The Lemon Fool

Morning all.

This is a question in advance of my 55th birthday in a few year’s time.

My pension is at a level now that if I took maximum tax free cash, I would be able to repay our mortgage. My assumption is that barring any investment/ global disasters when I turn 55 I should be in a similar position. My thoughts are to crystallise the appropriate amount from my SIPP and use the tax free cash to repay my mortgage. I would then use the same amount of cash I was paying to make the monthly mortgage payments to rebuild my SIPP. We have a repayment mortgage so the outstanding balance will reduce from the current position.

I have run a few calculations on some online calculators and it seems this option puts me in a better position financially than leaving things as they are. I believe it’s down to the 20% enhancement of tax relief on the boosted regular payments once the mortgage is repaid.

If this seems a good idea then my plan is to build up the cash pot within my pension fund over the next few years rather than reinvest it. This means I will sell as little as possible of my holdings when the time comes to extract the lump sum.

From a psychological position, I also feel that not having a mortgage would be a benefit for me.

Before I commit to this action, I just wanted to ask if I’m missing anything obvious and would welcome any comments from others who may have done the same / steered clear of this action.

Cheers, OLTB.

Once you start withdrawing money from a pension, further contributions are capped at £4k a year. They'd be capped anyway at £3600 if you stopped having earned income, but if you continue working you are limiting your ability to rebuild your pension.

Switching investments to cash is likely to underperform. Its normally done to reduce risk, but what risk do you have. If there is a crash, just carry on making the affordable mortgage payments and let the market recover. You will be better off in 10 years time.

Standard advice is that with low interest rates, your investments are likely to outperform so its not worth repaying from non-sheltered funds, though many do for peace of mind, and borrowing to invest is unwise.

Psychologically I can entirely see it.

I've not run the numbers, but unless your mortgage rate is relatively high and your expected pension return rate relatively low as well as you don't anticipate having significant tax liability in retirement, my initial thought is surprise that it is financially beneficial overall.

Are you allowing for the fact that if you do this then you are significantly increasing the amount of tax you are likely to end up paying on future pension withdrawals, so even if your pot ends up larger with this approach the increased tax liability exceeds the benefit?

JohnB wrote:Once you start withdrawing money from a pension, further contributions are capped at £4k a year. They'd be capped anyway at £3600 if you stopped having earned income, but if you continue working you are limiting your ability to rebuild your pension.

Switching investments to cash is likely to underperform. Its normally done to reduce risk, but what risk do you have. If there is a crash, just carry on making the affordable mortgage payments and let the market recover. You will be better off in 10 years time.

Standard advice is that with low interest rates, your investments are likely to outperform so its not worth repaying from non-sheltered funds, though many do for peace of mind, and borrowing to invest is unwise.

Thank you JohnB for replying - as I understand it, if I only withdraw tax free cash and put the rest of the money into a flexible-access drawdown plan then my annual contribution limits are unaffected. If I don’t draw income, then the money purchase annual allowance won’t be triggered. In terms of switching to cash, I’m just planning on not re-investing dividends that drop into my SIPP over the next few years so the cash pot builds up.

Thanks again, OLTB.

xeny wrote:Psychologically I can entirely see it.

I've not run the numbers, but unless your mortgage rate is relatively high and your expected pension return rate relatively low as well as you don't anticipate having significant tax liability in retirement, my initial thought is surprise that it is financially beneficial overall.

Are you allowing for the fact that if you do this then you are significantly increasing the amount of tax you are likely to end up paying on future pension withdrawals, so even if your pot ends up larger with this approach the increased tax liability exceeds the benefit?

Thanks xeny - I was surprised as well. At the moment, £1,000 pm pays the mortgage whereas if it was paid into a pension, £1,000 would be increased to £1,200 through tax relief and then a further £200 as I pay 40% tax. Over the year £12,000 becomes £16,800 without any growth taken into account. I don’t imagine being anything other than a basic rate tax payer in retirement but of course I don’t know what tax rules will be in place when I retire. As I’m not going to be retiring for at least 10 years, this will really boost my pension. I have a few years to keep working at the figures so hopefully my best course of action will get clearer!

Cheers, OLTB.

OLTB wrote:

JohnB wrote:Once you start withdrawing money from a pension, further contributions are capped at £4k a year. They'd be capped anyway at £3600 if you stopped having earned income, but if you continue working you are limiting your ability to rebuild your pension.

Switching investments to cash is likely to underperform. Its normally done to reduce risk, but what risk do you have. If there is a crash, just carry on making the affordable mortgage payments and let the market recover. You will be better off in 10 years time.

Standard advice is that with low interest rates, your investments are likely to outperform so its not worth repaying from non-sheltered funds, though many do for peace of mind, and borrowing to invest is unwise.

