Extra Cash: Should it go into a Mortgage or Pension?

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havenifa


Posted on: 1st May 2019

Whether you receive a lump sum, or you find that you have quite a bit to spare each month, having extra cash can sometimes leave you feeling conflicted. Although it can seem like a fantastic situation to be in, knowing what to do with the money can be confusing. It is likely that you will want the money to last for the long-term and benefit you later in life. Putting money towards your home or your retirement are both two sensible options, but which is best? Your mortgage or your pension?

Putting money towards your mortgage

If you do not own your home, then getting on the property ladder is likely to be the biggest financial objective in your eyes. Swapping monthly rent payments for mortgage repayments is a common goal for people. This is because the money is going towards a home that you can truly call your own, as opposed to handing money over to a landlord. If this is the case, it may feel like now is the best time to take the plunge and invest in a property, especially as low-interest rates are making mortgages more affordable.

However, if you are already a homeowner, you may be tempted to pay extra cash into your existing mortgage. This will help pay it off quicker, leaving you with even more cash when you get closer to retirement.

However, before you make a snap decision about putting all your extra cash towards your house, it is worth taking a second to think about the benefits of saving into a pension instead.

Putting money towards your pension

When you pay money into a pension, you will usually receive a tax top-up from HMRC. This means you will receive an extra £25 per £100 you pay into a pension as a basic rate taxpayer or up to £50 for top rate taxpayers. The most you can save into a pension each year to receive this is currently 100 per cent of your salary, up to a maximum of £40,000.

What’s more, pension funds are invested in the hope that the money will grow. A good pension fund is diversified and invested in a variety of assets for the sake of managing risk. Despite the fact that funds will fluctuate and there is no guarantee of a good return, your pension may achieve annual growth of around 4 to 6 per cent.

The sooner you save into a pension, as well as the more you manage to save, the healthier your pension pot should be when the time comes to retire.

Doing the maths

Of course, there are benefits to both options, but which one leaves you in a better financial situation? Comparisons are often based on hypothetical situations with variables to consider. However, Phillip Scott, financial writer at This is Money, has drawn an intriguing conclusion. He says that paying a lump sum of £1,000 into a pension could leave you £548 better off (£798 for higher rate taxpayers) after 25 years than if you put the same towards your mortgage. These calculations are based on a pension with an average annual average growth of 6%, and a mortgage with an interest rate of 6% (but do be aware to consider the risk of capital).

Balance

It’s certainly something to think about, but it always comes down to your own personal circumstances. When it comes to pension savings, think about the current size of your pension pot and how long you have until retirement. When thinking about mortgages, you must also factor in your mortgage rate and how many years you have left on your mortgage term. You should also do some research to find out whether there are any penalties for overpaying. Many lenders now allow you to overpay by up to 10 per cent on an annual basis without penalty. However, it would be wise to check your mortgage contract to be sure.

If you are yet to begin pension saving, or you are nearing retirement and facing a serious shortfall, putting extra cash away is often a smart decision. For many people, however, the balanced approach may work. As we said, it ultimately comes down to your personal circumstances!

Seeking expert advice

If you are not sure which path is best for you, we can help. With a team of experts who specialise in different financial areas, Haven IFA can help you assess your financial situation and point you in the right direction, ready for retirement. Get in touch to find out more.