# Pension v Mortgage



## Maybrick (28 Apr 2018)

Hi all,

Another question about pensions - probably very basic for most of you, but novices like me might find it instructive.

Here's a scenario. You are 45 years old, with no pension and a mortgage of 100K that still has ten years left to run. A relative dies and you inherit 100K. Do you:

a. Use the money to start a pension.

b. Clear the mortgage, then start a pension and maximize your contributions since you will have much more disposable income.

Or does it depend on other factors and, if so, what are they?

Thanks in advance for any advice.


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## Brendan Burgess (28 Apr 2018)

What is your income? 

Are you self-employed or employed?

What is the mortgage rate? If it's a tracker, I don't think you should pay it off. 

If you are paying tax at the top rate, you should contribute the maximum to the pension.

If you are not paying tax at the top rate, you should pay off the mortgage, as long as it's not a tracker.

Brendan


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## Maybrick (28 Apr 2018)

Thanks Brendan. This is not my exact situation, just asking for illustrative purposes. With that in mind:

Self-employed, income 40K, mortgage rate 3.2pc.


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## Brendan Burgess (28 Apr 2018)

If you are single, you have €6,200 taxed at the top rate, so you should contribute this to your pension fund and pay the balance off your mortgage. 

If you are married, you are not paying tax at the top rate so should pay off your mortgage. 

Brendan


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## Maybrick (30 Apr 2018)

Thanks again. I find it very instructive that there isn't a simple yes or no to my original question and so much depends on whether you are paying the top or lower rate of income tax.

This confirms my suspicion that although the tax benefits of starting a pension are real, they are also considerably exaggerated in some quarters.

One other point, from the viewpoint of somebody who likes to keep their financial affairs as simple and stress-free as possible:

Paying a lump sum off your mortgage is quick, straightforward, risk-free and delivers immediate benefits that are easy to see and understand.
Managing a pension is slow, complicated, involves at least a little uncertainty and won't deliver any benefits for many years to come.

This makes me feel a lot better about not starting a pension until my mortgage is history.

Anyway, I see there is a 'Key Post' about all this so I will go and study that. If anybody thinks I am wrong about any of the above, please feel free to put me straight.


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## blured (30 Apr 2018)

I am sure more clued in members can opine on this, but I wouldn't have thought its as straight forward or black/white as you have alluded to.

I would have thought, using a portion of the €100k inheritance to fund a maximum AVC for last year and this year (25% of your salary being €11,250) would give you a start in the pension of €22,500. This will also generate a significant tax credit for you, so you would be due tax back for this year and last year. You could then pay the remainder, €77,500 off your mortgage, leaving you a fairly small mortgage. You could then start making normal AVCs (perhaps as Brendan suggested just the portion of your salary at the higher rate) from 2019


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## Gordon Gekko (30 Apr 2018)

I’ve run the numbers on this.

I was faced with a choice of AVCs or accelerated repayment of my mortgage.

The AVCs won by quite a bit. The problem is that you can make a mortgage overpayment pretty much anytime, but with AVCs it’s a case of “use it or lose it”. If I don’t put it in this year, I can never put it in, which has a far greater effect at the other end.

10/15 years of mortgage overpayment at the expense of AVCs leaves too little time to build up the fund.


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## Sarenco (30 Apr 2018)

Maybrick said:


> This makes me feel a lot better about not starting a pension until my mortgage is history.


Personally, I think that may be a mistake.

In addition to the "use it or lose it" problem noted by Gordon, it is also important to try and diversify your investment risk over time in order to harvest something resembling the long-term average return on equities.

Or to put it another way, the earlier you start contributing to a pension the greater the probability that the returns on your contributions will be higher than the weighted average rate on your mortgage over the same time period.

Throw in the tax relief on pension contributions and I think that prioritizing pension contributions (at least where the tax relieved is at the higher rate), over paying down a mortgage ahead of schedule, becomes compelling.

That strategy is not absolutely _guaranteed_ to give you a better long-term financial result but the odds of it doing so are pretty overwhelming.


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## Brendan Burgess (30 Apr 2018)

Hi Gordon and Sarenco

I am a bit confused. Are you suggesting that he should contribute to a pension even if he is getting only 20% tax relief? 

If so, I don't agree.  He has twenty years of contributions to make.  It is better to make those contributions when he is getting 40% tax relief than 20% tax relief. 

There is a risk that he gets 20% tax relief on the way in, but that if his income has improved by retirement, that he pays higher rate tax on the way out. 

The uncertainty over future pension policy and the delay in getting the benefits means that 20% tax relief is just not worthwhile.

Brendan


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## nest egg (30 Apr 2018)

Can I make this a real example? 
Higher rate tax payer, 36 y.o., with a pension pot of 190k, and a mortgage of 445k (3%, 29 years remaining). No lump sum unfortunately.
Pension or mortgage?


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## Sarenco (30 Apr 2018)

Brendan Burgess said:


> Are you suggesting that he should contribute to a pension even if he is getting only 20% tax relief?


