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F<\/span>or many people chasing financial independence, clearing the mortgage ASAP is a key early retirement milestone. And if that\u2019s your plan, then the notion of paying off your mortgage with your pension instead might sound painfully slow.<\/p>\n But have you actually run the numbers?<\/p>\n Recently, I\u2019ve been considering moving to a more expensive house.<\/p>\n There\u2019s a snag, though: I won\u2019t be able to pay down a larger mortgage over 25 years. Or even over 30 years. Not without stopping my ISA and pension investments, anyway.<\/p>\n And I\u2019m not willing to give up on my laissez-FIRE<\/a> early retirement dreams just yet.<\/p>\n I\u2019ve realised though that I don\u2019t necessarily need<\/em> to pay off that bigger mortgage. I just need to service the debt while living in the house for as long as we want the extra space.<\/p>\n Once our kids have grown up \u2013 and their vacated rooms begin to suck in exercise bikes, old books, forgotten toys, and a ton of other clutter \u2013 then I can sell it.<\/p>\n At the same time, when my kids have grown up\u2026 well, I\u2019ll also be eligible to access my pension if I want to.<\/p>\n Which is a slightly scary thought. But it does come with some side benefits.<\/p>\n It\u2019s not the prospect of a free bus pass that I\u2019m excited about. Rather, it\u2019s the possibility of using my pension to pay off my mortgage.<\/p>\n I\u2019ve done my sums, and I think this could potentially save me 50% on my mortgage payments.<\/p>\n And what old age pensioner doesn\u2019t love a chunky discount?<\/p>\n Tax is simple in theory. But when you get into the weeds of gross and net payments, it can start to feel a lot more complicated.<\/p>\n Roughly speaking, if someone earns \u00a360,000 gross, then they receive roughly \u00a345,000 net into their bank account, after tax, under the current tax regime.<\/p>\n So if they choose to use \u00a3450 of their bank account cash to overpay their mortgage, it has actually cost them \u00a3600 of their gross earnings.<\/p>\n Most of the time this doesn\u2019t matter. Feel free to stand at the counter in Costa Coffee and point out that your \u00a34.50 coffee actually cost you \u00a36 in gross earnings. I doubt the rest of the queue will care too much.<\/p>\n With pensions, though, it matters tremendously.<\/p>\n That\u2019s because pensions \u2013 both defined benefit and defined contribution \u2013 allow you to mitigate and\/or delay your income tax bill.<\/p>\n I won\u2019t dive into how defined benefit pensions work, because you could easily write a book on the topic. But the principles with respect to taxation are similar.<\/p>\n I\u2019ll just use defined contribution pensions as the example today.<\/p>\n The central point:<\/p>\n That might be because your company puts money into your pension before even subtracting any tax \u2013 so-called salary sacrifice. In this case, you now have \u00a31,000 in your pension instead of \u00a3600 in your bank account.<\/p>\n Alternatively, you can transfer taxed cash into a SIPP, get an automatic 20% top-up from HMRC, and then claim another 20% back on your tax return.<\/p>\n Either way, for now you\u2019ve avoided paying 40% marginal income tax on that \u00a31,000.<\/p>\n However it\u2019s very hard to say precisely how much tax you\u2019ve saved by moving money into a pension in the long run.<\/p>\n For instance, at earnings of \u00a360,000 to \u00a380,000, with children, you might need to pay the High Income Child Benefit Charge<\/a> (HICBC):<\/p>\n You\u2019re also paying 2% \u2013\u00a0and your employer is paying 13.8% \u2013 in National Insurance.<\/p>\n At least until March 2029, however, you can sidestep National Insurance on earnings diverted into a salary sacrifice pension. Your employer might even be generous and share some of its 13.8% savings with you, too.<\/p>\n The point is, you can lose a lot in tax for each extra \u00a31 that you earn.<\/p>\n Let\u2019s set up a good old personal finance example scenario.<\/p>\n Meet Ingrid and Hans \u2013 a high-earning couple with children.<\/p>\n Ingrid earns \u00a380,000 after matching pension contributions. Ingrid pays a marginal tax rate of 57% due to the HICBC the couple pay for their three children.<\/p>\n Her husband Hans earns \u00a370,000 after matching pension contributions. His marginal tax rate is 40%.<\/p>\n They\u2019ve borrowed \u00a3750,000 as a mortgage to buy their family home. Assuming a 5% rate over 35 years, they are paying \u00a33,787 per month in repayments.<\/p>\n Ingrid and Hans are quite frugal elsewhere in their lives. They project that they\u2019ll be able to put aside \u00a340,000 this year.<\/p>\n What should they do with this surplus cash?<\/p>\n Hans\u2019s first instinct is to use the \u00a340,000 to make an overpayment on their mortgage. That\u2019s well within their 10% annual mortgage overpayment allowance.<\/p>\n After tax\u00a0\u2013 and after handing over \u00a340,000 to the mortgage lender\u00a0\u2013 they\u2019re left with \u00a368,122 in spending money:<\/p>\nThe mechanics of taxation are key<\/h2>\n
How pensions work<\/h3>\n
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It\u2019s not just income tax you need to consider<\/h4>\n
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Good things come to those who wait<\/h2>\n
Making mortgage overpayments<\/h3>\n