Paid or about to pay off your mortgage?

Making the most of any spare money.

One of the more positive financial outcomes of getting older is that many of us begin to reach the point at which our mortgage is paid off. The debt we took out in our twenties or thirties is at last beginning to dwindle as we reach our late forties and early fifties.

According to the Office for National Statistics, the average weekly cost of a mortgage in the 2016/17 tax year was £154.90 1, which works out at £671.23 a month.

Once your mortgage is repaid, if the average monthly repayment were reinvested in a personal pension, it would attract tax relief at a minimum rate of 20%. Even non-taxpayers get tax relief at 20% up to the higher of £3,600 and their annual income. Tax relief would add another £167.81 a month, giving a total payment into the pension of £839.04 a month.

Higher rate taxpayers could claim an additional 20% tax relief at the end of the tax year, which would be paid as a tax rebate of £2013.69 (based on 12 monthly gross payments into the pension of £839.04).

How much would this grow to by retirement?

The amount you get back at retirement will depend upon when you start saving, how much you pay in, the rate of return you earn and the charges you pay for your pension. If you paid in £839.04 a month, and after inflation and charges you earned an annual return of 2.5%, then the fund available at state pension age of 67 would be as follows (in today’s money):

As you can see, even though these contributions start in the second half of a working life, the amount generated by re-directing mortgage payments (once the mortgage is paid off) can be substantial.

The table also shows the lifetime income that could generated by buying a guaranteed income for life with your savings, but this is only one option. Thanks to the new pension freedoms, you have a range of other options such as:

  1. Taking the whole amount as a cash lump sum (three-quarters of it would be taxable).
  2. Taking a quarter tax-free and then taking regular taxable payments or taxable ad-hoc lump sums from the remaining three-quarters, until your savings are exhausted.
  3. Taking a quarter tax-free and using the other three-quarters to buy a taxable guaranteed lifetime income.
  4. Leaving the funds untouched to grow further and used later or passed onto others when you die.

However, not all pension policies allow all these options, so you may need to transfer to one that does what you want it to do. 

Example:

James has reached age 50 and has repaid his mortgage which was costing him £1,000 a month. James’ daughter, Emma, has just started university, so James plans to use £500 a month of the money saved to pay Emma’s accommodation costs. The other £500, he puts into his pension, where he receives a £125 monthly tax relief top-up, making his total monthly pension payments £625.

When James is aged 60, he decides to work part-time, but wants to pay off his car loan to reduce his monthly outgoings. He also wants to refurbish his kitchen and bathroom. By this time, James’ pension is worth £85,800 (assumes his savings grew at 2.5% a year after inflation and charges). James can take a quarter of his pension tax-free, or £21,450, which he uses to pay of his car loan and fit a new kitchen and bathroom.

He also stops the £500 a month he pays into his pension, given he is now working part-time. However, he leaves the remaining fund (approximately £64,000) in his pension.

At age 67, his remaining pension fund has grown to £75,500. As James now wants to give up working altogether, he uses these savings to buy a guaranteed income for life of £3,930 a year 2. This will be used to supplement the income he gets from his state pension and his workplace pensions.