Monday, 9 June 2014

Question on pension myths

Dinero asked as follows at Economic Myths: Pensions (various myths):

Are you saying it is a financial error for anyone paying interest on a mortgage to simmultaneously pay into a pension? That seems a bit of a radical statement, not heard that before.

Basic rule of investing is that if you can get a better return on your investment than you pay for borrowing (adjusted for risk etc) then you should leverage up. If your investment returns are lower than the cost of borrowing, you should pay off debt first.

The mortgage interest rate is a fairly known figure; but the overall rate of return you will get on a pension fund, decades in the future, subject to the ravages of fund manager charges, with ever changing tax and regulatory rules etc. is a big unknown. You don't really need to worry about the (future) value of your house when making this comparison as that will be the same whether you pay off your mortgage or not.

So let us phrase the question thusly: would it be a good idea to do mortgage equity withdrawal and pay that money into your pension fund? In financial terms, that is exactly the same as underpaying your mortgage and paying more into your pension fund instead.

That was sort of the idea behind endowment mortgages and it didn't go particularly well (it didn't go that badly either in many cases, if truth be told).


ThomasBHall said...

MEWing the house to pay into a pension pot- what a great idea, I'll get on it now!
I actually pay a premium to keep the cash to hand- mortgage rate is higher than savings rate, but it is fixed- and I'd rather have the cash on hand in case I want to do something with it than have (over)paid it on the mortgage and no longer can access it... If it gets to the end of the fix and IRs look awful, I'll pay it off then.

Mark Wadsworth said...

TBH, there is then a risk trade off. Is it better to pay every last penny into the mortgage and have not a single penny left for a rainy day? Clearly not, but what counts as 'rainy day' money and what is excessive?

mombers said...

What are the bankruptcy laws around pensions? MEW a whole bunch, put into pension, default on mortgage a few years before retiring and get repossessed + declared bankrupt. If yr pension pot is out of bounds for creditors, could you be quids in?

On a more sensible note, I get an employer match on up to 4% of my salary into my pension. As such, bundled with tax relief, I think it's a compelling offer. Basic rate taxpayers however it's not worth their while, especially if it's not paid by their employer. You only get income tax relief for non-employer contributions, i.e. 20%, vs 32% for employers (12% NI relief too). And of course they get a further 13.8% off via employer's NI relief.

Mark Wadsworth said...

M, re bankruptcy and pensions, I've only known one case like that in real life and you are exactly correct - they can't get at a bankrupt's pension, but that was ten years ago and the rules might have changed.

Dinero said...

What about the rules on the equity withdrawal scenario .It seems odd that borrowed money would be treated the same as income for tax releif. Is there a tax clause to stop the equity withdawal money from attracting the usual tax refeif top up that is paid by the government when contributions are made to a pension fund.