We have a national obsession with paying off our mortgage. In fact, there’s almost a stigma if you haven’t done so by the time you retire. Putting the rights and wrongs of this school of thought aside for now, I was wondering what people actually do when they manage to pay off their mortgage? For some, it must result in a substantial ‘pay rise’ so to speak. If you’re one of the lucky ones, you probably already have plans for that extra cash in your pocket. And I’m guessing that putting some, or all, of it into a pension is not high on your agenda, right? But perhaps it could be…
According to the Office for National Statistics, a 65 year old man in England is expected to live until he’s 84 years old, while a woman of the same age can expect to reach her 86th birthday.1 But these are only averages – there’s a likelihood that many of us will live longer than that. There’s also rising inflation to consider. If you retired back in 1997, on an annual income of £15,000, it would now need to be worth £25,839 to have the same spending power as 20 years ago. That’s due to an average inflation rate of 2.8% a year over that period – it’s only in recent years that inflation has been at record lows.2
As a result, I’m a firm believer in keeping as much money invested for as long as possible – preferably in a pension or Self Invested Personal Pension (SIPP). It’s not for everyone, and you many need to speak to a professional adviser before making such a decision, but moving money into a personal pension could pay dividends for the future. Here’s a reminder of how it works:
- You can pay into your pension until you are 75 years old.
- You can contribute up to £40,000 a year to a pension or SIPP, as long as you don’t exceed the lifetime allowance of £1 million. If you have already started to take benefits from your pension savings, then you can only contribute £4,000 a year.
- When you contribute to a pension, the taxman will contribute 20% as well. So if you pay £2,000 a month, it only costs you £1,600 from your own pocket. If you are a higher-rate tax payer, you can claim back an additional 20% through your tax return, meaning you are effectively only contributing £1,200 a month.
- You receive the first 25% of withdrawals tax free and, thanks to the new pension freedom rules, you can now spend your pension however you like.
- If you die, any money left in your pension will be passed to your beneficiaries, free of inheritance tax. If you die before you’re 75, any withdrawals they then make are tax free. If you die after the age of 75, any withdrawals will be taxed at their individual rate of income tax.
These highlight that it can make a lot of sense to use a pension as a way of continuing to invest for your future, even if you are already in the throes of retirement. It also makes sense to keep your money invested for as long as possible, especially given today’s paltry cash savings rate. If you’re worried about the cost of investing, remember that times have changed. Some investment managers, such as 7IM, offer transparent and fair fee structures that don’t cost the earth and won’t dramatically eat into your returns.
Far be it from me to question your intentions but, if you’re one of the many people who pay off their mortgage with a view to downsizing and living off the proceeds, remember that might not happen for a while, if ever. Most people don’t want to downsize immediately – especially if they are fit and healthy and/ or want to have a place to put up the grand kids.
Despite their slightly chequered history, pensions are still likely to be the most efficient and effective way of funding your retirement. I hate to be a kill-joy, but diverting those mortgage payments into a pension could make a lot of sense, even if I’m the first to admit that it would be much more fun to spend it on a lavish holiday.
Justin Urquhart Stewart
Co-founder and Head of Corporate Development
P.S. Please remember that the tax rules we’ve included here can change, and that taxation and any decisions depend very much on your own circumstances and what you want to achieve given it’s your money.
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