Mortgage Overpayment v Extra to Pension

techdiver

Hi,

I have a quick question for those of you in the know financially wise.

I am trying to decide whether to pay extra money off my mortgage or put extra money into my pension.

I am on the higher income tax bracket if that makes a difference and I have 340 months remaining on my mortgage (€162,000 approx outstanding) at 3.9%.

WOuld look to pay an extra €150 per month on the mortgage which would knock 7 years off at a saving of €29,000 over the lifetime of the mortgage.

i can't figure out which would be the best use of the money considering tax relief on the pension contribution etc.

Henry Ford III

The pension will be much more effective. Even if it achieved zero growth the return is still 40% (subject to the normal conditions).

That compares rather well with 3.9%.

kennyb3

I think this is way way more complicated than henry fords answer, not withstanding their 'subject to....' comment.

Much will depend on the rate of tax you expect to pay when you retire which will be determined by the size of your pension, the rate of tax at that time (unknown), the amount of TFLS if any still available at that time (unknown), if any pension levy or similar raid is ever re-introduced (unknown).

That's not to mention your employment prospects and how likely you are to need money at a future point in time - once the payment goes into the pension it's locked away until retirement age but with a mortgage repayment you could potentially recover it with the sale of the house.

As I said I don't think it's a very simple maths equation given a) the amount of variables b) the lack of long term pension planning/commitments in this country.

techdiver

Sorry to resurrect this but I was working on an equation to solve this and have come up with the following. Could someone peer review this for me?

So I want to put aside €150 net either to overpay my mortgage or to add to pension. I am in the high marginal rate of tax, so my relief on the pension contribution will be circa 49%.

So my net pension contribution would be €223.50 per month approx. Yearly that works out at €2682.

I have 28 years left on my mortgage. By paying off an extra €150 per month I will knock 7 years off and save around €29,000 in interest. Putting €150 per month for 21 years will directly fund the capital of the mortgage to the tune of €37,800.

With all that in mind over a 21 year period (28-7) the following are my calculations:

Pension:
€56,322 (€2682 x 21)

Mortgage
€66,800 (€37,800 + €29,000)

So mortgage wins out. Is this correct or am I missing something?

Trish56

Not an expert on this but should you not leave the capital payments to your mortgage out in this comparison as even if you do choose to put the extra money into your pension you still have to pay your mortgage. Maybe I'm missing something !!

techdiver

Trish56 wrote: »

Not an expert on this but should you not leave the capital payments to your mortgage out in this comparison as even if you do choose to put the extra money into your pension you still have to pay your mortgage. Maybe I'm missing something !!

The "capital" I reference is the extra not the standard mortgage payment. As it's over an above the standard it will reduce the capital instead of servicing interest.

kavanada

techdiver wrote: »

Sorry to resurrect this but I was working on an equation to solve this and have come up with the following. Could someone peer review this for me?

So I want to put aside €150 net either to overpay my mortgage or to add to pension. I am in the high marginal rate of tax, so my relief on the pension contribution will be circa 49%.

So my net pension contribution would be €223.50 per month approx. Yearly that works out at €2682.

I have 28 years left on my mortgage. By paying off an extra €150 per month I will knock 7 years off and save around €29,000 in interest. Putting €150 per month for 21 years will directly fund the capital of the mortgage to the tune of €37,800.

With all that in mind over a 21 year period (28-7) the following are my calculations:

Pension:
€56,322 (€2682 x 21)

Mortgage
€66,800 (€37,800 + €29,000)

So mortgage wins out. Is this correct or am I missing something?

OP- Just check your pension figures.

If you're putting €150 in per month, that €150 is the 50.5% amount. The government then add in 49.5% on top (€147.02) Total €297.02/month.

Your pension fund figures will then be greater than what you wrote.

I'd echo the poster's comments above about there being too many variables to say 'X is better for you'.

The recent FG sanctioned pension theft is a perfect example. I'd definitely recommend you googling that.

Everyone is different. How many kids, are they in college, wife work?, cash on hand in an instant access deposit account, expecting inheritance in 10 yrs when you're 65, etc.
I'm not asking you to answer these, they're just questions that'll help decide which is more beneficial to you.

Good luck.

rahor

By using the €150 to pay towards your mortgage, you are assuming that this is earning the mortgage interest rate as the growth rate (3.2%).
You are not allowing for any growth rate in your pensions contributions.
Also, you said you were a higher rate tax payer (i'm assuming your highest rate of usc is 5.5%), then should your gross pension contribution be 150/(1-0.495).... not an expert on tax!

kennyb3

Few main issues I see:

1. Where does 49pc relief come from? Is it not straight 40pc? (No prsi or usc relief on prsa)

2. At 49 pc relief your 150pm will gross to 294 - so your calc. looks wrong.

3. I think the number one thing your missing is the potential for the pension fund to grow (something the mortgage simply can't do). I say that as someone who hates the assumed (crazy) 5pc per annum growth the pension companies use. I also think one of the major issues with a fund is that at some stage you've to move from higher risk higher reward investments to lower risk lower returns - so you've effectively to call the market at some stage. Many got spooked and bailed in 2009 and effectively crystallised their losses.

