Defer the mortgage, top up a pension?
In the second in a series of business tips, Nathan Poole and Linda Giles advise that sometimes it makes sense not to pay off your mortgage.
Many of us will have a mortgage for most of our working lives. We will look forward to the day when that large monthly deduction from our earnings comes to an end. But what if you don’t have a pension? Perhaps you have worked almost exclusively in private practice and been planning to put some money into your pension, but things didn’t work out?
We suggest that if you have surplus cash and are tempted to pay off or overpay your mortgage, think twice before you do so. Putting that money into a pension might keep it working for longer and could be a more profitable move.
The tax appeal of a pension
A pension keeps your money working for you thanks to tax relief designed to incentivise saving for retirement. Tax relief boosts every contribution by 25%, so, for every £80 you contribute, the government puts in £20. If you are a higher rate tax-payer you also get higher rate tax relief. This would reduce your annual tax bill. For every £800 you put into your mortgage you could be investing £1,000 into a pension, plus getting higher rate tax relief, which could save you another £200 (or even £250) in tax.
Pensions can be hugely tax efficient when planned for correctly. Although, there are some aspects that need to be considered carefully, ideally with your accountant and independent financial advisor (IFA) working together:
- Possible Limitations? Any decisions on pension contributions may impact your annual allowance (AA) and lifetime allowance (LTA); your accountant must understand how the AA is calculated. There could be costly tax payments and penalties later down the line.
- The risks associated with variable mortgages and pension performance. Personal pensions carry investment risk and also incur as costs and charges. So the question is, will any net growth after costs and charges in the client’s pension exceed the cost of the interest being paid on their loan or mortgage? It is also critical that debt can be repaid in all circumstances.
- Interaction with NHS pension. A full understanding of the NHS pension scheme is critical.
- Are you a limited company or a sole trader/partnership? This matters because if you are taking money out of a Limited company to pay off a personal mortgage, you will need to extract that money somehow. If you have a large director’s loan owing to you, it would be possible to simply use that; however, if you need to declare dividends then there will be a tax charge. If the mortgage is a business loan in the limited company, there will be no tax charge to pay off the debt.
- Is the mortgage a business or personal debt? It is generally better to pay off personal debt first, before business debt. The interest on business debt qualifies for tax relief, thereby saving you tax at the highest rate. By contrast, personal mortgages do not qualify for any tax relief. It is however, important to compare the applicable interest rates before taking action.
When times are good, the idea that you might reduce or pay off your mortgage is appealing. But, not paying off the mortgage immediately might just be a good move, as per the case studies below. In each case we worked closely with the client’s financial advisor.
Case study 1
Dr and Dr R, a husband-and-wife dental team, left the NHS many years ago. They had prospered but their pension position was not strong. All their cash was going into their household spending or supporting their growing family. Supported by their IFA, we suggested to them that they should increase their offset mortgage facility when interest rates were low and put the cash freed up into a pension. A few years down the line, they still have a manageable mortgage debt to pay off. However, they now have a healthy pension and no regrets about their decision.
Case study 2
Dr P, only qualified for 15 years and with a young family, and is nevertheless conscious that working privately and he is not building up a pension. Another consideration was that he was about to move into a higher tax bracket which would eliminate his entitlement to child benefit. He put some money into a pension and, in one fell swoop, reduced his tax burden and retained the family’s entitlement to about £2,000 worth of child benefit.
Case study 3
Dr G, a dentist whose husband is her practice manager, she looks after the needs of the patients and manages the family budget. The only time her husband questioned her decision-making was when she suggested they put some spare cash into a pension instead of over-paying the mortgage. Once he had spoken to us and to her IFA, he saw the wisdom of the decision. It’s been a good move for the couple who are nearing retirement.
Paying off a mortgage debt, is normally the safe option. However, there may be other opportunities available more suited to your personal circumstances.
Find the first article in this series here.
More business advice can be found on the Ross-Brooke Dental website. Go to ross-brooke-dental.co.uk.