Should I use my pension to pay off my mortgage?

Exploring the long-term implications of using your pension lump sum to clear mortgage debt

With mortgage rates still higher than in previous years, many approaching retirement are considering whether to utilise their pension savings to pay off their mortgage. On the surface, it might seem like a clever move, freeing oneself from monthly repayments and easing financial pressures. However, the reality is more complex.

Withdrawing pension funds early can have lasting impacts on your future income, tax position, and investment growth. Taking money out before the intended time may lower what you can withdraw later, trigger unexpected tax charges or reduce annual allowances, and stop the compounding that boosts long-term returns, which could restrict your options in retirement.

Understanding the tax position

From age 55 (rising to 57 from 2028), you can usually access your personal or workplace pension. The first 25% can be taken as a tax-free lump sum, up to a maximum of £268,275 for most people. Additionally, any subsequent withdrawals are taxed at your marginal income tax rate, which can significantly reduce the amount available.

If your outstanding mortgage balance exceeds 25% of your lump sum, using additional pension withdrawals to clear it may not be financially wise. The extra income might push you into a higher tax bracket, leading to a larger overall tax bill. We can assist you in understanding the potential impact on your total retirement income.

Balancing interest rates and investment growth

When mortgage rates are low, it often makes more sense to keep your pension invested. Historically, pension funds have grown at a higher average rate than typical mortgage interest rates, especially for long-term investors. This suggests that keeping your pension invested could yield better results than repaying your mortgage early.

However, when rates are high, the decision becomes less clear-cut. While clearing your mortgage could reduce interest costs, your pension investments might still outperform over time, especially once inflation and compound growth are considered. You should also review your mortgage’s terms before making overpayments. Many lenders cap annual overpayments at 10% of the balance, and exceeding this can trigger early repayment fees.

Considering your retirement income

Withdrawing money from your pension now could restrict your financial flexibility in the future. A smaller pension fund means less income during retirement, which might reduce your ability to maintain your chosen lifestyle. Sometimes, the short-term gain of clearing debt is outweighed by the long-term loss of sustainable income.

Timing is also essential. Withdrawing from your pension during a market downturn can deepen losses, as you may sell investments when their value is temporarily low. By maintaining your funds in the market, your pension can recover alongside market growth. We can explain how different choices, such as partial repayments or staged withdrawals, might influence the longevity of your pension savings.

Exploring alternative options

If paying off your mortgage is a priority, think about looking beyond your pension. ISAs provide tax-efficient withdrawals and could be a more flexible option for those with savings outside of their pension. However, remember that ISAs are currently part of your estate for Inheritance Tax purposes, whereas pensions usually are not.

That said, this distinction is changing. From April 2027, unused pensions and death benefits are expected to be subject to Inheritance Tax, as announced in the 2024 Autumn Budget. These upcoming changes could influence how you organise your finances for retirement and succession planning, making professional advice even more important.

Taking a balanced approach

Deciding whether to use your pension to pay off your mortgage is a highly personal choice. It depends on your income requirements, tax situation, investment outlook, and emotional comfort with debt. While being mortgage-free in retirement provides peace of mind, you must also consider the long-term effects on your pension income.

Thinking about using your pension to pay off your mortgage?

By considering all factors, you can make a well-informed decision that supports both your financial independence and your retirement goals. Contact us for more information or to share your objectives. We can help you evaluate the trade-offs, model the long-term impacts, and explore more effective options to protect your retirement income.

THIS ARTICLE DOES NOT CONSTITUTE TAX, LEGAL OR FINANCIAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH. TAX TREATMENT DEPENDS ON THE INDIVIDUAL CIRCUMSTANCES OF EACH CLIENT AND MAY BE SUBJECT TO CHANGE IN THE FUTURE. FOR GUIDANCE, SEEK PROFESSIONAL ADVICE. A PENSION IS A LONG-TERM INVESTMENT NOT NORMALLY ACCESSIBLE UNTIL AGE 55 (57 FROM APRIL 2028 UNLESS THE PLAN HAS A PROTECTED PENSION AGE). THE VALUE OF YOUR INVESTMENTS (AND ANY INCOME FROM THEM) CAN GO DOWN AS WELL AS UP, WHICH WOULD HAVE AN IMPACT ON THE LEVEL OF PENSION BENEFITS AVAILABLE. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.