Not in this circumstance Brendan -


Sarenco said:


> I think that prioritizing pension contributions *(at least where the tax relieved is at the higher rate),* over paying down a mortgage ahead of schedule, becomes compelling.


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## Sarenco (30 Apr 2018)

mojoask said:


> Can I make this a real example?
> Higher rate tax payer, 36 y.o., with a pension pot of 190k, and a mortgage of 445k (3%, 29 years remaining). No lump sum unfortunately.
> Pension or mortgage?


I would prioritize maximising pension contributions over paying down the mortgage ahead of schedule, at least to the extent that the pension contributions benefit from tax relief at the higher rate.


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## Brendan Burgess (30 Apr 2018)

Sarenco said:


> I think that prioritizing pension contributions (at least where the tax relieved is at the higher rate),



Sarenco, this in still not clear to me. 

You and I agree that someone should contribute to their pension while they are getting tax relief at the top rate. 

Can you clarify whether you think that someone should contribute when their tax relief is at the 20% rate? 

Brendan


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## Sarenco (30 Apr 2018)

Brendan Burgess said:


> Can you clarify whether you think that someone should contribute when their tax relief is at the 20% rate?


In priority to paying down a mortgage (or any loan for that matter) at a rate equivalent to the risk free rate +3%?  No.

But I don't agree that somebody should never contribute to a pension if they are only receiving tax relief at the basic rate.


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## RedOnion (1 May 2018)

Brendan Burgess said:


> Are you suggesting that he should contribute to a pension even if he is getting only 20% tax relief?
> 
> If so, I don't agree.


Can I ask a different scenario for the purpose of discussion?

Let's say a high earner, mid 50's with a pension pot over 1m. Employer contribution 12% per annum. Should they continue to contribute AVCs, considering after their tax free lump sum they are projected to be paying higher tax rate on their pension?

Remember many people getting relief at higher rate will pay higher rate on exit. And a lot more will pay at lower rate. But an earner on lower rate will very likely receive pension completely tax free, under current reliefs, as they generally have lower pensions.

On top of the tax relief, the marginal utility of an extra 3k a year is much high to someone relying on state pension than to someone with a 50k per year pension.

Back to OPs scenario, someone in their mid 40's without any pension earning 40k is unlikely over 20 years to build up a fund where they will pay higher tax on exit.

Should a lower rate earner contribute?
Yes, some clear examples:

To the extent there are employer matched contributions
To the extent they can receive the entire pot tax free on retirement - particularly those getting close to retirement age
If they don't hold any debt, or need the money in 5 year horizon, to the extent they will get the pension tax free. Particularly if they are otherwise likely to 'waste' their money.


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## Brendan Burgess (1 May 2018)

RedOnion said:


> Should a lower rate earner contribute?
> Yes, some clear examples:
> 
> To the extent there are employer matched contributions
> ...



I agree with those. There are some circumstances where people paying 20% tax should contribute to a pension.

But not a 45 year old thinking of "starting a pension".  Presumably he is not close to retirement. Presumably his employer is not matching his contributions. 

Brendan


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## Buddyboy (1 May 2018)

Also, someone who is paying tax at 20% can benefit from the tax free lump sum on retirement. If they don't have the maximum service and the AVCs allow them to increase the tax-free lump sum.

Sorry, just saw that Red Onion made the same point.

Also, in my case, I was saving monthly into a fund anyway, so it made sense to switch to a more tax-efficient vehicle (AVCs). As I am 13 years away from retirement and already have a cash fund so don't need the money in the short to medium term. And a tracker mortgage of ecb + 0.5


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## Sarenco (1 May 2018)

Buddyboy said:


> Also, in my case, I was saving monthly into a fund anyway, so it made sense to switch to a more tax-efficient vehicle (AVCs). As I am 13 years away from retirement and already have a cash fund so don't need the money in the short to medium term. And a tracker mortgage of ecb + 0.5


That seems very sensible to me.

There are obviously significant numbers of people in their mid 40's with cheap tracker mortgages that do not pay much if any tax at the higher rate.  Personally, I think they would be right to prioritise making pension contributions over paying down their mortgages (or investing outside a tax-advantaged pension vehicle).


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## Steven Barrett (1 May 2018)

Maybrick said:


> Thanks again. I find it very instructive that there isn't a simple yes or no to my original question and so much depends on whether you are paying the top or lower rate of income tax.
> 
> This confirms my suspicion that although the tax benefits of starting a pension are real, they are also considerably exaggerated in some quarters.
> 
> ...



Can't you do both? Pay off the mortgage and redirect the mortgage repayments into a pension? Otherwise, you are going to spend the mortgage repayments on stuff now and have no money in 20 years time when you want to stop working.  

Yes, pensions are a slow. But unless you are lucky, building wealth is a slow process. By investing your money over decades, you harness the power of compounding and all those relatively small contributions you make month by month will grow without you having to do anything. Remember, it is likely that you will live for 20 - 25 years in retirement. That's a long time to go without any earned income. It's not easy to save that amount of money in a short period of time, you need to do it over decades. If you don't, you will have a miserable retirement because you'll have no money to do anything. 


Steven
www.bluewaterfp.ie


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