22 October 2012

Should I ... Use my Pension Lump Sum to Pay off my Mortgage?

Generally, pensions will pay you a tax-free lump sum when you first take it. One option for that is to pay off your mortgage or any other outstanding debts.
 
Note: you have to be over 55, and occupational pension schemes may not let you take your pension early.
 
That's logical if you have debts outstanding when you retire, but should you consider taking your pension early with the express purpose of paying off debts? ... perhaps while you are still working?
 
As ever, there are various pros and cons, including the fact that you may lose any further growth in your pension plan, and that the benefits your family will get if you were to die are generally greater before you take a pension than after.
 
One option is "income drawdown" where you can take the lump sum but don't have to take any income. That is not suitable for everyone but worth considering.
 
Another thing that may make it a good thing to do for some people is that you can recycle the pension income if you don't yet need it. In other words, use that additional income to pay back into a pension plan! The taxman doesn't mind since your pension income is taxable (so he gets his slice), but then you get tax relief as it goes into a new pension, and you also build up a new tax-free lump sum.
 
It works particularly well if you are a higher rate taxpayer now but expect to be a basic rate taxpayer in retirement - you get the higher rate relief now but will only pay basic rate tax in retirement.

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