David and Fiona Toogood
This article appeared in the Times on Saturday (Oct 6th). David Byers is a good journalist who allows people’s money issues to be properly addressed . Recently I’ve been helping out with one or two of the answers, so if you want to see what I think, I’ve posted this beyond the paywall! The Times is great – by the way! (Advert)
David Toogood, 65, has a private pension pot of £125,000 that he wants to draw down to pay off the £112,000 mortgage on his house in Market Harborough, Leicestershire. But is this the right decision for him, and what would the tax ramifications be?
Mr Toogood’s mortgage is an interest-only agreement and his loan is on the variable rate. This means he pays an uncompetitive interest rate of about 4 per cent and his mortgage costs him £375 in payments a month.
He would like to pay off the mortgage because he believes that, were he to start drawing a regular income from his pension (which he thinks would amount to about £300 a month), this would go on servicing the mortgage.
Mr Toogood, a motorcycle salesman, says that he feels financially secure, even without a private pension, as he approaches retirement.
This is because his wife, Fiona, who is 29 and works as a buyer for a chemicals company, will be earning for many years to come. Her wage at the moment is £25,000.
“She is much younger than I am, she has a good job and excellent prospects,” he says. Mr Toogood also has a state pension.
Given the circumstances, would drawing down his pension be a good idea to pay off his mortgage, and what tax penalties would he face in doing so?
THE EXPERTS’ ADVICE
Michael Owen, director of financial planning at Brooks Macdonald
“Given Mr Toogood’s age, he is able to access the fund, but he should check with his pension provider to ensure that (a) there are no penalties for doing so, and (b) that it can facilitate an unsecured funds pension lump sum (UFPLS).
“While a quarter of the pension fund [about £31,250 at present values] would be payable free of tax, the remainder would be taxable if he encashed it. The taxable income would be £93,750 and would give rise to a very high tax bill — perhaps as much as £25,860, assuming he has no other income, and more if he does. This means that the net pension payment is less than £68,000, plus £31,250 for the lump sum, and is less than £100,000 together; not enough to clear the mortgage.
“Mr Toogood could draw down smaller sums each year and make progressive reductions in the mortgage at lower rates of tax. If he has no other income he could take out £15,800, of which 25 per cent would be tax-free and the remaining £11,850 would also be tax-free, given the personal allowance in the 2018-19 tax year. This would take about seven years to clear the loan and may not be ideal.
“If he merely draws an income sufficient to meet the interest payments, he will never clear the mortgage.
“There is a middle ground, which involves taking out up to £60,000 this tax year; £15,000 would be tax-free and the remaining £45,000 would be set against Mr Toogood’s personal allowance and 20 per cent tax band and would leave him £53,100 net if he has no other income.
“This could be repeated in the next financial year, subject to rates and limits in place. Such a strategy would save about £6,000 more in tax over two years than would be the case taking it all this financial year.”
Steve Webb, director of policy at Royal London
“Mr Toogood could draw a quarter of his pot as a tax-free lump sum and pay off a chunk of his mortgage, while checking for any penalties for overpayments.
“But if he were to take the rest of the fund as a lump sum, this would be added to his taxable income for the year. Given that higher-rate income tax cuts in at gross income of about £46,350 a year, a lump-sum withdrawal of more than £90,000 would take him well into the higher-rate bracket, where 40 per cent tax applies. Worse still, if he were to do this while he was in paid work, even more of the pension withdrawal would be taxed at 40 per cent.
“There is an additional sting in the tail, which is that HMRC operates ‘emergency taxation’ on one-off pension withdrawals, so it over-taxes people and then expects them to fill in a form to claim it back.
“Alternatively, he could put the balance of his pension into a drawdown fund and withdraw smaller chunks each year, keeping within the 20 per cent tax band. The mortgage would be paid off more slowly, but the amount lost in tax would be less.”
Henry Tapper, pensions expert at First Actuarial
“Mr Toogood has rightly worked out his pot will only guarantee £300 a month. That’s not enough to pay the mortgage interest payments, let alone the £112,000 principal.
“David shouldn’t cash in his pot in one go because 25 per cent of his pension pot [£31,250] is tax-free and could pay down the mortgage to £80,750. If he cashed the remaining £93,750 today he’d pay £29,000 in tax. He would take home only £65,000 and still have £16,000 debt.
“Instead, he could consider ‘drawing down’ his pot over three years at about £31,000 a year. This way he’d pay tax of £5,500 a year — £16,500 in total — so his income from cashing his pot would be £77,000, enough to pay off almost all his loan.
“Admittedly, he would have to pay £2,000 extra interest, but that would still leave him £10,000 better off — and that’s ignoring any interest on his pot.”
David’s response
“It seems my pension won’t pay off my mortgage. I might well take it out in instalments and pay off chunks of the mortgage progressively instead. I’ll have a think about it.”
If you would like to appear in our column, email portfoliotherapy@thetimes.co.uk
Yours is quite the best composed response. Poor Joe Soap does have to struggle with how complicated pensions are.
How much is the house worth? Can he downsize?
Government should have tax reliefs on pension withdrawals at this point if they’re intended to reduce debt.
Debt does no one any good.
UK gov should know that with ~ £50 billion in interest payments last year.
No wonder they need to raid this old man’s pension savings.