A significant number of high earners overpay their mortgage but aren’t maxing out their pension contributions. Now, this could be the right decision in some circumstances but, if you stopped overpaying the mortgage and instead put the money into your pension, you could pay your mortgage off twice as fast! Unbelievable right?..
Well, let me take you through the numbers. As an illustration, we will use somebody earning £135,000 a year.
The 60% tax trap
Firstly, it’s important to remind you of the dreaded 60% tax trap. When an individual’s taxable income reaches £100,000, their tax-free personal allowance is gradually cut by £1 for every £2 of additional income. Once their income reaches £125,140 they lose their personal allowance entirely.
As a quick example: if you were to earn £1,000 over the £100,000 mark, it will be taxed at 40% costing you £400. However, you’ll also lose £500 of your personal allowance. To add insult to injury, that £500 will now also be taxed at 40%, costing you another £200. The additional £1,000 of income will cost you £600 in tax total – 60%!
How to avoid the 60% tax trap and more…
Did you know that people earning over £100,000 can pay an effective tax rate of 60%?
How does this apply to paying off your mortgage?
Let’s now imagine that you have a mortgage of £250,000 and you pay £1,000 of your mortgage each month, or £12,000 a year. If, as in my example, you were earning £135,000, that £12,000 would cost you over £17,000 in tax before it’s even arrived in your bank account.
To break this down let’s take £29,358.62 of our high earner’s income:
It’s exhausting just listing all of that tax! In summary, your £12,000 annual mortgage payment will require almost £30,000 in income.
| Taxable amount | Tax | Rate | Cost |
|---|---|---|---|
| £29,358.62 | National Insurance | 2% | £587.17 |
| £25,140 | Income tax | 60% | £15,084 |
| £4,218.62 | Income Tax | 40% | £1,687.45 |
| Total tax paid | £17,358.62 | ||
| Remaining | £12,000 |
Do you want to improve your tax position?
The more tax you pay, the harder your investments must work to grow your wealth. Our advisers can provide practical advice to help reduce your tax bill. Get in touch to discuss how we can help you.
So, to pay off your £250,000 mortgage, it will take almost 21 years and cost you over £600,000 of your hard-earned money!
Paying off your mortgage faster…
Now it’s time for the magic secret: if you, instead, took that same £29,358 a year and put it into your pension, that money will be gross of all tax. Not only that but you won’t fall into the 60% tax trap. Additionally, when you turn 55, you can take 25% of your pension completely tax-free. Depending on the size of your pension pot, you can take a maximum of, guess what… around £250,000.
So, if you’ve built up a decent pension, by the time you want to pay off your mortgage, you could use your pension tax-free lump sum to pay off the entire remaining amount.
By using your pension, you’ll pay off the mortgage in just over 8.5 years, and that’s without even investing the money. It’s likely you’ll be able to shave a further 1.5 years off this timeline when investment growth is added.
Overall, (get ready for this) you’d save over £360,000 in tax and pay off your mortgage over 13 years faster!
So, if you’re a high earner thinking about over-paying your mortgage, believe it or not, it might be time for you to take some pension advice.
Do you want to improve your tax position?
The more tax you pay, the harder your investments must work to grow your wealth. Our advisers can provide practical advice to help reduce your tax bill. Get in touch to discuss how we can help you.
Article sources
Editorial policy
All authors have considerable industry expertise and specific knowledge on any given topic. All pieces are reviewed by an additional qualified financial specialist to ensure objectivity and accuracy to the best of our ability. All reviewer’s qualifications are from leading industry bodies. Where possible we use primary sources to support our work. These can include white papers, government sources and data, original reports and interviews or articles from other industry experts. We also reference research from other reputable financial planning and investment management firms where appropriate.
Saltus Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority. Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested. Tax rules may change and the value of tax reliefs depends on your individual circumstances.
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