Anyway I think you might want to assume even a small growth rate - your personal call as to what but even using 1pc per annum it will drastically alter your calculations.

Edit: largely beaten to it as I typed

Bubbaclaus

You only get tax relief from PAYE, so it's max 40% tax relief. No tax relief for pension contributions on USC and PRSI.

So that needs to be adjusted in your calculation.

Also the fact that your pension will be taxable when you're receiving it in the future should be taken into account also.

bilbot79

Overpay your mortgage while the interest rate is low. Then you'll make bigger inroads into the capital, reducing the impact of future rate rises. The later switch to pension.

Mortgage overpayment is a great thing. If you pay 300 extra for a year then nothing for year 2 you'll be better off than if you paid off 150 for 2 whole years

NewDirection

I've done a bit of an excel model on this and there is one giant simplification you can do to make the formula way easier.
In the case where you overpay your mortgage and reduce the term by 7 years, if you assume you will use the money you would have paid into the mortgage from year 22-28 into your pension instead all sort of variables fall out of the equation.

In this case the only thing that matters is if the pension annual growth is over or under 3.9%.

Thats the maths side of it. Personally I'd be loading it into the mortgage. There is greater financial freedom being mortgage free than having a big pension fund, in my opinion.


** Also assuming that the generous tax benefits that currently exist, will also exist in 22 years time (which depending on who is in government may or not be the case)

kavanada

Actually, sorry OP.

As has been notified above, you would get 40% contribution on anything you put in.
So your €150 would get you €100 added on top per month for a total of €250.
Still not too bad.

Do try to keep a slush fund of 3 months typical expenditure on hand if you can before putting money into the mortgage or a pension AVC/PRSA. Especially if you've kids.

newacc2015

NewDirection wrote: »

In this case the only thing that matters is if the pension annual growth is over or under 3.9%.

Thats the maths side of it. Personally I'd be loading it into the mortgage. There is greater financial freedom being mortgage free than having a big pension fund, in my opinion.


** Also assuming that the generous tax benefits that currently exist, will also exist in 22 years time (which depending on who is in government may or not be the case)

If OPs pension is based on the S&P 500. It should roughly return 10% per annum over the long term. Far more than 3.9% on a mortgage. Also investing in a pension easier is far more important than paying off a mortgage. Investing in his pension for 5 years will make a huge difference in the long run versus choosing to pay off his mortgage for 5 years then choosing to invest in his pension.

OP even putting €50 more off your mortgage will make a huge difference.

bobdillon

This is not an easy calculation. It depends on your circumstances and/or preferences.
If you pay off the mortgage the saving will not be a compounded amount. Instead it will be the sum of the capital and interest rate savings for the 28 years. It will be a lower rate of return than if you invested it, and it will not compound.

techdiver

Hi all, thanks for your replies.

I think I will spread a bit across both options.

The advantage of overpaying the mortgage with TSB is that you can also use the overpayment for a no questions asked payment holiday at any point in the future if needed. It gives a small bit of a safety net.

I will probably put an extra 150 on the mortgage and scrape a bit more together for a couple of percent on the pension also.

Thanks for all the advice and opinions.

kennyb3

newacc2015 wrote: »

If OPs pension is based on the S&P 500. It should roughly return 10% per annum over the long term.

Have you got a source for this?*

* past performance is not a guide to future performance

Bubbaclaus

Bubbaclaus wrote: »

You only get tax relief from PAYE, so it's max 40% tax relief. No tax relief for pension contributions on USC and PRSI........

Unless the OP has an Executive Pension Plan.

spectre

This is an interesting question and not straightforward for those with lots of years (say 20+) left of working.

For those who are a lot closer to retirement, it probably makes sense to lump as much as possible into a pension rather that trying to repay the debt quicker - depending on the numbers, it may even make sense to go interest only on the mortgage if it means getting that tax-free lump sum up to the maximum level.


I'm sceptical of pensions for a number of reasons:
1. The "savings" on contributions (40% marginal tax) is misleading. The tax rates at exit are difficult to predict. By 2050 there is expected to be only 2 workers for every pensioner (today we have five workers for each pensioner). This change in demographics suggests very high rates of personal taxation in the future, thus potentially eliminating the tax savings on entry.

2. Pension fund expected growth. The rates of growth touted by Pension sales people should be treated with the utmost suspicion. 5% annual growth sounds extremely ambitious to me. Sales people will often cherry pick date ranges from the past provided tremendous yields.

Pensions companies typically have high costs (employees, buildings, marketing etc.) and make large profits for their shareholders. Where does this money come from? Ultimately, it comes from customers. It seems to me a little naive to expect 5% annual growth on my pension fund whilst also helping to pay the Pension company's costs+profits.

3. Government levies - Between 2011 and 2015 the Irish government effectively stole 2.7% of the total private pension pool. This can and most likely will happen again.

