Key Post Pay down your SVR mortgage before starting a pension, but don't leave it too late

elacsaplau

Registered User
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892
Interesting rebuttals Brendan.

I think I can defend the points I made but alas a worthy defence will take more time than I have available for the next 2 days. In the meantime, I'll let others take up the very interesting debate!
 

Brendan Burgess

Founder
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48,391
Hi elac

As always, I am more interested in arriving at the right answer than winning a debate. Your last point about early retirement is so important, that it should be up at the top. Some of the others have pros and cons, but the possibility of early retirement, voluntary or forced, changed my view on the issue. It's essential to make some pension contributions from age 40 onwards, even if you still have a balance left on your mortgage.

Brendan
 

elacsaplau

Registered User
Messages
892
Hi Brendan

Just by way of background, what I was challenging in my original post (in the earlier thread) was the conclusion that seemed to be emerging from the earlier thread that there was no benefit in commencing pension payments before paying off one’s standard variable rate mortgage – the idea being that one will always be able to catch up on one’s pension contributions (and the associated tax relief) at a later stage in one’s career. And what I was trying to do is to provide scenarios where this hypothesis may not turn out to be true as I felt the debate had swung too far from the traditional extreme (it’s never too early to start your pension) to almost the opposite extreme. My comments below should be read in this context.

For the purposes of my commentary below, I am assuming that the net return from a pension fund equals the net return on paying down one’s mortgage. This assumption may actually be unfair to the merits of pension funding as, in the long term, I believe that a pension fund is likely to beat the SVR return. Remember the SVR rate should reduce in line with reductions in the LTV ratio and that pension funds enjoy, Michael Noonan’s idiocy aside, tax exempt growth. This is, of course, a separate debate.

Scenario 1: You die

Brendan: Will the spouse be better off?

Commentary: Spouse is better off! €100k contributed to a pension costs €59K – so €100k returned to spouse in cash v. €59k off mortgage.


Scenario 2: You get sick

Brendan: If my income reduces temporarily, better to have a small mortgage.

Commentary: Just to be clear, the reason I included this in my list was not because having a great pension is a great thing when you are sick!! - when out of work, due to illness, what is needed (apart from good medical and family support, etc.) is sufficient cash in the present and so a need for emergency savings and long-term income (permanent health) insurance is most important. I was simply including this as an example of where pension funding at a later stage in life may not be possible at all or to the same extent.


Scenario 3: You become unemployed

Commentary: Arguably investing in up-skilling (when employed) would be a substantially superior “spend” than either mortgage over-payments / pension contributions. Also, in terms of investments, a “rainy day” fund would have far greater utility than a reduced mortgage or pension fund. However, the points made in relation to scenario 2 remain valid here also as a response to the hypothesis I was challenging.


Scenario 4: Your income reduces

Brendan: I may not be able to contribute enough to a pension.

Commentary: So we agree?!


Scenario 5: Your income is or becomes in excess of the cap

Brendan: I don’t follow this argument. If my income increase beyond the €115k, then I can make the maximum contribution and I should not fund beyond €800k anyway.

Commentary: Your contributions are capped so you cannot catch up on years where no contributions were made. (The Duke, in later posts, accepted this point following inputs from SBarrett.) There is also the possibility that the cap reduces if say, Mary Lou (remember her – she used to be very out-spoken regarding perceived wrongs in our society???!!!) gets her hands on the tiller or part thereof. (Please delete references to Mary Lou if appropriate. Alternatively, please set up a “Letting off - off the scale – steam!!!!”)

The opinion regarding a max fund of €800k is one I do not share. €800k less the €200k TFLS does not give a substantial guaranteed income. Apart from the resultant income being well below the standard rate cut-off point, there are valid reasons for having a more substantial fund, e.g. upon early retirement, upon death, upon foreign residence in a state with lower tax - not to mention having sufficient scope with one’s retirement fund to weather the inevitable volatilities of non-guaranteed investments, etc.


Scenario 6: The rate of tax relief reduces

Brendan: If the rate reduces to 30%, there would be no point in a higher rate taxpayer contributing to a pension fund.

Commentary: There is a possibility that the rate of tax relief may be reduced in the future years. It follows that enjoying full marginal relief when it’s available is a better position to take than, coming back to the original argument, over-paying the mortgage now and contributing to a pension later when the available tax relief is not what it is now! A simple example, in bye-gone years, I enjoyed 48% relief on my contributions; next year it will be 40%, etc. In very simple terms, I do not accept the combined arguments of deferring pension contributions now and that if the rate reduces to 30%, there is no point in making pension contributions for higher rate tax-payers!


Scenario 7: Alternative tax efficient investments become available in the future

Brendan: Is this not an argument for paying off your mortgage? If I paid off my mortgage at age 50, I can choose between contributing to a pension and some other tax efficient investment. If I have already put my money into a pension fund, I can’t choose between paying off my mortgage and the tax efficient alternative.

Commentary: What I am getting at here is that once you pay tax, it is gone, gone, gone – never again to see the light of day.
If you take the tax relief now, you can decide in future years whether continuing to contribute to a pension makes sense or whether there are other more attractive investments. It comes back forcefully to the original premise of what is the most tax efficient investment currently available to me right now? I’ve no idea what the tax laws will be in the future in Ireland or elsewhere – all I know for sure is that they may be different in 20 years’ time and the premise I was challenging didn't recognise this appropriately!


Scenario 8: You wish to early retire

Brendan: This is the big argument that swung it for me.

