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Jake writes: I’ve been working as a freelancer for the past eight years and not paid into a pension – so I’m at risk of not having enough saved for retirement. I also opted out when I was in full-time work. I’m 31 and own my flat in London with a mortgage.
I’m due to pay it off in 30 years but I’ve worked out that by overpaying I can cut this dramatically to as little as 15 years. My current plan is prioritise early repayment of my mortgage, and treat that as my eventual nest egg in retirement. Is that the best strategy to take?
Callum Mason, The i Paper’s deputy money editor, responds: We had some back and forth on email to go into your situation in more depth.
You opted out of your pension when you were working as an employee because your wage was low – under £30,000 in London – and you felt you needed the money you would have contributed. You said that you do have some pension savings, but that the amount is “negligible” at the moment.
As you explain, you are now self-employed, and so you aren’t automatically enrolled in a pension by your workplace with employer contributions, as employees are.
Aside from with pensions however, you describe yourself as an “aggressive saver”, at times working a second job. You were able to put a £50,000 deposit down to buy your first flat in south London and you also have £20,000 in emergency savings as well.
You are well aware that savings into a pension comes with benefits – you can claim back income tax for example – and that saving early means your money can compound, but at the same time, you say your main goal is to repay your mortgage.
Your mortgage is at a rate of 4.6 per cent at the moment and you’re on a 30-year term. You hope to get it paid off in 14 years time – so when you’re 45.
I spoke to Greg Moss, a chartered financial planner at founder of Eleven.2 financial planning, to ask him about your approach.
His first point, before we get into the mortgage overpayment versus pension saving debate, was that you shouldn’t feel as if you’ve “missed the boat” on retirement saving.
“Mathematically, the earlier the better, so the fund has as long as possible to compound tax free. But there’s no such thing as too late and our clients start this process at different stages of life.
“People who fund pensions consistently from very early in their careers do exist, but they aren’t as common as you might think. So don’t let that put you off,” he says.
In terms of your strategy, he says it is “perfectly valid” to overpay debt before thinking about pensions, and that this applies even more if you expect to earn more later in your career.
You get income tax relief on pension contributions at your marginal rate – 20 per cent if you’re a basic rate taxpayer and 40 per cent if you’re a higher rate payer.
If you expect to earn over the high rate threshold in the future – currently £50,270 – then paying into your pension later can give you a greater tax relief than paying in now.
“The easiest way to think about it is that overpaying a mortgage gets you a risk-free return of whatever your mortgage rate is – so, 4.6 per cent, which is a decent net return, comfortably above inflation – the same money in a pension would benefit from tax relief, and potentially higher growth if invested in the stock market.
“But that extra return isn’t guaranteed to be better and comes with risk,” he explains.
He does, however, sound caution about treating your property as a “nest egg” for retirement.
Some people refer to their property as their pension because they intend to sell or release equity – pulling cash from your property – in retirement, and living off the money they make.
“It’s a risky strategy because you’re then very dependent on the growth of one asset class – residential property – and you could end up having to work longer than you want if you can’t sell your property quickly,” he says.
He says this plan “would be different from prioritising paying off a mortgage first, then funding pensions and investments later on”.
I hope this guidance is helpful, and does something to calm your worries about not having enough in your pension.
Good luck with their mortgage overpayments and retirement saving, whenever you decide to prioritise it.
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