Pay off mortgage early or pay into pension and claim tax relief?

8611

Registered User
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16
Hi,

Not sure if this would be better here or in pensions forum but I'll try here.

I have a mortgage of approximately 200k. Its a variable taken out in about 2006.

My property is probably now worth around 280k so I am not in negative equity (though I significant of capital went in which is now disappeared).

I am self employed. I have a tax liability for 2013 which can be reduced if I pay into a pension.

Once I pay my tax bill as it is (i.e., without paying into a pension) I will have a decent amount sitting in bank accounts. I could probably pay up to 30k off my mortgage.

Alternatively I could reduce my tax liability for 2013 by paying into a pension.

Early payment mortgage calculators suggest each 10k I pay off the mortgage will save me €600 in mortgage interest per year. Each 10k sitting in the bank will receive about €140 in interest so its definitely better value to pay off the mortgage than leave money sitting in the account.

But is it better value to pay into the pension fund?

Zurich's pensions calculator tells me I can pay and claim relief on up to 20k and will in effect 'get' 34k for that payment of 20k.

My personal circumstances are that I have not as yet started a pension and am in my mid 30s. I am happy in my current home for now but will probably be looking for somewhere bigger in about 6 years.

Anyone any views or comments on which one makes more sense?

I'm leaning towards paying off the mortgage as it frees up more money for the next few years.

Will it affect me looking for another mortgage in a few years time if I've paid this one off early? I.e. will bank like me less because I paid it off early? Will they be less likely to give me a mortgage because I don't have 100k sitting in the bank as down payment on the property (I assume I could prob just re-mortgage my existing property if this was the case).

Any thoughts appreciated, or indeed if someone could recommend a professional I'd gladly pay to make the right decision.
 
Hi 8611

I kicked off this general discussion last month and the Duke concluded that you should pay down an SVR mortgage in all circumstances. I can't find any flaw in his logic.

if someone could recommend a professional I'd gladly pay to make the right decision.
I very much doubt that you would get better advice than in that thread. And even if you found a good advisor, it's likely that they would sell you a pension.

I would say pay it off your mortgage. Given that you might be moving again in the medium term, this will mean that you will have a lower Loan to Value and should be able to get a better rate.

Brendan
 
Don't forget a pension will reduce your prelim for 2014 a well.

The figures run in the thread that Brendan linked to do show that paying off a mortgage is better value.

However, the figures are based on straight line assumptions, when we know that in reality that markets and rates don't go in such a straight line e.g. you invest €1,000 and it grows by 100% in year 1 and falls by -50% in year 2. The average growth rate over 2 years is 25% but you only have €1,000, not €1,250.

I would look at striking a balance, some into the pension and some into reducing your mortgage.


Steven
www.bluewaterfp.ie
 
Interesting question 8611

The outcome from the earlier debate that Brendan has quoted concludes that paying down variable mortgages makes more sense than contributing to a pension. Re-reading this thread, the conclusion seems to me to be principally predicated on the basis that as the Duke put it there is "no tax advantage in contributing now rather than deferring."

In the interests of debate, I'll give some counter arguments.....

This premise (of there being no tax gain) may be valid in specific circumstances but much less likely to be true (if at all) in any of the following situations:

- you die
- you get sick
- you become unemployed
- your income reduces
- your income increases (say above the cap)
- your income is already above the cap
- the rate of tax relief reduces
- alternative tax efficient investments become available in the future
- you wish to early retire, etc., etc.

Accordingly, whilst not without merit, the absolute nature of the Duke's conclusion needs to be challenged as does the tone of Brendan's "And even if you found a good advisor, it's likely that they would sell you a pension."!!!!
 
Wouldn't compound interest favour the investment.

It seems a lump sum of 10,000 into the mortgage is a simple interest saving, your mortgage is 10,000 less this year, it's 10,000 less next year...

If the 10k is invested in a pension with 41% tax relief then there's an instant profit of 4,100 as well as the compunded returns. If that 4,100 is invested into the pension at the start then that's even better.

