Author Topic: UK based - Inside Pension or Outside? And Interest Only Mortgages  (Read 3231 times)

nelly365

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UK based - Inside Pension or Outside? And Interest Only Mortgages
« on: September 20, 2016, 02:14:40 PM »
Hi,

Iím maybe 6 months into the journey and turning up the dial on getting the wife and I to grow our moustaches.  Iíd like your thoughts on a few points Iím trying to get my head around please.

First; we are two UK based, 31yr old accountant and self-employed physiotherapist. We have a 2yr old child, taking home ~£82k after taxes, currently saving around 45% (optimising all the time as expenses drop off, ie the hired car).  Iíve targeted 55% saving rate to be achieved by the turn of the year.  We bought the house we are in, mortgage at 3.54% interest rate.  We have around £50k in cash, trackers and P2P lending.  Only borrowing is the mortgage.

1.   I heard Mad FIentist say on his podcast that he was indifferent between monies that were invested inside a pension and those that are not. (I assume as he is still happy to work, as and when he chooses whilst being FI)  Iím trying to get my head around this, in the UK pensions cannot (currently) be accessed until you are 58yrs old.  This concerns me, as while I can save a great deal of tax by filtering money into my pension its Ďlocked upí until many years beyond when I want to be FI.  Therefore what is the current thinking amongst those with bigger moustaches on how I should consider my splitting between the two?

2.   What do the moustaches think of the idea of (when up for renewal in late 2017) converting my mortgage into Interest Only Ė and investing the difference for growth.  My home is in the north of Scotland and is and will continue to be negatively impacted by the issues in the oil industry, Iím not sure if this makes a difference really, but it certainly adds to my anxiety and I basically donít expect or have a particular desire to Ďprofití from the future sale of my house.  So if I was interest only its value can fluctuate and Iím just living in it really rather than feeling like Iím Ďinvestingí in it!

I think thatís it for now Ė really appreciate your thoughts.


Playing with Fire UK

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #1 on: September 20, 2016, 05:12:13 PM »
I like the idea of an interest-only mortgage to pay off after 58.

I tried to get one on my (unmortgaged through circumstance) house and gave up as being too difficult. Most places I found that would do IO will only count 25% of your pension towards finally paying off the mortgage. You will probably get offered lower LTV on IO than repayment.

A house price crash could bite you if you needed to sell while the house was in negative equity and the market was in the toilet (not independent events).

I consider my pension and non-pension funds differently. If nothing else, there is a possible tax liability still wrapped up in pensions that ISAs don't suffer from. I also don't want to be skint and decades out of the workplace but with a massive pension that the government then decide that I can't access until I'm 90.

nelly365

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #2 on: September 21, 2016, 02:45:33 AM »
Thanks for your reply and I agree your points.

What though, specifically, would you suggest for splitting monies invested inside pension and outside.  What factors would you consider?

JohnnyRingo

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #3 on: September 21, 2016, 03:27:54 AM »
Hi,

I'm in an analogous position to you, in that I'm a UK-based professional (lawyer), similar age, savings and household incomes. My take on your questions:

1. I think of my pension pot as second tranche of cash to help us out in our old age, rather than as our primary saving/investing vehicle. I pay in 15% at the moment, which helps reduce the tax bill. My employer matches to 5.5%.

2. I've taken the opposite view on mortgages by deciding to start heavily overpaying it. We should clear ours in the next 5-6 years. This decision was primarily motivated by the tumultuous post-Brexit market. While stocks are buoyed at the moment (perhaps by an influx of US cash enjoying the very favourable exchange rate?), I fear they could crash. I decided I'd rather have the certainty of 3.89% 'gains' (our mortgage rate) while we see how things play out. Admittedly, this is a pretty cautious strategy, and not in-keeping with my investing strategy to date, but I do like the idea of being mortgage free and hitting ~70% savings rate. With our investments, I am shifting towards a Harry Browne style Permanent Portfolio.

