Living with debt is not ideal for anyone – especially those approaching or already in retirement.
According to research by financial firm partnership, around 610,000 over 55s intend to pay off their mortgage with their pension.
New pension freedoms offers the opportunity to take a cash lump-sum and settle mortgages and loans, but many borrowers are unsure whether this is a good way to spend their retirement savings.
To help with the dilemma, financial firm Towry has worked a case study of a typical borrower.
“It’s tempting for retirement savers to take the money and clear their liabilities,” said the firm’s Andy James. “However this may not be a good idea for many borrowers and it is important to work the figures out before taking any action.”
The case study looks at Mr A, who would save £582 a month in mortgage repayments and save £938 in interest payments over three years if he repaid a £20,000 mortgage with cash from his pension.
Financial implications
He would also have peace of mind that he had no large debt hanging over his head, especially if interest rates rise later in the year.
He looks at flexible access drawdown, which would allow him to take £20,000 of his £80,000 fund tax-free as a 25% pension lump sum payment.
This would pay down the mortgage, saving him the monthly repayments and interest.
However, the freedom from debt and peace of mind he gains come at a cost, James explained.
First, the £20,000 is no longer liquid cash he can spend, but is tied up in his property. The money could only be released by further borrowing or selling the home and downsizing.
If he dies before he reaches 75 years old, the money would be part of his estate and may be subject to inheritance tax depending on whether his estate is over the nil-rate threshold, but the remaining £60,000 in his pension fund could pass to beneficiaries tax-free.
If he died at 75 or older, the £20,000 is still part of his estate but the £60,000 would become taxable income to his beneficiaries. If his heirs were basic rate taxpayers, the least they would pay would be £12,000.
Other options
Rather than take the pension cash, Mr A could consider other options:
- Overpaying on the mortgage by £100 a month, which would reduce the interest paid by around £149 and cut the term by six months.
- Paying the mortgage with other investments or savings
- Do nothing
“The decision here is whether that £20,000 will earn Mr A more than £938 if he leaves the money in the pension and continues to make payments,” said James. “Even a relatively low risk three year fixed rate account should accomplish this.”
