Extra money? Should you top up your pension or pay extra on your mortgage?
You’ve got some extra money and you’re keen to invest it wisely. Extra mortgage repayments and topping up your pension contributions are excellent choices, yet you need to be aware of how your extra payments will play out so you can tailor your plans for the results you want.
Our straightforward summary sets out the pros and cons for each so you can make choices that work for your circumstances.
Enjoy these perks when you make extra mortgage payments
- Paying extra into your mortgage helps you own more of your home faster and gives a strong sense of security: you – not the bank - own the roof over your head. Watch out for early repayment and overpayment charges from your mortgage provider.
- Paying off a mortgage early is a huge achievement. You are liberated from a big monthly expense - and you own a significant asset.
- If you’re thinking about moving or re-mortgaging it’s usually the case that the more equity you have in your home, the better the range and quality of mortgage deals available to you.
- The better your mortgage deal, the faster and more efficiently you’ll pay off the debt and own your own home.
It all sounds so simple – let’s explore.
Interest rates, debt anxiety and mortgage overpayments – here’s what you can do
Check whether you can pay off more of your mortgage by switching to a better deal. If you’re on an interest only mortgage, switching to a mortgage that pays the capital and interest will mean you’ve cleared the loan by the end of the term.
The debt associated with a mortgage can cause anxiety, knowing the bank owns more of your home than you do. One solution could be focussing on clearing the debt to restore wellbeing to a healthier place. Yet it’s just as important to consider how effective extra mortgage payments will be in relation to what you get for your money.
The interest you pay on your mortgage is influenced by the Bank of England base rate, which has been set at an historic low of 0.1% since March 2020 when the first lockdown began.
There’s a lot of speculation around interest rates increasing in the near future but they are a very long way away from the highs of previous decades. Think of the 1970s and the whopping Bank Rate of 17%. Or the early 1990s when the Bank Rate average 15%. Imagine trying to deal with interest rate hikes like that!
Making extra mortgage payments might not save you as much as it may have done in the past when interest rates were higher. With interest rates so low now, your money might give you more if invested elsewhere – like topping up your pension, perhaps.
Understand how tax incentives reward extra pension contributions
When you invest in your pension your money attracts potential tax benefits, employer contributions and investment opportunities. That sounds great, but what does it mean for your money?
Extra pension contributions can earn you free money. The important point is the Government actually tops up the money you pay into a pension – by 20% - it’s free money! If you’re a higher rate taxpayer, you get another 20% back on your tax return and if you are an additional rate taxpayer you receive 25%. You don’t get free money for overpaying your mortgage.
Understanding the way tax relates to your pension is crucial to goal smashing success. Our excellent three-minute read sets out how generous tax incentives reward your pension pot top ups.
Extra pension contributions can earn you more money from your employer too
It’s not just the Government who steps up to help when we top up our pensions. Employers usually match extra pension contributions up to a certain amount.
For example, if you pay 6% into your pension pot you could benefit from your employer matching your 6% contribution in addition to the tax relief benefit you receive - another return on your investment you wouldn’t get if you paid extra on your mortgage.
Ask your employer if you can make extra pension contributions via salary sacrifice. This means you sacrifice a fixed amount of your salary in return for a gross employer pension contribution.
Both you and your employer save on your National Insurance contributions as well as Income Tax. While salary sacrifice comes with some considerations and restrictions it’s regarded as an efficient way to contribute to your pension and make tax and National Insurance savings at the same time.
Remember: a savvy financial habit is making sure you have emergency funds tucked away and accessible, because if you choose to invest your extra money in your pension your money is locked away until you are 55.
Pensions are investments – give them time and attention and they can grow
Your pension is a long-term investment, and your pension savings are invested in the financial markets.
Try not to get caught out by thinking top ups to your pension fund “don’t work”. Extra pension contributions absolutely can work thanks to the wonders of compounding (the returns you earn on your returns). We’ve set out how extra pension contributions and compounding work together to deliver results, here.
The earlier you invest in your pension - and the more you invest with extra payments when you can - the more opportunity you give your money to grow so it can look after you later.
How Bestinvest can help you smash your financial goals
At Bestinvest we help people look after their money - because when you’re saving for the rest of your life, it helps to have a straight-talking expert with you every step of the way.
Our Best SIPP* delivers freedom and control over your pension investments – and a great range of investments to choose from. It’s easy to open an account online, set up monthly contributions or pay in lump sums. And you can transfer your old workplace or personal pensions into the Best SIPP too.
If you’d like to chat, make an appointment for a free pension review and one of our team members will give you a call.
We offer excellent ISAs and investment accounts if you’re keen to build up a separate nest egg - independent of your pension or mortgage.
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*SIPPs are not suitable for everyone. If you don't want to invest across different asset classes or don't think you will make use of the investment choices that SIPPs give you, then a SIPP might not be right for you.
This article does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact a financial adviser.