help you pay the loan off early.
As mentioned earlier what the over 55’s do with pension freedoms does depend on personal circumstances and there are some strategies available that do make sense and can be tax efficient if planned right. However, due to the complexity of it all I would advise consulting with an IFA who is familiar with mortgages as well as pensions who can ensure you make wise decisions.
Kieron Bassett DipPFS
16th March 2015
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