Hope this helps :)

former player

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #4 on: September 21, 2016, 04:44:34 AM »
I'm in the "pay off your mortgage" camp.  That's partly about feeling secure and partly about having the freedom of not being locked into a certain level of payments for what feels like ever more.  It's not a purely maths based decision, but takes into account future uncertainties and emotional wellbeing.

If you take the equity out of your house (which is effectively what an interest-only mortgage is: every month you are taking out what would be equity to the equivalent of the payment of principal) you are borrowing to invest.  That works beautifully when economies are doing well and is disastrous when they are doing badly.  Are you expecting the UK economy to do well for however long you need a house (any house) to live in?  It's not a bet I would be willing to take.  The people worst affected in a downturn are the ones who borrowed to invest.   If you would rather invest in the stock market than in housing you are almost certainly better off, financially and risk-wise, selling your current house, living in rented accommodation and putting your "house principal" money directly into the stock market without the big risk of a large and unpaid loan hanging over you.  If you want to live in a house you own rather than rent for the rest of your life, bite the bullet and make payments on your principal.

Splitting investment between pension and not-pension is tricky because of all the uncertainties.  The most tax-efficient way might be to project your expected earnings and savings forward to determine a possible overall FIRE date.  Then calculate how much you will need if you spend down your investments to near nothing between FIRE and 58, and put everything else into the pension, remembering that you have up to 26 years in which to grow the tax benefits you get from the money you put in.  So depending what your tax position is, I'd look first at putting any money you pay 40% tax on into a pension.

Saving about £40k a year between the two of you, it could of course all go into ISAs from next year onwards and be tax-paid going in but tax-free coming out.   

cerat0n1a

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #5 on: September 21, 2016, 08:25:26 AM »
I believe it is still 55 for a private pension. Although the coalition government announced plans to link it to be ten years below the state retirement age in 2013, they never actually did so. Of course, that may change in future.

There have been a few threads on here about the pension/non-pension issue and posts on various UK FIRE blogs. Essentially, you should count both pension & non-pension money as part of your stache; the tax advantages of pensions are too good to ignore, particularly for higher rate tax payers. The trick is to get the right proportion of money outside the pension wrapper to last from when you RE to when you can get at the pension. Using the ability to take out 25% of your pension as a tax-free lump sum and paying down mortgage is a common tactic even in non-FI circles.

I'm also in the paid-off-the-mortgage camp, but it's as much an emotional decision as a financial one these days. I was paying 6% interest when I paid it off, and was a 40% taxpayer, so I would have had to get a 10% pre-tax return for there to have been a better investment for me.  Today, with tax-free allowances for interest & dividends, much bigger ISA limits and much lower mortgage interest rates, it's probably slightly better financially to keep the mortgage.

Playing with Fire UK

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #6 on: September 21, 2016, 11:51:13 PM »
I think that the rules on putting money into a pension are going to get tighter for higher rate tax payers (nothing guaranteed). When there was talk about some of the tax relief going I put all my higher rate pay into my SIPP until I looked at the value and potential growth estimates and decided there was enough to cover me from age 55 (although I don't think I'll be able to access it until age 58). I continue to get my employer's match because free money is the best.

@Former Player; I agree with you that the outlook for the UK is unsteady, but I have fewer concerns about the global economy.

Deciding to pay off the mortgage is a very personal decision; I think the ability to pay a low interest mortgage with tax-advantaged money is too good an opportunity to pass up. A big part of it is whether being 'debt free' or 'mortgage free' is important to you. I consider myself free of debt when I don't need to worry about whether I can pay it (eg available savings outweigh the debt and the interest is low/free). Other people would be horrified by this!

My favourite blog post about how to do this is http://www.thefinancezombie.com/2015/11/the-bridge-to-financial-independence.html

Doubleh

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgag
« Reply #7 on: September 22, 2016, 12:49:42 AM »
One approach for the pension vs other savings question is to save a year's worth of expenses for every year between ER and pension age to bridge the gap - that makes sense for those with 10 years or so to go until pension age but if you're looking to retire before 40 or so that fund would approach the 25x expenses that most consider enough for an indefinite time so is very conservative and essentially ignoring your pension.