Thank you JohnB for replying - as I understand it, if I only withdraw tax free cash and put the rest of the money into a flexible-access drawdown plan then my annual contribution limits are unaffected. If I don’t draw income, then the money purchase annual allowance won’t be triggered. In terms of switching to cash, I’m just planning on not re-investing dividends that drop into my SIPP over the next few years so the cash pot builds up.

Thanks again, OLTB.

My understanding is the same as yours on contribution limits not being affected provided yo do not draw taxable benefits.

Although at current mortgage interest rates, it does seem beneficial to stay invested, there is psychological benefit to being clear of all debt. It was a big milestone for me.

I am going to suggest something that is generally regarded as heretical around here: Time the market.
Don't make a fixed plan just yet. Stay reinvested in your SIPP. Wait until you turn 55. If at that point you consider the market to be 'highly valued', sell a chunk, take it as a tax free portion and pay off your debt. If the market tanks by then, stay invested and wait for recovery. Means a difficult timing decision later.

One added thought. Have you assessed your likely pension position relative to the lifetime allowance?

If it looks as if you're going to bump up against the LTA, that can be a motivation to crystallise early, so as to limbo under it as far as is possible and save up 'headroom' for growth and/or future contributions. Also, a de-motivation to make heavy future pension contributions in excess of any employer match.

This plan ticks many of the boxes that would put you in breach of the PCLS recycling rules. You might be OK though provided no more than 30% of the PCLS makes its way back into the pension. This article explains the rules well.

https://www.pruadviser.co.uk/knowledge- ... recycling/

OLTB wrote: At the moment, £1,000 pm pays the mortgage whereas if it was paid into a pension, £1,000 would be increased to £1,200 through tax relief and then a further £200 as I pay 40% tax.

Not quite. If you send £1,000 to your provider they reclaim £250 in tax for you, so you end up with a gross contribution of £1,250. Then you reclaim £250 from HMRC so the net cost to your wallet is £750.

Good, innit? Make hay while the sun shines.

I just can’t see the appeal of paying off your mortgage when interest rates are so cheap that in effect you are being paid to borrow the money. If you can fix for 5yrs at sub 2% then carry on not paying it off,leave your money invested, and grow wealthier.

Although I no research to substantiate this, I would suspect that the desire to pay off mortgage debt is highest amongst those who don’t have retirement and other savings.

vand wrote:I just can’t see the appeal of paying off your mortgage when interest rates are so cheap that in effect you are being paid to borrow the money. If you can fix for 5yrs at sub 2% then carry on not paying it off,leave your money invested, and grow wealthier.

Although I no research to substantiate this, I would suspect that the desire to pay off mortgage debt is highest amongst those who don’t have retirement and other savings.

Thank you for your comment vand. I didn’t think the figures would work either but they appear to. My mortgage is a fixed rate of 1.99% and I assume my pension will grow at 6%. On that basis it makes sense to leave my pension alone and keep paying the mortgage. However, if I take some tax free cash from my pension and completely repay my mortgage, I forego 6% growth from the money I took from my pension in exchange for peace of mind. The big difference though is if the money I was paying to my mortgage (£1,000 pm roughly) now gets directed to my pension, I don’t get a 6% return, I get a 40% return (the tax relief enhancement) straight away, plus my assumed 6% assumptive annual return.

Unless I’m missing something (and the recycling rules mentioned above don’t clobber me).

Cheers, OLTB.

OLTB wrote:

vand wrote:I just can’t see the appeal of paying off your mortgage when interest rates are so cheap that in effect you are being paid to borrow the money. If you can fix for 5yrs at sub 2% then carry on not paying it off,leave your money invested, and grow wealthier.

Although I no research to substantiate this, I would suspect that the desire to pay off mortgage debt is highest amongst those who don’t have retirement and other savings.

Thank you for your comment vand. I didn’t think the figures would work either but they appear to. My mortgage is a fixed rate of 1.99% and I assume my pension will grow at 6%. On that basis it makes sense to leave my pension alone and keep paying the mortgage. However, if I take some tax free cash from my pension and completely repay my mortgage, I forego 6% growth from the money I took from my pension in exchange for peace of mind. The big difference though is if the money I was paying to my mortgage (£1,000 pm roughly) now gets directed to my pension, I don’t get a 6% return, I get a 40% return (the tax relief enhancement) straight away, plus my assumed 6% assumptive annual return.

Unless I’m missing something (and the recycling rules mentioned above don’t clobber me).

Cheers, OLTB.

Don't forget that you will be taxed on the pension when you make withdrawals. Provided you don't exceed the LTA though and can make withdrawals at basic rate tax it wours out at 15% tax after taking the tax free PCLS.