Should I use my pension to help clear my mortgage?
I am a 56 year old man who hopes to retire at age 65. I pay both a private pension and my company pension.
In total, my monthly contributions, including my employers’ top-ups, are around £450 and my total pension fund is close to, but not above, the lifetime benefit.
At the moment my mortgage runs until the age of 71, but I would like to pay it off earlier.
Should I use the money from my retirement to make a lump sum payment, as my fixed rate is likely to go up when I take out a new mortgage later this year?
Is withdrawing a lump sum from your pension pot the best way to control your mortgage payments before retirement?
Fran Ivens from This is Money replies: With mortgage rates skyrocketing, many people will find themselves in a similar situation, looking for a way to reduce their payments.
More than 1.4 million people will have to re-mortgage this year at much higher interest rates as fixed-rate mortgages that were stuck during periods of historically low interest rates come to an end.
According to the Office for National Statistics, nearly six in 10 deals (57 percent) due to renew in 2023 currently have a rate of less than 2 percent.
While you can downsize or find a tenant to lower your costs, a lump sum will allow you to stay in your home without having to share your space. However, before you retire is always a big decision.
I’ve talked to some wealth planners to find out what your options might be – as well as the pitfalls to watch out for.
John Moseley, financial planner at Charles Stanley says: ‘There are a few areas that need to be clarified and reviewed to determine the best way forward in this situation.
‘First of all, the mortgage runs up to 71 years, but it would certainly be preferable to have paid off this mortgage at retirement.
“Revolving mortgage payments at retirement are not ideal, as retirement income is generally lower than income during working life.”
SJP’s Lee Blissett adds: “You need to be sure that you can afford to retire at 65 and that the remaining pension fund will be enough to meet your needs after you pay off the loan.”
Assuming at least part of your retirement is held in investments rather than cash, spending part of the money to pay off the mortgage would mean you lose the chance to appreciate that money.
If you’re relying on your retirement to increase in value to pay at least a portion of your retirement, it’s wise to have a plan in place just in case that doesn’t happen, especially if you’ve taken out a lump sum.
Higher costs: Rising mortgage rates mean some borrowers are looking for ways to pay off their loan before closing a new deal at a higher rate, leaving them less in debt
There’s also the uncertainty surrounding uncertain future interest rates, which will affect how expensive your mortgage payments will be when you retire. Depending on the size of your pot, higher rates can seriously affect your quality of life.
If you opt for the lump sum payment, you need to be sure that your retirement fund has enough to pay off the mortgage while meeting the lifetime benefit (LTA) restrictions.
The standard LTA is currently £1,073,100 (frozen at this level until tax year 2025/2026), meaning the maximum pension start amount available on a lump sum or tax-free cash basis is 25 per cent of £1,073,100 or £268,275. Is this enough to pay off your mortgage?
On the other hand, if your pension amount exceeds the allowance, you will likely be stung with a lifetime allowance. Any funds above the allowance are taxed at 55 percent if taken as a lump sum or 25 percent if used as income.
“Another way to pay off your mortgage is to look at the personal contributions being paid into retirement,” says Moseley. “As you approach the limit of the lifetime benefit, these benefits may be more beneficial if they are diverted from retirement to an overpayment of mortgage.”
This would mean that instead of paying one amount all at once, you would trickle down extra money to pay off your mortgage over time.
This reduces the potential liability for the lifetime surcharge and allows you to still pay off the mortgage in a shorter period than the current remaining repayment period.
Depending on how much you overpay, your mortgage lender may charge you. This limit is often set at 10 percent of the outstanding balance per year.
Time to think: our reader has nine years left before retirement, which is a good time frame to start building a plan
“Make sure you are fully aware of any charges that will result from overpaying on the loan,” says Nicholas Mendes by John Charcol.
“Before making a decision, it’s worth talking to a broker about your options if you go off your current flat rate.”
A fixed rate provides security for the payments during the term. It pays to review all the rate options available in the market three months before the current rate expires, giving you plenty of time to make any necessary changes.
How else would they be able to pay off the mortgage?
It may also be worth considering other savings or assets you can use to pay off the mortgage before you hit your tax-advantaged retirement funds.
“If you are in the fortunate position of having other savings in the form of ISAs or bonds, it may be more beneficial to use these as pensions are exempt from income tax, capital gains tax and estate tax,” says Mendes.
Planning ahead is always beneficial, and having nine years left before retirement gives you a chance to create a financial plan and prepare yourself for a smooth transition into retirement.
Finally, if you’re determined to pay off your mortgage before retirement, another option may be downsizing.
If you move to a smaller home, you should have a smaller loan that is more manageable to pay off without having to use your retirement savings.
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