Two of the most common uses for excess savings are to either pay down your mortgage or increase your pension contributions
If you have been lucky enough to build up a level of cash savings over the pandemic you may be wondering what are the best options for these funds.
With zero or negative interest rates it does not make sense to hold a significant amount of cash on deposit. Two of the most common uses for excess savings are to either pay down your mortgage or increase your pension contributions.
This is a decision that requires some planning and you should seek advice. If you chose either option you are tying up your funds for a lengthy period. One of the first things to do is work out what short term plans you might have like a holiday or car and ensure you have sufficient funds for emergencies and short-term spending plans.
These funds can be kept on deposit because they are secure and accessible. Calculate how much you have remaining and work with this figure.
There are a number of things to consider around both the mortgage and the pension. How long is the remaining term on the mortgage, what is the interest rate and how old will you be when you will have it repaid. Do you have a company pension, how well is it funded, does your company match your contributions.
Once you have the main figures for both pension and mortgage to hand you can make some straightforward calculations.
If you have a mortgage of €150,000 with 25 years remaining and an interest rate of 2.50% your monthly repayments would be €672.93 per month. If you were to pay a lump sum of € 10,000 off the balance it would reduce the repayments to €628.06 and you would save circa €3,457 in interest assuming interest rates don’t vary over the remaining term.
If you could opt to leave the repayments at the same level after making the lump sum contribution you would knock almost 3 years off the term of the mortgage and save circa €8,500 on interest. Overpaying on a regular basis has significant benefits over the term of a mortgage. Most lenders will allow you overpay your mortgage by a certain amount even on a fixed rate.
Your other option is to increase your pension. The biggest advantage of putting extra money into your pension are the tax benefits. If you are a standard 20% taxpayer a €10,000 lump sum contribution will benefit from tax relief of 20% and 40% for those on the higher rate.
You need to be mindful of the age-related tax relief limits. Your €10,000 contribution could turn into an investment of €12,500 for standard rate taxpayers, or €16,666 for those on the higher rate.
Straight away you’ve achieved a 20 or 40 per cent return then at no risk. If you have 20 years to retirement, and achieve an average annual return of 5 per cent, your money for a higher rate taxpayer will have grown to about €44,000 by this date depending on the performance of the funds. Making an additional payment of €200 per month gives the equivalent of € 280 contributions for the higher rate taxpayer. Over a term of 20 years this is significant.
For most people when they retire they take out an Approved Retirement Fund. Your pension pot stays invested, continuing to achieve returns over your lifetime. If you are in an employee scheme where your employer is also making contributions, they may have to match your new increased levels and you are benefiting from both amounts.
From a numbers perspective, making the extra contributions to your pension gives a better return but for some people the idea that they are mortgage free offers a greater emotional return and this cannot be discounted. Being able to clear your mortgage early and having security of tenure in your house is a very valid choice.
The last number of years have taught a lot of people that value of having less debt and this allows for a better quality of life. The guaranteed nature of paying down your mortgage is also an advantage and depending on your loan to value you may be able to refinance onto a lower rate. Depending on your retirement plans you may need to boost your pension pot and these are all valid considerations.
In reality neither option is wrong and it might make sense to do a bit of both. The important thing is to check the numbers and consider your personal circumstances. Take advice on the issue and even the process of doing this will help in the decision.
Conor Harte is a Financial Planner with Wealthwise Financial Planning who are based in Block C, Hartley Business Park , Carrick on Shannon, www.wealthwise.ie All details and views contained within this article are for informational purposes only and does not constitute advice. Wealthwise Financial Planning makes no representations as to the accuracy, completeness or suitability of any information and will not be liable for any errors, omissions or any losses arising from its use. Wealthwise Financial Ltd T/A Wealthwise Financial Planning is Regulated by the central Bank of Ireland.#CI66141
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