Brendan Burgess
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This is based on the current pensions and tax regime. This regime will change before you reach retirement
Here are the key questions this post will address:
Why contributing to a pension is usually a good idea
It may be better to save outside a pension scheme but if contributing to a pension is the only way to force you to save, then this would be a more important factor.
If your employer matches your pension contribution, you should max your contribution
For example, if you contribute 5%, they contribute 5%. If you contribute nothing, they contribute nothing.
It is always right to max your contributions to the level of your employer’s contributions in this situation.
Factors arguing for maxing your contribution now
When I wrote this post first back in 2019, the Irish mortgage market was not normal. Bizarrely, many lenders charged the same rate on a 50% Loan to Value mortgage as they charged on a 90% LTV. And lenders did not always allow you avail of the lower rates available to new customers, so reducing your LTV might not have led to much of a saving.
But since then there has been a move to LTV lending. For example, here are Avant's lending rates:
Let's say you are just over 60% LTV and you are deciding what to do with €20k. Paying it off your mortgage is clear as you get a 6% tax-free, risk-free return on your investment.
If you are thinking of switching mortgage providers...
This is a bit more complicated.
1) If you are switching to Avant or one of the other lenders which have lower rates for lower LTVs, then you should be paying down your mortgage so that you get down below the trigger point.
2) However, if you are switching to one of the cash-back lenders, you probably want to borrow as much as possible and then pay off some capital after drawing down the mortgage.
Why saving for a deposit is a higher priority than contributing to a pension fund
Both are forms of long-term saving.
It is generally cheaper to pay a mortgage than to rent, so the earlier you can get on the housing ladder the better. Even if you think that house prices are going to fall, you should still save up for a deposit, so you can buy when house prices fall.
Having a bigger deposit has huge advantages
Many people take out uncomfortably high mortgages to get on the housing ladder and that is fine. But your priority should be to pay it down to a more comfortable level as quickly as possible.
There are two measures of comfort – Loan to Income and Loan to Value
A comfortable mortgage in relation to your income is a level which allows you to handle a rise in mortgage rates or a drop in income - for example, if you want to take unpaid leave.
A mortgage of €300k would be uncomfortably high for a couple earning €50k each, but quite comfortable for a single person earning €100k.
A young person starting off their professional career who has reasonable expectations of significant salary increases would be able to tolerate a higher LTI. This is why many lenders give young solicitors and doctors exemptions from the LTI limits.
The LTV is a lesser consideration, but still a consideration. If property values fall, you may go into negative equity and would be trapped in your home unable to trade up or move location. And, as pointed out earlier, high LTV mortgages usually have higher mortgage rates on the whole loan.
So you should target getting your LTV down to 80%.
If you are thinking of trading up
If you are living in a one bed apartment with a young child, your absolute priority will be to trade up. As a second time buyer, you will need a deposit of 20% of the price of the house you want to buy. So you will need to have this either in equity in your existing property or in savings. So you should not be making unmatched pension contributions.
If you are thinking vaguely that you might like to trade up after a few years, but you have enough equity in your home to fund the 20% deposit required, then having access to your savings is less a priority.
There is a risk that the 40% tax relief might be reduced in a future Budget
At the moment, you get 40% tax relief on your contributions if you are paying at the top rate. This might be cut to 30% in which case you will regret not having contributed more at 40%.
“But if I don’t use my contribution limit this year, don’t I lose it?”
In your 20s, you can contribute up to 15% of your salary to your pension fund up to a maximum of €17,250 each year. If you don’t contribute this year, you lose that opportunity. In your 30s, the limit is 20% and €23,000.
I don’t see this as a major issue in your 20s and 30s. If you have focussed on getting the deposit together and paying down an uncomfortably high mortgage, your mortgage repayments in your 40s and 50s will be lower than they would otherwise have been leaving you space to utilise the maximum pension contribution limits then.
So maybe you should strike a balance between pension contributions and overpaying your mortgage
The big risk is that tax relief might be reduced from 40% to 30%. So even if your mortgage is a bit high, maybe contribute something to your pension fund and overpay your mortgage a bit as long as you have a plan to get your mortgage down to a comfortable level in the short to medium term.
