Money Makeover Mid 30's - Tackle Pension or Mortgage

Sarenco said:
If I had followed your advice and prioritised paying down my mortgage in my 30's over maximising pension contributions, I would be significantly poorer today.
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Prioritising pension is absolutely right when you have a very comfortable mortgage.

But if you have an uncomfortable mortgage, as the OP has, then it's wrong.

If you can predict the future...

You will both continue working until your 60s
You won't ever want to trade up
You won't want to take unpaid leave or reduce your hours
Interest rates won't rise too much
Equity returns will continue to outperform mortgage rates in the future
You won't split up
Pension rules won't change

Then it's very clear, that you should stuff your pension.

But if you can predict the future, then your mortgage is comfortable.

Brendan
 
Sarenco said:
That is particularly the case when you include the tax relief on contributions, which effectively constitutes an interest free loan from the State.
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This is a great way of thinking of it.


People also tend to long they are going to live, but also the power of compounded returns over very long periods too. A 35-year old woman is likely to work for another thirty years and live for another fifty years. That means the middle of your expected pension drawdown period is forty years away.

I looked at the S&P annual return (inflation adjusted, dividends reinvested) for the 40-year periods ending below:

2022: 9.1%
2012: 5.2%
2002: 6.1%
1992: 7.0%
1982: 6.6%


This is comfortably above the inflation-adjusted cost of mortgage borrowing over the period (see below), and in many cases by several percentage points. Compounded over several decades, there really are massive expected benefits to equities over paying down your mortgage more rapidly.

 
Brendan Burgess said:
Prioritising pension is absolutely right when you have a very comfortable mortgage.

But if you have an uncomfortable mortgage, as the OP has, then it's wrong.
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I really don't agree that the OP's mortgage is uncomfortable.

As things stand, their fixed monthly mortgage payment represents less than 20% of the household's net monthly income, excluding bonuses and child benefit payments.

Even if the OP's wife took unpaid leave for a period, the fixed monthly mortgage payment would still only represent around 30% of the household's net monthly income, excluding bonuses and child benefit payments.

That looks perfectly comfortable to me.
 
NoRegretsCoyote said:
People also tend to long they are going to live, but also the power of compounded returns over very long periods too.
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This is the whole point that I am trying to get people to think about.

The Magic of Compound Interest applies to loans as well!

It is just not relevant how long they will live.

The OP has a choice

1) Overpay pensions now and pay off the mortgage in due course.
2) Overpay the mortgage now and make up the "missed" pension overpayments later.

Both will benefit from compounding.

In my opinion, there are many uncertainties facing the economy generally and people individually. This is an uncomfortably high mortgage. Reduce it to a comfortable level. Your mortgage payments later on will be lower, and you can use the money saved ( and compounded) to up your pension payments later.

Brendan
 
You are correct.
But we are not talking about decades.
We are talking about the number of years it will take for the OP to get his mortgage down to a comfortable level.
At that stage, they will then increase their pension contributions.

Brendan
 
Paying down a mortgage ahead of schedule has a compounding effect at the weighted average mortgage rate over the original mortgage term. No doubt about it.

However, pension contributions benefit from tax relief so you have a larger sum compounding over the same term (120/140 versus 100).

The tax relief on pension contributions is effectively the same as an interest-free free loan from the State. And because of the tax free lump sum, tax credits and lower rate bands on drawdown, you are unlikely to ever have to fully repay that interest-free loan.

Also, the expected (but not guaranteed) rate of return on equities will always be higher than expected residential mortgage rates.
 
Sarenco said:
Paying down a mortgage ahead of schedule has a compounding effect at the weighted average mortgage rate over the original mortgage term. No doubt about it.
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That is great. This is really important for people to understand. People should stop saying "You must start a pension early because of the compounding effect"
 
Yes, you have a larger sum compounding.

But it's important to realise that this will be taxed at 75% of your marginal rate on retirement, which for most people will be 30%.

And in case there is any doubt, when you have a mortgage below 60% LTV (to avail of the lowest mortgage rates) and if it is otherwise comfortable, you should max your allowed pension contributions - even though there is a risk that the historical outperformance of equities might not continue.

Brendan
 
Brendan Burgess said:
But it's important to realise that this will be taxed at 75% of your marginal rate on retirement, which for most people will be 30%.
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I don't think that's right Brendan.

Take a €800k pension pot. €200k taken as a tax-free lump sum, with the balance drawn down at a rate of 4% per annum from an ARF.

4% of €600k is €24k. The total tax liability on that element of the drawdown, less personal tax credits, is around €1,500. As things stand today, obviously.

So, tax relief of 40% on contributions, and a blended tax rate of less than 5% on drawdowns.
 
Sarenco said:
That is particularly the case when you include the tax relief on contributions, which effectively constitutes an interest free loan from the State.
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Not sure about that. To the extent it comes back as a tax free lump sum, it is a gift. To the extent it comes back as taxable income it is not an interest free loan as the rolled up interest is also taxed.
But your bigger point that equity investment over the longer term should beat 2.2% p.a. even after charges is hard to refute.
There are of course other considerations around flexibility versus a one track question of which has the better growth prospects.