It's worth remembering that much of the advice in the fi sphere is targeted to the US where pensions are relatively easy to access early; I have looked pretty hard and haven't found a realistic way of getting funds out of a uk pension before the age the government decides you can access it - if anyone has any suggestions I'd love to hear them.

Eventually the approach we have settled on is to include pensions in our stache, but to always look at numbers both with and without pension included. At the point we plan to retire around 40, we should have about 20% of our funds in pensions so a 4% withdrawal rate on our total fund would equate to 5% of our non pension assets. To my mind that is hopefully sustainable enough that we hope not to spend down the entire non pension assets before retirement, but it is possible that we will deplete the non pension fund somewhat while the pension bucket continues to grow, shifting the percentages. Of course this will need careful monitoring especially in the early years, we plan to address this by shooting for a lower level of expenses in our first few years of er, and potentially doing some part time work if needed to bridge any gap. Interested to hear other people's approaches.

I also agree with Playing with Fire UK that it seems a good bet the government will make it much harder to get higher rate tax relief on pension contributions in the next few years so maybe you should fill your boots while you can! Another alternative you could consider is to set up in business on your own through a limited company, either as your own accounting firm or as a contractor to corporate clients. That could give you a number of options to reduce your exposure to higher rate tax.

As to the mortgage it's worth remembering again that much of what you read is targeted to US investors, where mainstream mortgages are typically repayment and have a fixed rate for the whole 30 year term. We have investment properties in the US and I'm comfortable not rushing to pay off a 30 year loan at a fixed 4%. I'd be much more wary of holding onto a uk style mortgage with the exposure to interest rates that brings. Don't forget that with an interest only mortgage the size of your payment will increase proportionally more if rates rise - what may seem a very small repayment at current rates will be much less comfortable if they return to 5% or so.

cerat0n1a

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgag
« Reply #8 on: September 22, 2016, 02:47:11 AM »
I have looked pretty hard and haven't found a realistic way of getting funds out of a uk pension before the age the government decides you can access it - if anyone has any suggestions I'd love to hear them.

There are companies which offer to do this - but they're IMO scammy and best avoided. The most obvious method is the one already discussed - take out an interest only mortgage and use the 25% tax-free lump sum withdrawal from a private pension to pay that down as soon as you hit the appropriate age. Clearly that has costs and risks as PlayingwithFire says.

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but it is possible that we will deplete the non pension fund somewhat while the pension bucket continues to grow, shifting the percentages.

Of course, because you are living off the non-pension fund, it will deplete (or at least not grow as quickly as the money in the pension bucket), so it is to be expected that the %age of your wealth within the pension wrapper will be at its lowest when you FIRE and highest immediately before the point when you can access the pension.

Another reason (again as stated earlier in the thread) to keep the two figures separate is that you have already paid tax on the money which is in an ISA or other investments. Money inside your pension has not had tax paid and is potentially taxable on the way out. An ISA producing an income of £20k per year puts more in your pocket than a pension paying out £20k per year would do.  I guess this doesn't become a factor until you have around £250k in the pension.

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As to the mortgage it's worth remembering again that much of what you read is targeted to US investors, where mainstream mortgages are typically repayment and have a fixed rate for the whole 30 year term. We have investment properties in the US and I'm comfortable not rushing to pay off a 30 year loan at a fixed 4%. I'd be much more wary of holding onto a uk style mortgage with the exposure to interest rates that brings.

There's no tax advantage to having a mortgage on the home you live in here, unlike the US. That definitely changes the arithmetic. I believe it's different for UK rental properties where (currently) the mortgage interest can be deducted from rental income to calculate your taxable profit.

Another big UK/US difference when it comes to property is that the average house price here has gone up by a factor of 4 since 2000, whereas the FTSE-100 is slightly down over that period. With hindsight, the best strategy might have been to take out the biggest mortgage possible, buy a big house or multiple houses and not bother with shares. I don't expect that to continue, but I would have said the same 10 years ago and I would have been wrong then...

