Many homeowners hope and plan to be mortgage free when they retire. But how realistic is this? Wealth and Wellbeing Monitor found in June 2022 that 12% of retirees (around 1.5m people) say they had outstanding mortgage debt when they retired. Of those not yet retired and with an outstanding mortgage, 33% think there will still be an outstanding balance payable by the age of 65.

When you turn 55, you’re able to draw money down from dormant pension pots that you hold. In fact, you can release 25% of the total amount in the pot, tax-free, as a cash lump sum. This can be used to pay off your mortgage. But whether this is the right decision for you is not straightforward. Read on for some of the factors you need to take into consideration.

Pension Freedom

A huge reform to pensions happened in April 2015 with the initiation of Pension Freedom. It gives greater flexibility to allow you to release the entirety of your pension pot as a single cash payment. 25% of it will be free from tax obligations, and the remainder is taxed as income – so you’ll pay the tax amount for your income bracket. In order to release the cash, your pension must be dormant – so you are no longer paying into it – but you don’t need to be retired to make use of this scheme.

Factors to consider

• Why using your pension to pay off your mortgage may not be for you

If you have a particularly low mortgage interest rate, and/or if your pension fund growth is greater than your mortgage interest rate, it could be better to leave your cash in your pension to take advantage of the benefits it provides. It is unlikely in this instance that the interest you will save by reducing your mortgage will give you a better return than leaving the money invested in your pension to grow. You should also check if there are limitations to your pension benefits if you release a lump sum from your pension pot.

Don’t forget – if you take a lump sum out of your pension, you will have less money available to you in retirement. So, you should ensure that you will still have enough money available to you to cover any monthly outgoings you’ll have in retirement. If the 25% tax free lump sum does not cover your outstanding mortgage in its entirety, mortgage payments will need to be included in this.

Finally, by leaving your pension untouched, it means that when you get to retirement age, you’ll still have the tax-free amount available to you. This could provide a level of comfort and security at a time when your income streams are more finite.

• Why you may wish to use your pension to pay off your mortgage

Despite what we have said above, there are some reasons why it may be beneficial to pay off your mortgage with your pension.

If you are nearing retirement, paying off your mortgage will give you the security that is sought after by many retirees. You will own your house outright and won’t owe the bank any money. A big factor in a comfortable retirement is having enough money to cover monthly outgoings – if you’re able to use the 25% tax free cash lump sum to pay the full outstanding mortgage off, you’ll not have mortgage repayments to make each month. This can significantly reduce your outgoings.

With inflation having been at high levels for a long while, mortgage rates have also been high. If this is the case with your mortgage, using a cash lump sum from your pension to pay off your mortgage could be of benefit to you, as you’ll save on the interest you’d otherwise have to pay.

Conclusion

Ultimately whether you should use your pension to pay off your mortgage will depend on your personal circumstances. We can help you determine if it’s the right decision for you.