Should you pay more into your mortgage or your pension?

This article was last updated on 04/11/2024

When it comes to our finances there are often decisions we have to make. From which savings account to choose to how to budget each month. The amount of money we invest for our future, whether that be in a property or a pension, is another common debate.

Many people in the UK aspire to own a property. For some, they want their property (or properties) to eventually fund their retirement. Recent data suggests those with a mortgage to pay off are paying less into their pensions. They also end up with less retirement income than those who don’t own a property. So with this in mind, should you ever sacrifice one to pay more into the other?

A challenging property market

The question of investing in property or pension has long existed. With the current property market, your priorities may have changed. Homeowners who are tackling mortgage rate increases are having to consider whether to up their payments. And for those who are yet to join the property ladder? The rising cost of living‘s impacting their ability to save for a decent house deposit.

Former CMO at Habito; Abba Newbery says: “For most people, the struggle is to get on the property ladder in the first place.”

If you have ambitions of investing in property, you may have to decide whether to reduce your spending each month or to put less money away for your future.

Unfortunately, as everyday prices rise so does the cost of retiring. The Pensions and Lifetime Savings Association (PLSA) recently reported that the cost of retiring has increased across the board. According to their Retirement Living Standards, the amount you’d need to achieve a minimum standard of living has risen by nearly 20%.

So, with the current cost of living and mortgage rates rising coupled with the need for an increased focus on saving for retirement, there’s much to consider.

Getting onto the property ladder vs. saving for retirement

Joining the property ladder

There’s a struggle to balance paying into your pension while saving up for a house deposit. It’s easy to see how the desire to become a homeowner could outweigh the enthusiasm to start saving into a pension. Especially if you’re a few decades off retirement. Property might feel more gratifying than a pension. Plus, pensions can seem far more complicated than property. People might be worried about making the wrong choices when it comes to their pension. Whereas property has typically been seen as a ‘safer’ investment, thanks to house-price growth and lower borrowing costs.

Founder of The Financial Joy Academy and The Humble Penny; Ken Okoroafor says: “We need to get better at helping people visualise the benefits of their pensions.”

If you’re lucky enough to get on the property ladder, there are of course several pros that come with this. Property’s tangible, you can see and experience it. Crucially, you can enjoy it well ahead of your retirement years, whereas you can’t touch your pension money until you reach retirement age. If eligible, you can claim your State Pension from age 66 (rising to 67 from 2028) and you can withdraw from your personal, private or workplace pensions from age 55 (rising to 57 from 2028).

Saving for retirement

While it may be less tangible than property, there’s a strong case for investing in your pension. With Auto-Enrolment, eligible employees can save into a workplace pension and benefit from employer contributions. This is broken down into:

• Employees have to pay at least 5% of their annual ‘qualifying earnings’, which includes 1% tax relief from HMRC.

• Employers have to pay at least 3% of an employee’s annual ‘qualifying earnings’ into their pension.

Most savers will usually benefit from tax relief on their personal contributions. And when you reach retirement age, you’ll be able to withdraw 25% of your pension as a tax-free lump sum. There are also incentives when it comes to passing on your pension when you die. If you die before age 75, your beneficiaries can usually take your retirement savings tax-free. If you’re over 75, your beneficiaries will pay tax at their nominal rate. This is the case for defined contribution pensions, which most modern workplace and personal pensions are.

VP Brand and Communications at PensionBee; Rachael Oku says: “Investment growth is one of the key aims of investing. But with pensions, that’s only really part of the story, there are lots of incentives.”

You can’t touch your pension money before your mid-50s, whereas you can sell your property for the cash at any time. But this can be a benefit to pension saving as pensions grow over time and benefit from compounding. So, the longer you leave your savings invested, the more they’ll grow.

Are there any cons to using your property as your retirement fund?

Getting onto the property ladder is a great financial goal to have. But it’s important to understand the practicalities of using your property for your retirement income. If you own buy-to-let properties, you’ll have the option to sell them or continue generating income from letting them out. But using your main property to fund your retirement might mean you have to sell your dream home. If you want to free up any or all the money you’ve invested in your home, you’ll need to vacate it and downsize.

You also need to consider property market movement. What if the property market dips as you approach retirement? You could end up having to sell your property for less than it’s worth so you can access the cash quickly.

