I am a 56 year old male hoping to retire at 65. I contribute to a private pension in addition to my occupational pension.
In total, my monthly contributions, including my employer’s top-up, are around £450 and my total pension fund is close to, but not higher than, lifetime allowance.
Right now my mortgage is to last until I’m 71, but I’d like to pay it off sooner.
Since my fixed rate is likely to go up when I remortgage later this year, should I use my pension money to pay off a lump sum?
Could taking a lump sum from your retirement pool be the best way to manage your pre-retirement mortgage costs?
Fran Ivens of This is Money responds: As mortgage rates have skyrocketed, many people will find themselves in a similar situation and looking for a way to lower their payments.
More than 1.4 million people are facing a remortgage at a much higher rate this year, as fixed rate mortgages locked in during periods of historically low interest rates come to an end.
According to the Office for National Statistics, almost six in ten agreements (57%) due for renewal in 2023 are currently at rates below 2%.
While you can downsize or find a tenant to cut your costs, using a lump sum allows you to stay in your home without having to share your space. However, tapping into your pension fund before you retire is still a big decision.
I spoke to some wealth planners to find out what your options were – as well as the pitfalls you should 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 course of action in this situation.
“First, the mortgage must last until age 71 – but it would certainly be better to pay off that mortgage in retirement.”
“Ongoing mortgage costs in retirement are less than ideal, as income levels in retirement are generally lower than income levels during working life.”
Lee Blissett of SJP adds: “You need to be sure that you can afford to retire at 65 and that the remaining pension fund will be sufficient to meet your needs after you pay off the loan.”
Assuming at least part of your pension is held in investments rather than cash, spending some of the money to pay off the mortgage would mean you lose the possibility of those funds appreciating.
If you’re counting on the increase in the value of your pension to pay for at least part of your retirement, it’s wise to have a plan in place 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 signing a new deal at a higher rate, reducing what they owe
There is also the uncertainty surrounding uncertain future levels of interest rates, which will affect the cost of your mortgage payments in retirement. Depending on the size of your pot, higher levels could significantly affect your quality of life.
If you were to go the lump sum route, you would need to ensure that your pension fund has enough money to pay off the mortgage, while respecting the Lifetime Allowance (LTA) restrictions.
The standard LTA is currently £1,073,100 (frozen at this level until tax year 2025/2026) meaning the maximum pension start lump sum or tax free money available is 25% of £1,073,100 or £268,275. Will this be 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 charge. Any funds above the allowance will be charged at 55% if taken as a lump sum or 25% if used as income.
“Another way to pay off your mortgage would be to look at personal pension contributions,” says Moseley. “If you are approaching the lifetime allowance limit, these payments may be more beneficial if diverted from the pension to overpayments on the mortgage.”
This would mean that instead of paying a lump sum, you’ll be pumping extra money into paying off your mortgage over time.
This would reduce the potential lifetime allowance liability and you could still pay off the mortgage within a shorter period of time than the current repayment period remaining.
However, depending on how much you are overpaying, your mortgage lender may charge you a fee. Often, this limit is set at 10% of the outstanding balance each year.
It’s time to reflect: our reader still has nine years before retirement, which is a good time to put a plan in place.
“Make sure you are fully aware of any charges resulting from an overpayment on the loan,” says Nicolas Mendes by John Charcol.
“Before making a decision, it’s worth talking to a broker about your options when leaving your current fixed rate.”
A fixed rate gives certainty to payments over the term. It’s worth looking at all available rate options in the market three months before the current rate expires, giving you plenty of time to arrange any necessary changes.
Otherwise, how could they pay off the mortgage?
It may also be worth considering other savings or assets you have that could be used to pay off the mortgage before tapping into your tax-advantaged pension funds.
“If you are lucky enough to have other savings in the form of Isas or bonds, these may be more advantageous to use because pensions are exempt from income tax, tax on -values and inheritance rights”, declares Mendes.
Forward planning is always beneficial, and having nine years before retirement gives you a chance to put a financial plan in place and prepare for a smooth progression into retirement.
Finally, if you are determined to pay off your mortgage before retirement, another option could be downsizing.
Moving to a smaller property should leave you with a smaller loan that may be easier to repay without having to use your retirement savings.
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