Given the uncertainty regarding the pension investment, I believe that reducing the capital on your mortgage should be prioritised over a pension.

Source for 2050 pensioners-workers forecast:
http://www.onefinance.ie/whats-the-problem-with-irelands-state-pension-system/

Merowig

In regards to your first and third point: a house and land can be taxed as well.

It is possible to tranfer the pension fund to a foreign pension arrangement. I have no problems to do that should it be necessary or more advantageous for me.

spectre

Merowig wrote: »

In regards to your first and third point: a house and land can be taxed as well.

I fail to see your point. The amount of property tax payable is unrelated to mortgages and pensions.

Merowig wrote: »

It is possible to tranfer the pension fund to a foreign pension arrangement. I have no problems to do that should it be necessary or more advantageous for me.

You mean emigrate? You may not like the idea of emigrating when you get to 70.

Merowig

spectre wrote: »

I fail to see your point. The amount of property tax payable is unrelated to mortgages and pensions.

The point is that if the government needs money - regardless for what - he can tax the hell out of any landlord as well.
So by avoiding saving in your pension fund your money is stuck in a property which can be hard to sell and can be heavily taxed as well.

You mean emigrate? You may not like the idea of emigrating when you get to 70.

Either emigrate or just creating an additional fund in an other European country, transfer your Irish fund to that one and get paid through the new one.

spectre

Merowig wrote: »

The point is that if the government needs money - regardless for what - he can tax the hell out of any landlord as well.
So by avoiding saving in your pension fund your money is stuck in a property which can be hard to sell and can be heavily taxed as well.

The question is not whether we should buy property. The question assumes that we already have a mortgage. The topic is about pensions vs repaying mortgage quicker.

Merowig wrote: »

Either emigrate or just creating an additional fund in an other European country, transfer your Irish fund to that one and get paid through the new one.

Pretty sure income from foreign pensions is treated as normal taxable income by the Irish government. You would need to emigrate to a less tax hungry jurisdiction.

Merowig

Moving your pension scheme abroad would still avoid any potential future levy. And nothing stops you to move the pot back to Ireland....

techdiver

Sorry to resurrect this old thread that i started, but I am coming back for some review of my figures to see if my assumptions are correct with regards to my current situation.

I have since split my mortgage in half. One tranche is @3.1% variable for 27 years, the second is at 2.99 fixed for 10 years.

I will currently overpay my variable rate by €250 per month, but I now also want to decide whether to put an extra €150 per month into the mortgage or invest it in my pension which would be €250 after tax relief @40%.

I'm doing the following calculation over 10 years (until the fixed term finishes).

My figures are as follows:

Pension
€250 per month x 10 years = €30,000

Mortgage

77,460 @ 3.1% over 27 years.
Currently overpaying by €250 per month saves €20,170 in interest and leaves €20,834 remaining after 10 years.

If I load the extra €150 per month onto the mortgage I will save €24,251 in interest (an extra €4,081) and fully clears that tranche of the mortgage after 10 years.

So by my calculations the "net value" of the extra €150 onto the mortgage is €24,915 (€20,834 + €4,081).

Conclusion
So with all that in mind unless I'm mistaken, the better "investment", would be to add the €250 (€150+Tax Relief) to the pension as opposed to mortgage as it will yield €5,085 (€30,000 - 24,915) more over 10 years not even taking invested return on the amount into account.

Are my figures and assumptions correct. Could anyone offer any opinions on my options?

Cheers.

bilbot79

techdiver wrote: »

Sorry to resurrect this old thread that i started, but I am coming back for some review of my figures to see if my assumptions are correct with regards to my current situation.

I have since split my mortgage in half. One tranche is @3.1% variable for 27 years, the second is at 2.99 fixed for 10 years.

I will currently overpay my variable rate by €250 per month, but I now also want to decide whether to put an extra €150 per month into the mortgage or invest it in my pension which would be €250 after tax relief @40%.

I'm doing the following calculation over 10 years (until the fixed term finishes).

My figures are as follows:

Pension
€250 per month x 10 years = €30,000

Mortgage

77,460 @ 3.1% over 27 years.
Currently overpaying by €250 per month saves €20,170 in interest and leaves €20,834 remaining after 10 years.

If I load the extra €150 per month onto the mortgage I will save €24,251 in interest (an extra €4,081) and fully clears that tranche of the mortgage after 10 years.

So by my calculations the "net value" of the extra €150 onto the mortgage is €24,915 (€20,834 + €4,081).

Conclusion
So with all that in mind unless I'm mistaken, the better "investment", would be to add the €250 (€150+Tax Relief) to the pension as opposed to mortgage as it will yield €5,085 (€30,000 - 24,915) more over 10 years not even taking invested return on the amount into account.

Are my figures and assumptions correct. Could anyone offer any opinions on my options?

Cheers.

I think your figures sound alright. Though I noticed you haven't accounted for profits earned in the pension which should probably be considered. On paper the pension looks better but the mortgage is more fun