The conventional wisdom that maximising pension contributions is the first thing to consider in a case such as yours is based tax efficiency. But pensions are not tax free in an absolute sense. You don't pay tax on the contributions but (apart from the lump sum) you pay tax when you withdraw your accumulated wealth from the vehicle (be it by annuity or any of the more modern devices).
So, the benefit of pension top-ups is greatly reduced if you're going to be in the same band of income tax when you retire as now. Thus, if it looks like you already have a level of provision likely to keep you at the top rate, forget about the so-called tax advantages.
Next, the return on your investment. Here you're in finger-in-air territory. In a low interest rate, low inflation rate world the nominal return on capital invested is a bit undramatic. The days when life companies quoted double digit returns in their literature seem a long way off. The recent returns from those companies have done little to inspire confidence in their ability to grow your wealth at a rate significantly in excess of long-term interest rates. This is compounded by the phenomenon of life companies pulling out of equities in recent troubled times and “investing” in cash – which obviously lessens the benefit of subsequent rises in equity values to the policyholder.
In short, while years ago it was always assumed that fund returns would way outperform long term interest rates, that assumption doesn’t seem to be quite as clear cut any longer.
This is critical, since you can easily earn a rate of return ahead of interest rates (how much ahead depends on the margin your lender charges over the ECB rate) by simply making overpayments on your mortgage. Such returns are risk free.
Of course, you do need to bear in mind the tax relief you receive at the basic rate on your mortgage interest. For a non-first time buyer couple, this can be worth up to €1,000 (provided they’re paying a minimum of €5,000 interest). Early redemption of chunks of your mortgage, once the interest bill per annum is less than €5,000 will “cost” you the 20% relief. But do bear in mind that not paying a chunk of interest because you’ve repaid the capital effectively saves you 80%, not the 20% mentioned above. In short, continuing to owe money to benefit from very limited tax relief on the interest is of dubious merit as an investment strategy.
So that’s the technical stuff out of the way. What you should now do is consider your current versus your medium and long term financial outlook.
If you could get your mortgage paid off, say, 5-10 years early, imagine the change that could make to your life. Multiply your monthly mortgage payment by 24 and that will give you some idea of the equivalent increase in your gross annual salary (for a higher rate tax and class A PRSI payer). Just imagine how that could change your life at that stage. Seems appealing to you? Then overpay your mortgage rather than fatten up your pension pot.
Many of us get obsessed about retirement and put ourselves through genuine hardship now in the hope of an easy retirement. But life is full of uncertainties. We might not be well enough (or even alive at all) to enjoy the tropical sunsets on golden beaches we foresee in our retirement. But we are well enough to enjoy an extravagant holiday this year, which we’re not able to take because we’re saving for one in thirty years time. Just where is the sense in that? Convinced? Then just spend the money now and forget about increasing your pension or mortgage payments.
You see, it’s not really a question that anybody can answer for you. But thanks for raising it – it’s something we should all be considering.
Edited by ClubMan to fix typo (reference to mortgages instead of pensions in the second sentence).