If you received a large lump-sum of money; what would you do with it?
Holidays? Speed boats? Gifts for friends and family?
Many people would pay off their mortgage.
The feeling of sitting back and relaxing, knowing that your home has finally been paid for must be extremely satisfying. People often spend their entire working lives paying off the mortgage, and for many it is the one thing that prevents them from giving up work altogether.
The Pension Freedoms introduced in 2015 mean that over-55s now have more access to their pension pots, but is using it to pay off the mortgage such a good idea?
How many people pay off the mortgage with their pension?
Research from Just (a provider of retirement income products) reveals that hundreds of thousands are planning to use their pension to pay off their mortgages. In a survey of 1,000 over 40s, they found that under 30% were planning to clear their mortgage with regular payments. This represents a potential 2.8 million (Source: ONS) people that are relying on other means, such as:
- Inheriting a lump-sum of money
- Other forms of savings
The study also found that the older people get, the less likely they are to be confident that regular monthly payments will cover the mortgage. For example:
- 70% of 51-55 year olds were confident
- 50% of 61-65 year olds were confident
The length of repayments also concerns the 51-65 age group, with 23% of those asked stating that they expect to continue making payments until they are 65. A quarter of these people believed that they would be paying their mortgage off beyond the age of 70. Worryingly, 7% of the people surveyed believed that they would have to sell their home to make up the shortfall, representing approximately 285,000 of over 40s.
Tom Selby, Senior Policy Analyst at AJ Bell, commented: “For many people using some of their pension to pay off outstanding loans will make financial sense, particularly if those loans come with sky high interest rates. However, savers also need to be conscious that making large withdrawals could also result in them paying extra tax and this also needs to be factored in. More fundamentally, the main purpose of a pension is to provide an income throughout retirement, so anyone making large withdrawals to pay off debts also needs to consider whether they need to top up their savings afterwards. Their ability to do this will be limited if they withdraw any taxable income as a result of the Government’s decision to slash the Money Purchase Annual Allowance to £4,000. It is the complexity involved in taking decisions of this nature, and the potentially heavy consequences of getting it wrong, that make regulated financial advice so valuable.”
Reasons not to repay your mortgage with your pension
There are many factors to consider when making any financial decision, and this one is no different. What is right for one person may not be right for the next. However, there are a few key disadvantages to bear in mind, such as:
Unnecessary taxation: The Pension Freedoms allow you to access 25% of your pension pot tax-free at the age of 55. Any additional amounts well may be subject to income tax, so accessing large amounts to pay off the mortgage may result in a large, and perhaps unexpected, tax bill. If you are keen to pay off your mortgage early, and you decide using money from your pension is the best way to do so, withdrawals should be timed carefully to minimise tax.
Other expenses: Unfortunately, when you pay your mortgage off, it doesn’t stop your other bills coming through the letterbox. Utility bills, council tax and other lifestyle expenses still need to be paid. If you’ve used your pension pot to repay your mortgage, what will you use to provide an income in retirement? Understanding whether you have enough money in your pension to repay your mortgage, and provide sufficient income in retirement, takes careful planning.
Interest Rates: With interest rates at all-time lows, the rate you pay on your mortgage may be so low it’s actually better to leave the money invested than pay off the debt.
Who can help me?
Deciding what to do with your pension is one of the biggest decisions that you’ll make when you decide to stop working. Not only does the money have to provide an income, it also has to last the whole of your retirement.
Taking quality, professional advice will not only make you aware of your options, but will also help you to work out the best action to not only make the most of your pension, but your retirement as a whole.
To talk about pensions or mortgages, please get in touch using the phone number at the top of the page.