If interest rates rise or if your job or income looks less reliable, then maybe pay more off your mortgage. If you are a public servant with a secure job, then maybe swing towards your pension.
If you are paying only 20% tax relief, you should not be making unmatched pension contributions in your 20s or 30s
Any balance in your fund in excess of €2m on retirement, will be taxed at punitive levels.
If you have a pension fund of €500k at 40, it could easily rise to €2m by retirement, even without any further contributions.
- Tax relief on pensions may be changed to 30% for everyone. If you are paying tax today at 40%, then you will lose out if you defer contributions to a time when the tax relief is reduced to 30%. On the other hand, if you are paying tax today at 20%, you would be better off deferring contributions to a time when you might get tax relief at 30%.
- At present you can build up to a fund of €2m tax-efficiently. Anything over that is taxed at a penal rate. This limit might be reduced or increased.
- Pension funds accumulate tax-free, but a FG minister imposed a levy on pension funds. If it has happened before, it could happen again – especially with a left wing Minister for Finance.
Here are the key questions this post will address:
- Should you delay buying a house to start a pension or should you delay starting a pension to buy a house?
- Having bought a house, is it better to use any available savings to contribute to your pension or to pay down your mortgage?
Why contributing to a pension is usually a good idea
- You get tax relief at your top rate of income tax on your contributions
- The fund grows tax-free
- On retirement, you can take around 25% tax-free.
- While you pay tax and USC on what is left after the tax-free lump sum, your top rate of tax then may be lower than the rate you are paying now.
- You cannot access your money until you retire
- You might need the money sooner to get on the housing ladder or cut your debt
- If you are paying tax at 20%, then you will get only 20% tax relief. You might be better off waiting until you are earning enough to get tax relief at 40%.
- You do not want a situation where you get tax relief at 20% but end up paying tax and USC at 45% when you draw it down in retirement.
It may be better to save outside a pension scheme but if contributing to a pension is the only way to force you to save, then this would be a more important factor.
If your employer matches your pension contribution, you should max your contribution
For example, if you contribute 5%, they contribute 5%. If you contribute nothing, they contribute nothing.
It is always right to max your contributions to the level of your employer’s contributions in this situation.
Factors arguing for maxing your contribution now
- You are paying tax at 40% on your income
- The 40% tax relief may be reduced to 30% in the near future
- If you don't use your annual contribution limit, you will lose it
- You have already bought your home and your mortgage is down to a comfortable level
- You don’t intend trading up for some time
- You do not have any other expensive borrowings
- You have no other intended expenditure
- You are closer to 40 than 20 – because you will have less time to utilise your maximum contributions
- You have a very small pension fund because you were a late starter
- You are saving for the deposit on a house
- You are in danger of going into arrears on your mortgage
- You have an uncomfortably high mortgage
- You have a house and a comfortable mortgage but you are planning to trade up
- You are not earning enough to pay 40% tax
- You have no taxable income
- You are closer to 20 than 40 – you have plenty of time to “catch up.”
- You already have a very large pension fund
When I wrote this post first back in 2019, the Irish mortgage market was not normal. Bizarrely, many lenders charged the same rate on a 50% Loan to Value mortgage as they charged on a 90% LTV. And lenders did not always allow you avail of the lower rates available to new customers, so reducing your LTV might not have led to much of a saving.
But since then there has been a move to LTV lending. For example, here are Avant's lending rates:
Let's say you are just over 60% LTV and you are deciding what to do with €20k. Paying it off your mortgage is clear as you get a 6% tax-free, risk-free return on your investment.
If you are thinking of switching mortgage providers...
This is a bit more complicated.
1) If you are switching to Avant or one of the other lenders which have lower rates for lower LTVs, then you should be paying down your mortgage so that you get down below the trigger point.
2) However, if you are switching to one of the cash-back lenders, you probably want to borrow as much as possible and then pay off some capital after drawing down the mortgage.
Why saving for a deposit is a higher priority than contributing to a pension fund
Both are forms of long-term saving.
It is generally cheaper to pay a mortgage than to rent, so the earlier you can get on the housing ladder the better. Even if you think that house prices are going to fall, you should still save up for a deposit, so you can buy when house prices fall.
