Do you have a Pension-linked mortgage? Mind the gap!

Sunday, 15th March 2009 11:00 - by Resident IFA

I received a referral from a local Accountant this week, one of his Clients having had a Pension-linked mortgage for approximately 21 years, now realising the end of his mortgage term is fast approaching and he really needs to seek advice. Using 'round' figures, I found the following factual information from sifting through his accumulated paperwork: o He is 47 years old, retiring (hopefully) at age 60 o 3 Pension plans (Retirement Annuity Contracts (RACs)) in place o Contributing just over £80 per month gross o Projected total fund value at age 60 (assuming 7% growth per annum from now until retirement) of £58,000 o Mortgage of £30,000 Briefly, the idea of a Pension-linked mortgage is that the ‘Tax-free cash’ element of the Pension plan(s) would provide the amount needed to repay the mortgage debt at the end of its term. The vast majority of Pensions now provide 25% of the fund value at retirement as the aforementioned tax-free lump-sum. This type of mortgage is thus similar to an Endowment mortgage, yet not carrying the life cover an Endowment plan would and also diminishing your retirement benefits by utilising Pension tax-free cash. The Client has had this mortgage for approximately 21 years, having 4 to go. Taking 25% of the projected total Pension fund value (this growth scenario being ‘with a fair wind’), above, he will only receive £14,500. This not only uses up valuable tax-free cash he could have otherwise used to supplement his income/invest, it is also over 50% shy of the £30,000 figure he needs to be able to repay his mortgage in 4 years time. Suffice to say, and he saw this too, he ideally needs to consider a Capital Repayment mortgage to guarantee paying-off his mortgage debt before retirement and free-up his Pensions lump-sum. He may well have to extend his mortgage term as repaying part-capital, part-interest (how a Repayment mortgage works) on £30,000 will be quite a hefty payment over 48 months or thereabouts. The saving grace is that he has over 12 years until retirement, so can ease this pain a fair bit. Other people with a Pension-linked mortgage might not be so lucky. The Client’s current total Pension fund value is just over £30,000, estimated to provide approximately £1,950 taxable income per annum at age 60…if using the whole fund, i.e. not taking the tax-free lump-sum, to provide income. So, my reservations and suggestions concerning his mortgage do not even start to address the Pension planning issues of: o What income and lifestyle does he want in retirement? o What are his wider plans and likelihoods i.e. business sale? o What other planning/Investments/Savings does he have to aid his retirement? o How much can he afford to contribute, monthly or lump-sum, to his Pension over the next 12 or so years? o What is his attitude to Pensions? Is he aware of the tax-relief Pension contributions attract? If in doubt, seek the advice of an IFA (Independent Financial Adviser). Until next time…