I am a 55 year-old female aiming to retire at 67. I currently pay into a private pension and stakeholder pension through work, and am a higher rate taxpayer.
Monthly pension contributions to both pensions (including employers contribution) total around £600 per month. My total pension fund is less than the lifetime allowance.
I have a large mortgage which currently is set to run until age 75. However, I will be making overpayments and potential lump sum payments in order to aim to pay it off by age 67 when I intend to retire.
Home loan question: Should I use a dormant £50k pension pot to pay off my mortgage?
Currently I am on a fixed rate so the maximum overpayment is around £20,000 a year for the next two years without penalty.
I have a dormant work pension valued around £50,000 which I want to withdraw at some point and use towards reducing my mortgage.
My question is whether to withdraw all or part now, or leave it until closer to retirement date taking into account the 25 per cent tax free amount, annual allowance and MPAA (money purchase annual allowance) and potential mortgage interest saved (currently 2.44 per cent).
I have sufficient pension and property investment retirement income to not need the dormant work pension referred to above as income in retirement.
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Steve Webb replies: At first glance, using a pension pot to clear your mortgage can look like a very attractive option, especially if, as in your case, you feel that you can manage in retirement without that particular pot.
Whilst I can’t give you individual financial advice, not least because I don’t know your full situation, I can however draw your attention to three reasons why someone in your situation might want to pause before cashing in a pension to help pay off a mortgage.
The first thing to think about is the return on your money if you leave it in a pension compared with the return if you use it to reduce your mortgage balance.
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Your mortgage rate is 2.44 per cent so this is the (after tax) return you would get if you pay money into your mortgage, and this rate is fixed.
By contrast, the rate of return on the money invested in your pension is not guaranteed but could be expected to be higher than this.
In particular, if you were thinking of running your pension on for another 12 years and made sure that you were investing for growth, most pension company projections would suggest a rate of return much better than 2.44 per cent, even allowing for tax.
You should be aware, of course, that these investment returns are not guaranteed and there may be times when the value of your pension goes down as well as up, but over the medium term you are likely to get a better return leaving your money in the pension.
A second thing to think about is your tax position, especially if you were to cash in your pension now.
As you know, you could take a quarter of your £50,000 pension tax free, leaving £37,500 subject to tax.
However, as you are a higher rate taxpayer, you would pay 40 per cent tax on this amount, giving you a £15,000 tax bill.
By contrast, if you wait to access your pension until you no longer have a wage, you will almost certainly only be paying tax at the basic rate.
In this scenario, the tax bill would be half as much, so you could save yourself £7,500 in tax simply by waiting (ignoring any growth in the value of your fund between now and then).
A third downside to accessing your pension now is that you would (as you mention) trigger the ‘money purchase annual allowance’ (MPAA).
This is a cap on the amount of money you can put into a pension whilst still benefiting from pension tax relief.
Once you have accessed a ‘pot of money’ pension and taken out some taxable cash this triggers the MPAA and reduces your annual allowance to just £4,000.
I see that you are currently contributing over £7,000 a year to your pensions, including benefiting from a valuable employer contribution, and you will be getting higher rate tax relief on these contributions.
It would be unfortunate if the decision to access your other pot inhibited your ability to build up the main pension which you plan to rely on for your retirement.
In summary, the main things to think about when deciding whether and when to use a pension pot to pay off a mortgage are:
– The return you can get on your pension compared with the interest rate on your mortgage;
– The risk of a hefty tax bill on a one-off pension withdrawal if you take your pension while you are still in paid work;
– The likelihood of triggering the MPAA, thereby restricting your ability to save tax-efficiently into a pension between now and retirement.
There is no doubt that the introduction of ‘pension freedoms’ in 2015 has given people with pot of money pensions new options about how to use their savings, and the potential to use part of their pension to help clear their mortgage can be an attractive flexibility.
However, anyone considering doing this needs to consider carefully both the impact on their long-term ability to support themselves in retirement as well as some of the timing issues which I have flagged in this column.
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