Fiducia Wealth Management
Posted in Fiducia News on 27.03.24
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Common scenarios are a promotion leading to greater surplus income, inheritance, or a noticeable reduction in costs, such as paying off unsecured debt. Whether that newly found surplus income should be allocated to building your retirement fund or eliminating your mortgage sooner is a common financial dilemma.

 

There are pros and cons to each choice depending on your situation. Here is an in-depth look at factors to weigh up when deciding between retirement savings and mortgage overpayment in the UK.

 

The Case for Focusing on Retirement Savings

– Tax Advantages

Contributing to SIPPs, workplace pensions and ISAs enjoys significant tax benefits, allowing for faster growth. Mortgage payments do not benefit from the kind of tax incentives that increase pension values.

For example, if you put £1,000 towards your pension, you immediately benefit from 20-45% tax relief depending upon your personal income tax situation. You then benefit from tax free growth for the life of the pension and, the longer the investment term, the greater the impact.

Pension withdrawals benefit from tax free cash and the likelihood that your personal rate of income tax is less in retirement, producing a tax “profit” when comparing net contributions to net withdrawals. These tax advantages provide a strong rationale to start retirement savings sooner rather than later.

 

– Potentially Higher Returns

Collective investment funds are projected to grow at 5%-7% per year over the long term by being diversified across equities, bonds and property. Whereas mortgage rates average around 4% per year. Therefore, there is an incentive to invest as opposed to paying down debt. However, investment returns are not guaranteed. They can vary substantially from decade to decade. Upside potential must be balanced with market risk based on your personal timescales.

The same can be said for borrowing to build a property portfolio. Rental voids can occur, and growth of property prices can be less than anticipated.

 

– Employer Matching

If your employer offers matching contributions to your pension, this provides extra money toward retirement. For example, if your employer pension contributions up to 5%, but only if you match it.

The majority of people should make sure they are contributing at least that much before diverting surplus income towards mortgage over payments.

 

The Case for Prioritising Mortgage Repayment

– Debt Freedom

There is a strong psychological benefit to paying off your mortgage and owning your home before you retire. The security of having this major expense eliminated can be transformative. A paid off home also reduces mandatory living costs substantially.

 

– Risk Reduction

Paying off your mortgage guarantees a saving on interest costs. Whereas the future returns from investing cannot be guaranteed.

 

– Flexible Cash Flow

With the mortgage paid off, more disposable income opens up in your budget each month. This gives greater flexibility to direct cash toward travel, hobbies or preparing for unexpected expenses in retirement years. It also gives a better idea of retirement expenditure.

 

Other Factors to Consider

– Your Age and Time Horizon

If retirement is still 20-30 years away, time is on your side for compounding growth in pension accounts, making this a higher priority. But if nearing retirement age, eliminating the mortgage may take precedence. After all, carrying debt into retirement can limit options and reduce financial capacity for the unexpected.

 

– Alternative Investment Opportunities

Consider whether excess cash has better risk-adjusted return potential in investments like buy-to-let property versus overpaying the mortgage. Run projections for different options. When doing so, it is recommended that assumptions for growth are conservatively low and costs, such as debt, conservatively high.

 

Summary

The solution is to carry out an evaluation of your full financial picture. This requires a sound grasp of personal objectives, income and expenditure and assets and debts. For many it is likely to entail a multi-faceted and flexible approach by both investing and paying down debt in tandem. This approach gives wealth time to grow whilst making a meaningful impact to what we define as “good debt”.

At Fiducia, our multi award-winning team of Chartered Financial Advisers can help you reach your goals in a timely and tax efficient fashion. To have a free initial discussion with a member of our team, contact us below.