I note this later point.
I am probably being a bit semantic. But if the eventual benefit is not taxed then it turns out that the original tax relief was a gift, not a loan, as it was not repaid at all, never mind its interest. Of course, this supports your overall argument.
 
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I don't follow this.

When you take the money out it will be taxed at 40%. (in this case as they will have a decent income.)

You might argue that they don't need to take it out and that whoever they leave it to will have a smaller tax liability.

But the chances are that they will have far more than €800k and that they will take out more than 4%?

And you seem to be allocating the tax credits to this income. But this is marginal income above their state pension. Won't that use up their tax credits?

Brendan
 
Well, I assumed that the pension drawdown was the sole income for simplicity.

If you add a full State contributory pension to a €24k drawdown, you arrive at an annual income of around €36k. The total tax liability on an income of €36k is around €4,500 per annum for an individual over 66.

So, tax relief of 40% on pension contributions and a blended tax rate of less than 10% on retirement income in this case (including the TFLS).

It is certainly true that the attractiveness of a pension from a tax perspective starts to gradually diminish once a pension pot reaches €800k.

But it never vanishes completely. At least until you exceed the SFT.
 
Brendan Burgess said:
But if you have an uncomfortable mortgage, as the OP has, then it's wrong.
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But the Op doesn't have an uncomfortable mortgage.

They have combined income of 120k and mortgage is 12% of gross income. That's well within the suggested Debt to income ratio of 26%.

If they were paying 40% of their income to mortgage it would be concerning but I can't see how in their financial position the mortgage payment is a concern
 
@Sarenco To the extent that the benefits are taxed at the same rate as the relief, the relief is totally irrelevant, True your net contribution will grow at tax free interest but so too will the relief and that will all go to the taxman, in fact the relief is nothing more than an investment of the taxman in your pension which also grows gross of tax. It actually represents an undisclosed asset of the national finances. I remember colleagues in fat DB schemes who were going to be in the 40% tax bracket on their pension and still piled into AVCs thinking they were getting tax relief on the contributions, it was an illusion.
To the extent, and this is mostly, that the benefit is taxed at less than the relief then the relief is not a loan at all, it is a gift which does not have to be paid pack.
One can see that tax relief is in many situations in part or in full a loan but it is a loan with interest at the growth rate in the fund.

I am just correcting your terminology, not arguing with your overall thrust that pensions in general are a tax efficient savings vehicle, as the Boss states.

Examples:
Gross Contribution 100
Tax relief 40
Net Contribution 60
Growth 100% Pension Pot 200
(1) Withdrawal as Tax Free Lump Sum; nothing paid back to Taxman, no loan involved
(2) Tax on withdrawals 40% x 200 = 80
Net benefit 120 = 2 x Net Contribution; Loan of 40 from Taxman paid back with 100% interest, of no benefit whatsoever to the contributor
(3) Tax on withdrawals 20% x 200 = 40; Half of loan paid back with full interest, half forgiven and effectively a gift. In this example, it so happens that it is the same as an interest free loan, as you only had to pay back the original amount of the relief, but this is a coincidence.
 
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A good friend of mine is 40, has a pension fund of €400k or so, contributing since his mid-20s. He is in an industry that has seen a lot of growth and has benefitted from a long bull run since 2009 of course.

He rented for years and bought a house at 38 for about €400k with a 60% LTV.

It's only one example, but I can't see any scenario where his wealth would be higher today from having prioritised a mortgage over pension contributions.
 
The early 2000s was very similar to now. We had years of good stockmarket returns. Pensions were showing good returns. Many people thought that 100% mortgages were fine. Big mortgages and big pensions were the financial engineering used to maximise wealth. We all expected life to continue onwards and upwards.

But guess what? We had a big recession.

Do you want me to go back through the history of Askaboutmoney and find all the people who were deep in arrears, who suffered great stress and who occasionally lost their home? We had over 100,000 people in arrears.

They would have been far better off if they had prioritised a comfortable mortgage over maxing their pension contributions. When their finances recovered, their mortgage repayments were lower and they could start maxing their pension contributions.

Brendan
 

A lot would depend on timing. If he had bought a house when house prices fell, then I think he would be much better off now. Even if he had bought at the peak, if he had got a tracker, he would be better off now. But it also depends on comparing the house he bought with the house he rented.

But that is more about the timing of the purchase of the house rather than whether he prioritised paying his mortgage or his pension.

Brendan
 
Brendan Burgess said:
They would have been far better off if they had prioritised a comfortable mortgage over maxing their pension contributions.
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I'm not so sure Brendan, particularly given how hard it is to reposess in Ireland.

Suppose in 2010 you found yourself on a much reduced income and you had the choice of stopping pension contributions or going interest only on your tracker mortgage. Certainly in hindsight it would have made far, far more sense to do the latter: borrow at 1% to fund tax-relieved pension contributions that have doubled (tax free) since.

Many people can deal with a residual mortgage when they withdraw 25% of their fund tax free on retirement.
 
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