Mortgages Guide | Mortgage Help Product Information

TheMoveChannel.com | Pension

Introduction

If you don't belong to a company pension scheme or are self-employed, you can use a personal pension plan as a tax-efficient way to save the cash lump sum necessary to repay an interest-only mortgage whilst planning for your retirement at the same time.

Not that many people are even aware that know that you can tie your mortgage to your pension. Lenders are encouraged not to advertise this type of mortgage because the government doesn't particularly want people to use their retirement fund to pay off their mortgage. There is no doubt that only a minority of people will find that pension mortgages are a suitable choice of product. Then again for some people, such as a financially sophisticated self-employed higher rate taxpayer, they can be ideal choice.

As with all the other types of interest-only mortgage, interest is paid to the lender on the whole of the loan for the entire term of the mortgage. This choice of repayment vehicle combines your mortgage interest payments with payments into your personal pension fund. In itself, this feature of pension mortgages rules many people from having them, as not everyone is eligible for a personal pension scheme. Company pension schemes are not normally used, though they sometimes can be in special circumstances if permitted by the lender.

Your payments go into your pension fund, which then grows over time. You will have full control over your choice of pension product provider. However, your bank or building society will expect the insurer to set predicted growth levels at a conservative level to help ensure that there is enough in the fund to pay off your loan at retirement. The pension plan is designed to mature on your retirement.

The loan term must end between the ages of 50 and 75 unless the borrower is in an industry where the Inland Revenue permits earlier retirement.

The pension also needs to provide you with an income during retirement, so only twenty five percent of the total pension fund can be taken as a lump sum. This lump sum is used to pay off your mortgage while the remainder provides you with a pension income. This means that you need to accumulate four times the value of your home loan in your pension fund in order to pay off your mortgage. This may be difficult, especially with a high value property.

You should consider getting a separate life insurance policy in case you pass away before the pension matures. With this type of mortgage, level term assurance for the value of the loan is normally used.

Advantages

Just as a pension is the most tax-efficient way of saving, it is also the most tax-efficient method of paying back your mortgage. The premiums you pay into your personal pension plan are subject to tax relief at your highest rate of tax. This makes use of a pension plan particularly cheap for a higher rate taxpayer, as they will receive tax-relief at 40% on their pension contributions.

Furthermore, as well as tax relief on interest paid to the lender, you get some tax-relief on pension related life insurance, which means that you can make further savings by arranging your life cover in conjunction with your mortgage.

The underlying pension fund is also tax-efficient, as it is not taxed on its investment income or on the capital gains it makes when selling the investments held by the fund in order to replace them with new shares or other financial instruments. This tax efficiency should lead to a higher return on your investment than the same contributions into an ISA or endowment.

There is nothing stopping you from contributing more than your required level of repayment, as long as you are within your overall pension contribution limits. This can leave you with a cash surplus left over from your mortgage repayment at retirement. You can make these additional voluntary contributions when it suits you financially, but there may be a minimum limit on the size of the extra payment.

You can also be left with a cash surplus on retirement if your pension fund outperforms the level assumed at the start of the plan. Long periods of low interest rates can increase the likelihood of this happening, as a greater portion of your monthly payment will go towards your pension contribution and less will go towards meeting your interest payments.

Disadvantages

Because of the need to accumulate four times the value of your home in the pension plan, this type of repayment vehicle will require a significantly higher monthly outlay than the other types of investment vehicle used with interest-only mortgages. There are limits on the size of the contribution that you can make into your pension, which can make reaching your required amount difficult, especially if you are buying a very high-value property. Other people may not be able to afford to contribute as much as their limit and also may struggle to reach the required fund value.

Not everyone qualifies for a personal pension, so this route is not available to all - only the self-employed or anyone not in a company pension scheme can normally use them. A problem arises if you change status and are no longer eligible for a personal pension. You would have to switch to a different repayment vehicle and may be penalised financially for this.

The benefits of your pension plan cannot be taken until retirement, usually until you are at least 50 years of age. That means you are realistically stuck with this type of mortgage until your retirement, making it the repayment method that requires the most long-term viewpoint.

If you don't wish to retire at the end of your mortgage term, then you will end up paying more interest on the loan than with other repayment vehicles. This is likely to be the case if you start the pension mortgage more than twenty-five years before your planned retirement date. You should also remember that you will get a lower pension in retirement if all or part of your lump sum is used to pay of your mortgage.

As with an ISA mortgage, tax-free investments are great in theory, but since pensions are equity-linked it's not so great when the value of the investment is actually falling, as may have been the case over the early years of this century.

Pensions are complicated to understand, with all sorts of rules and regulations governing contributions. Given that many people are pretty lapse in ensuring their pension arrangements are in order at the right time in their life, it is no surprise that few people are mentally or financially ready to combine their mortgage with a pension, instead preferring more simplistic methods of clearing the mortgage debt.

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