Commentary: Happy days :)
 

Brendan Burgess

Founder
Messages
48,391
Hi E

I have amended the first post as follows

Summary of thread's conclusions (but it's worth reading the thread in full, as differing views are discussed)

....
7) If you die, your estate will get your pension fund tax-free, so if have a terminal illness, maximising pension contributions is very tax effective.

There are some situations where delaying contributions to a pension may be disadvantageous

If you wait until your mortgage is paid off in full before contributing to a pension, your circumstances may change and you may not be able to exploit the full tax advantages of pension contributions


  • You may not have enough years left to build up a fund of €800,000
  • Your earnings may reduce in later years, due to
    * A reduction in income
    * Loss of your job through illness or unemployment
    * A wish to take early retirement
  • A future government may reduce the rate of tax relief on pension contributions, in which case, contributing to a pension fund now while you can get tax relief at 40% would make sense.


As a result, you should start prioritising your pension contributions over mortgage repayments from around age 40.
 

Brendan Burgess

Founder
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48,391
I will deal with Points 5 and 6 together.

Scenario 5: Your income is or becomes in excess of the cap
Scenario 6: The rate of tax relief reduces

There are scenarios where it would be better to contribute today, because the tax relief might be reduced in the future. But I would say that these are outweighed by the scenarios where the tax treatment of the pension received would be worse.

For example, many people were convinced by the pensions industry to stuff their pension fund, because they could get 25% of it tax-free on retirement. Now, they find that they can get only 25% of €800,000 tax-free on retirement. Furthermore, the pension they receive will be subject to USC at 8%. So they might have received tax relief at 40%, only to find it taxed at 48%.

If Mary Lou gets her hand on the tiller, I suspect that the €800,000 could be reduced further and the top rate of tax on pensions will be increased beyond 48%.
 

Brendan Burgess

Founder
Messages
48,391
Scenario 7: Alternative tax efficient investments become available in the future

I still think that this is a big argument in favour of paying off your mortgage.

What I am getting at here is that once you pay tax, it is gone, gone, gone – never again to see the light of day.

But once you contribute to a pension, you can't touch it until you retire.

At any time, I can choose to contribute or not to a pension fund. I must pay off my mortgage, so the only choice I have is in the timing of the payments.

Let's say that Alec follows your advice and maxes his pension contributions from age 25 and makes no overpayments on his mortgage. Mary follows my advice and pays off her mortgage by age 40 and then begins to contribute to a pension fund.

Mary Lou increases the marginal tax rate and scraps the €200,000 tax free lump sum. Mary can then choose not to contribute to a pension fund. Alec can choose not to make any further contributions, but he can't reverse the decision.

Let's say that the tax treatment of pensions remains the same, but the government introduces the equivalent of the UK's ISA. Mary may choose to use up the annual limits on the ISA, before contributing to a pension. Alec must meet his minimum mortgage repayments and so may not be able to max his contributions to the ISA.

It seems to me that delaying contributions to a pension fund, gives the most flexibility.
 

Riverman

Registered User
Messages
13
A very interesting and enlightening discussion - thanks everyone. But:

Here is the picture that should be put to a person seeking advice in this area:

"Say, you had a sum of money to invest and you had a choice of a tax free return absolutely guaranteed of 5% (note the absolute guarantee, banks don't default on mortgages!) or of investing in an equity fund, similarly tax free but subject to charges of over 1% p.a., which would you prefer?"
Banks do (occasionally!) reduce mortgage rates. If your mortgage rate reduces to 4% then your "tax free return" on the extra money you have previously paid into the mortgage reduces to 4%. So although 5% may be a good estimate of the long-term rate, it's not "absolutely guaranteed". On the other hand, of course, it may turn out to be higher!
 

Duke of Marmalade

Registered User
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3,849
A very interesting and enlightening discussion - thanks everyone. But:

Banks do (occasionally!) reduce mortgage rates. If your mortgage rate reduces to 4% then your "tax free return" on the extra money you have previously paid into the mortgage reduces to 4%. So although 5% may be a good estimate of the long-term rate, it's not "absolutely guaranteed". On the other hand, of course, it may turn out to be higher!
I didn't mean it was guaranteed in the long run. It is guaranteed to the next resetting and as such that should be your short term call - if rates get reduced and the calculus reverses then presumably you can top up your mortgage.

I take the point being made that tax relief deferred could be tax relief foregone if the rules change or if you hit the caps. The point I was making was that tax relief deferred does not imply the loss of compound interest on that relief which I think to some at least is a part of the "never too early mantra".

In a sense the tax calculus is a bit of a red herring. There are so many pros and cons. From a pure economic perspective, without the tax distortions, the point stands that mortgage interest saved seems a better bet than equity investment.
 

kokiyou

Registered User
Messages
6
Very interesting thread.

Should this be updated now that the below Tracker Mortgage example is almost the same as current mortgage rates?
If not, could I have the below Scenarios math explanation please - and I can run my own numbers offline?

Ulster Bank rates of 2.3% with cashback == rates of ~2.2%

Scenario 1 - Tracker mortgage
Tracker rate: 2%
Mortgage Repayment €1,000 per month paid for full term
€1,000 put into pension, monthly for 25 years - €552,998

Divert €1,000 from pension into mortgage. Tax at 54% = €460 extra into mortgage.
Mortgage paid off in 15.66 years
Pay mortgage amount plus €1,000 into pension (€3,174 pm) for 9.33 years = €435,955.
 
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