Should you make mortgage payments at the expense of your pension?

Former CMO at Habito; Abba Newbery says: “I think the opportunity to use your house as leverage is important.”

You might be considering increasing your mortgage payments to pay the debt off sooner. This can be tempting, especially at the expense of a long-term savings product such as your pension, but it’s important to consider your goals. To some, paying off your mortgage sooner brings a sense of mental freedom, while also reducing your living costs.

But there’s also an argument for continuing with steady mortgage payments. This could allow you to enjoy your desired lifestyle, and still put some of your money away into savings. Whether that’s for family holidays, into a pension or ISA, or towards an emergency fund.

If you’re expecting to come into an inheritance in the future and plan to use it to pay off your mortgage, there’s a chance that the amount you receive could be less than you’re expecting. This could be for a number of reasons including senior relatives needing to pay for care in their later life. So if this is something that’s on the horizon for you, it would be beneficial to talk about it with your family and understand the risks together.

Should you take money out of your pension for a house deposit?

You might be considering taking money out of your pension to invest in property. Whether for yourself or to help a family member out. In 2022, 46% of first-time buyers had family help getting their mortgage. If you have children or grandchildren, you might be considering taking money out of your pension to help them with a house deposit.

If you have a defined contribution pension, which workplace and private pensions usually are, you can take money from the age of 55 (rising to 57 from 2028). But before doing so, there are a few things to consider.

If you’re over 55 (57 from 2028)

• Keep in mind how long your pension pot needs to last you. When looking at the whole amount, you might think you can spare some for a house deposit. But once you divide your whole pot by the number of years you hope to live for, things might look different.

• Remember your tax-free allowance is only 25%. Anything you withdraw from your pension over 25% will be subject to income tax. If you’re withdrawing money for a house deposit, you might wipe out your entire tax-free allowance in one go.

• If you haven’t taken out a lump sum or purchased an annuity, your pension’s still invested in the stock market. So there’s less opportunity for your pot to grow if you withdraw a chunk of it for a house deposit.

• You also need to bear in mind the rules around inheritance tax. If you take money out of your pension, you can gift it to your child or children tax-free. But if you die within seven years, the recipient will be subject to inheritance tax.

• You might be considering withdrawing from your pension to loan your children money for a house deposit. If you give them an interest-free loan, you’ll not pay any tax. However, if you want to charge interest, you’ll have to pay income tax on any interest you receive.

If you’re under 55 (57 from 2028)

• If you withdraw money from your pension early, you’ll be charged a substantial amount of tax. HMRC could view early pension release as an unauthorised withdrawal. This means you could be taxed up to 55% on the amount you take out.

The rules are different for defined benefit pensions but you can contact your pension provider for more details.

Another way some people help their children get on the property ladder is to use equity release. Equity release is a way of turning some of the equity in your home into cash. If you own a property and are over 55, you may be able to release equity from your property through an equity release mortgage - either as a lump sum or smaller regular payments.

There are numerous consequences to such deals that you need to be aware of. The interest rates can be high, especially for younger borrowers, and the interest rolls up over time, so there could be significantly less available for you to leave to family members in the future. There are also repayment charges, impacts on state benefits and other things to consider which are explained in this MoneyHelper guide.

Key things to consider

• Think about how long your retirement is going to be - you might be able to start taking some pension money out from 55, but you’ll potentially live until you’re 90+.

• While things like inflation, mortgage rates and cost of living fluctuate over time, so does the cost of retiring and knowing how much you’ll need later will help you decide where to invest now.

• If you’re a long way off retirement, you might need to consider at what age you’ll be able to claim your State Pension and, if there’ll even be an adequate State Pension in the decades to come that aligns with your retirement goals.

• Keep in mind the practical cost of using your property as your retirement fund - it could mean vacating your family home and downsizing which you might not want to do.

• Diversification’s key and, when saving for your future, is a much better option than putting all your eggs into one basket.

• Make sure you understand the tax implications of taking money out of your pension for a house deposit. And consider the impact on your own lifestyle in retirement.

Listen to episode four of The Pension Confident Podcast and hear our guests discuss the property vs pensions debate. You can also read the full transcript.

Risk warning

As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.