Playing with Fire UK

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #9 on: September 22, 2016, 11:47:04 AM »
Yes, our mortgages aren't fixed for 30 years, but they are soooooo cheap right now and 5 and 10 year fixes are available, as well as 25 year trackers. The governments seem terrified of rates rising and everyone being unable to pay their mortgage.

If you have a reasonable ISA stache there isn't as much to fear from a rates rise - when mortgage interest exceeds your expected investment return just move it over.

The pension release companies are all scammy, they are enabling you to break the law and when you get caught then there will be a ~55% fine on top of the ~30% fee you've paid to the company.

dreams_and_discoveries

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #10 on: September 22, 2016, 02:05:41 PM »
I agree our pension system isn't as flexible as the US, and there's no way of getting the money out until the access age, which I believe is still officially 55 now, but likely to rise to 57/58 for my generation.

I'm saving a mixture of pension & non pension investments, I'm lucky that I can max out my pension, ISA and put money into taxable investments. I've got an excel model that forecasts my contributions and balances, then my drawdown of these assets. It really is a balancing act, between saving (or deferring) tax and not running out of money. Working on my 4 year plan, in about 3 years I reckon I'll have enough in my pension, so I'll then cut back these contributions and go to fully non-pension investments.

I don't believe it's that easy to get an interest only mortgage at the moment, lending rules have really tightened and there are a lot of hoops to jump through and you need to provide proof of how you'll pay off the capital after the interest only period. Rates are amazing however, I'm at just 1.5% which would be considered astounding 10 years ago - you can get even lower if you want to pay the fee.

Playing with Fire UK

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #11 on: September 22, 2016, 02:35:12 PM »
I don't believe it's that easy to get an interest only mortgage at the moment, lending rules have really tightened and there are a lot of hoops to jump through and you need to provide proof of how you'll pay off the capital after the interest only period. Rates are amazing however, I'm at just 1.5% which would be considered astounding 10 years ago - you can get even lower if you want to pay the fee.

When I was looking at IO mortgages a SIPP/DC pension was one of the accepted ways of clearing the mortgage, but they would only accept 25% (I assume the TFLS). They also only wanted a proof of a plan to clear the mortgage, you didn't need to have funded the plan yet.

Doubleh

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #12 on: September 22, 2016, 03:23:22 PM »
Agree that essentially all of the arrangements that purport to get you early access to your pension are scam artists that will leave you with next to nothing - hence why i say that I haven't found a practical way yet and am assuming there isn't one.

Playing with Fire UK

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #13 on: September 22, 2016, 03:38:48 PM »
The mortgage time-shift is the best I've found.

If I were in a position of considering going to an early access company I'd first look into bribing a doctor to certify that I was terminally ill. Then the pension accessing bit would be legal (although no less morally bankrupt and distasteful).

former player

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #14 on: September 22, 2016, 04:05:28 PM »
If I were in a position of considering going to an early access company I'd first look into bribing a doctor to certify that I was terminally ill. Then the pension accessing bit would be legal (although no less morally bankrupt and distasteful).

You and your doctor would have an interesting time trying to explain to HMRC that you were still paying taxes and entitled to your state pension a decade or more later, and then defending the resulting tax fraud case.   As usual with crime, not worth it.


Playing with Fire UK

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #15 on: September 22, 2016, 04:47:48 PM »
If I were in a position of considering going to an early access company I'd first look into bribing a doctor to certify that I was terminally ill. Then the pension accessing bit would be legal (although no less morally bankrupt and distasteful).

You and your doctor would have an interesting time trying to explain to HMRC that you were still paying taxes and entitled to your state pension a decade or more later, and then defending the resulting tax fraud case.   As usual with crime, not worth it.

Misdiagnosis. Sorted.

[Just to be clear, this is not my plan, not a suggestion and only provided as a comparison to the lengths I would go to in order to avoid pension liberation companies]

former player

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #16 on: September 23, 2016, 01:26:54 AM »
A pilgrimage to Lourdes.

nelly365

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Re: UK based - Inside Pension or Outside? And Interest Only Mortgages
« Reply #17 on: September 26, 2016, 03:08:48 AM »
Thanks all - the link provided to the Finance Zombie has given me a new basis for my spreadsheet play.