For example the final figure on 14100 over 30 years at 5% compound growth would be 60,000. If it's just 10k invested it still ends up at 43,000.

I'd probably need to think a bit more but it seems 10,000 into a mortgage at 5% for 30 years saves 15,000 euro.
 
Hi Ashambles

If you assume an equal net rate of return, then I think the point being debated is as follows:

1. With a pension: (A) gross sum plus (B) compounded return = sum at end of term

2. Outside pension: (C) net sum plus (B) compounded return = sum at the end of term

The gist of The Duke's argument is that if we assume B = B (i.e. cancel each other out), then the relationship between A and C remains constant throughout and effectively at some later date, the option to gross up the net amount is available. It follows that the merits of the guaranteed nature of the mortgage return and the inherent lack of flexibility around pensions led him to his conclusion.

Where I disagree with him is that "life happens in between our plans" and there are various examples where the facility to gross up the net amount may not be on as beneficial terms as are currently available!
 
I've got some homework to do! Thanks all, will read through that other thread and see what I come up with.
 
Well all I can say is its not as simple an equation as whether to choose to leave money in a deposit account or pay off the mortage!

Some variables-

- has the analysis in the other thread included the fact that there is tax relief on mortgage interest, or that your pension is taxed when you get paid it, or the availability of the lump sum tax free?

- I note that the tax relief available on pension contributions increases as you get older though I'm not sure how to incorporate this into my decision (I'm 35 now)

- another factor for me is that my earnings fluctuate, in a good year I could conceivably make 50% more than a bad year, given that there may be years when I have less of a chance to claim the tax relief (because I have less of a liability) maybe I should pay more in those years to the pension (obv I will have less money available in those years though, but the point is that at the moment, having neither been paying off the mortgage or paying into a pension I have a lot more in the bank than I would be able to save in a given year

- a friend made a good point to me in relation to the importance of understanding how much money I'll need on retirement, I would think 30k a year would be sufficient for me to live comfortably if I was 70 today and retiring. Maybe I should also factor this in vis a vis what total pension size I want, whether I can achieve that at a later point in life and instead pay off the mortgage now?

- also there are the known unknowns - will the govt change the tax regime in relation to pensions? Will the limits change etc?

Also the stat from Brendan's article that the average person getting a mortgage now has a deposit of 10% of value of the home, and that different LTV mortgages have different rates should be factored in. If I envisage buying a home for say 600k in 6 years time then I need 60k in the bank and disposable in 6 years time, and I may benefit from being able to get a better rate on what will undoubtedly be a much bigger mortgage than the one I have now.

The more you know the more confusing it gets!

As it happens I have a relative who used to work in pensions so I might bounce some ideas off him.
 
Two other factors which have occurred to me so far

1 - there is much speculation that the tax relief available on pensions so far will be reduced in the next few years, ergo I should make use of it while I can

2 - in the present structure in later years I can claim much higher tax relief in that I am allowed pay a higher percentage of my income into the fund, if I was to pay off the mortgage earlier I would have more disposable income in those years to avail of the higher relief
 
There are far too many variables and unknowns to make a 100% spot on assessment. A simple one is pension returns are higher than your assumptions (MSCI Emerging Markets has averaged 11% for the last 10 years). Or as you say, legislation may change, interest rates, income, your own needs for money, you expectations.

Neither option is the wrong option.


Steven
www.bluewaterfp.ie
 
I'm not going to say which is better to do. Maybe you should do neither.

Keep your money maybe for the next house.

Particularly if the current mortgage is relatively cheap. It is after all a good method of saving.

Pensions, I don't trust, I don't trust the people who sell them, the people who create them, the people with whom they are invested with. Time and again people seem to lose out on their pension investments, especially when it's too late in life to make up for 'professionals' managing the pension investments, while they always seem to win and have fantastic commissions and profits.

And worse than that, you cannot trust the govermnent. Noonan only went and increased the levy, and as far as I can tell it's daylight robbery.
 
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