Should you take your tax free pension lump sum to pay off mortgage as interest rates rise? | Personal Finance | Finance newsbhunt


Although owning one’s property outright can release certain pressures in retirement, taking out a lumpsum from pensions can cost people thousands and lessen their annual retirement income.

The Bank of England is predicted to raise rates yet again to 5.5 percent (according to a recent poll by Reuters) this coming September and with no signs of slowing down, Penfold is calling on Britons to make informed decisions on their mortgage repayments.

According to the UK House Price Index 2022, house prices rose on average 10.3 percent over the previous year.

This kind of interest is an excellent return on investment, and at first glance, looks to beat Penfold’s estimated yearly pension interest performance of 8.58 percent.

However, what property values do not benefit from, and which pension funds do, is compounding interest.

Assuming an annual price increase of 10.3 percent, the average house valued at £286,000 (source: ONS) today, will be valued at £610,038 after 11 years.

Meanwhile, if someone’s pension pot is valued at £286,000 when they are at the normal minimum pension age of 55, and they leave it completely untouched until they reach the state pension age of 66, they should have access to £707,317 in their pot.

This extra £100,000 is thanks to the power of compounding interest and does not account for typical additional monthly contributions which would push that number even higher.

However, if they were to withdraw 25 percent of that £286,000 pension pot at 55, they would miss out on a significant amount of compound interest, and retire with only £530,488 in their pot – far less than the £707,317 they could have had, according to Penfold.

As mortgage interest rates and yearly repayments continue to rise for the average household, British homeowners may be tempted to dip into their pension pots to pay off their mortgage debt early. However, doing so could have serious implications for your retirement income.

Britons with defined benefit pension schemes are eligible to withdraw up to 25 percent of their total pot tax-free once they reach the normal minimum pension age, which is currently 55. Any withdrawals beyond that are taxed as regular income.

Upon withdrawing this tax-free lump sum, it can be used for any purpose, including paying off one’s mortgage.

While there are certainly benefits to reducing the amount left on one’s mortgage, or even paying it off completely, there are also major benefits in leaving the tax-free lump sum in one’s pension pot to grow for as long as possible.

Pete Hykin, co-founder and CEO of Penfold says: “Owning your home outright is one of the best ways to live comfortably and reduce your outgoings during retirement. However, your pension is your replacement for your salary, so it is also vital to maximise your retirement income by investing in your pension throughout your career.

“We welcome the flexibility afforded by defined contributions and the ability to withdraw a lump-sum at the age of 55 to help pay off your mortgage, but we also want Britons to be fully aware of the missed opportunity to accrue compound interest on that lump-sum, so that they make informed decisions which are right for their own personal circumstances.”


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