Having a bigger deposit has huge advantages
- You get on the housing ladder earlier
- It will be easier for you to get a mortgage
- You can buy a bigger house. It is better to buy your “second” house now, rather than to buy a starter home and then trade up after 5 years.
- The higher your deposit, the lower will be your Loan to Value Ratio. The lower the LTV the lower the mortgage rate – on your entire loan.
Many people take out uncomfortably high mortgages to get on the housing ladder and that is fine. But your priority should be to pay it down to a more comfortable level as quickly as possible.
- You are less likely to fall into arrears, if things go wrong.
- When interest rates rise, you will not be as badly affected
- If your income falls or you lose your job, you will find it much easier to reschedule your mortgage
- If you can bring the LTV below 80% you can get a lower mortgage rate.
- If the mortgage rate is 3%, paying down your mortgage is the equivalent of getting a guaranteed, tax-free return of 3% on your investment. It is also charges-free.
- If you want to trade up, having plenty of equity in your home, makes it easier
- And, of course, you will pay off your mortgage earlier. After you have cleared your mortgage, you will be able to contribute more to your pension fund.
There are two measures of comfort – Loan to Income and Loan to Value
A comfortable mortgage in relation to your income is a level which allows you to handle a rise in mortgage rates or a drop in income - for example, if you want to take unpaid leave.
A mortgage of €300k would be uncomfortably high for a couple earning €50k each, but quite comfortable for a single person earning €100k.
A young person starting off their professional career who has reasonable expectations of significant salary increases would be able to tolerate a higher LTI. This is why many lenders give young solicitors and doctors exemptions from the LTI limits.
The LTV is a lesser consideration, but still a consideration. If property values fall, you may go into negative equity and would be trapped in your home unable to trade up or move location. And, as pointed out earlier, high LTV mortgages usually have higher mortgage rates on the whole loan.
So you should target getting your LTV down to 80%.
If you are thinking of trading up
If you are living in a one bed apartment with a young child, your absolute priority will be to trade up. As a second time buyer, you will need a deposit of 20% of the price of the house you want to buy. So you will need to have this either in equity in your existing property or in savings. So you should not be making unmatched pension contributions.
If you are thinking vaguely that you might like to trade up after a few years, but you have enough equity in your home to fund the 20% deposit required, then having access to your savings is less a priority.
There is a risk that the 40% tax relief might be reduced in a future Budget
At the moment, you get 40% tax relief on your contributions if you are paying at the top rate. This might be cut to 30% in which case you will regret not having contributed more at 40%.
“But if I don’t use my contribution limit this year, don’t I lose it?”
In your 20s, you can contribute up to 15% of your salary to your pension fund up to a maximum of €17,250 each year. If you don’t contribute this year, you lose that opportunity. In your 30s, the limit is 20% and €23,000.
I don’t see this as a major issue in your 20s and 30s. If you have focussed on getting the deposit together and paying down an uncomfortably high mortgage, your mortgage repayments in your 40s and 50s will be lower than they would otherwise have been leaving you space to utilise the maximum pension contribution limits then.
So maybe you should strike a balance between pension contributions and overpaying your mortgage
The big risk is that tax relief might be reduced from 40% to 30%. So even if your mortgage is a bit high, maybe contribute something to your pension fund and overpay your mortgage a bit as long as you have a plan to get your mortgage down to a comfortable level in the short to medium term.
If interest rates rise or if your job or income looks less reliable, then maybe pay more off your mortgage. If you are a public servant with a secure job, then maybe swing towards your pension.
If you are paying only 20% tax relief, you should not be making unmatched pension contributions in your 20s or 30s
- Your salary may well increase and you might be able to get 40% tax relief on it in the future
- Even if your salary does not increase, there is talk of giving everyone 30% tax relief on their pension contributions irrespective of their tax status so you would be better off if you delay contributions to that date.
- 20% tax relief and tax-free accumulation is just not enough compensation to lock up your money for up to 30 or 40 years
- If you are paying 20% tax, you are on a low income, and contributing to a pension might not be your priority.
Any balance in your fund in excess of €2m on retirement, will be taxed at punitive levels.
If you have a pension fund of €500k at 40, it could easily rise to €2m by retirement, even without any further contributions.
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