Pension vs Mortgage: Where Should Your Money Go?
With limited spare cash, should you pay more into your pension or overpay your mortgage? Both are sensible—but one often wins. Here's how to think about it.
The Case for Each
Pension
- Tax relief on contributions (20-45%)
- Employer matching (free money)
- Investment growth potential
- Protected from bankruptcy
- 25% tax-free at retirement
Mortgage Overpayment
- Guaranteed "return" equal to your rate
- No investment risk
- Reduces term or payments
- Emotional security of ownership
- Flexibility if you switch to offset
The Numbers: Pension Usually Wins
Thanks to tax relief, pensions often come out ahead—especially for higher rate taxpayers.
Example: You have £100 to spare. Mortgage rate: 5%.
Mortgage: £100 overpayment saves you £5 per year in interest.
Pension (40% taxpayer): £100 contribution = £167 in your pension after tax relief. If that grows at 5%, you gain £8.35 per year—even before considering the 25% tax-free lump sum.
When Pension Wins
- You have employer matching: Free money you can't get elsewhere
- You're a higher rate taxpayer: 40%+ tax relief is hard to beat
- Your mortgage rate is low: Below 3-4%, pension almost certainly wins
- You have time: More years for investment growth to compound
- You're nowhere near retirement age: Money has decades to grow
When Mortgage Wins
- Very high mortgage rate: If your rate is 6%+, the guaranteed "return" is compelling
- Basic rate with no employer matching: The pension advantage shrinks
- Job insecurity: A smaller mortgage means lower required payments
- Approaching retirement: Less time for investments to recover from dips
- You sleep better: The peace of mind from lower debt is worth something
The Balanced Approach
You don't have to choose just one:
- First: Get full employer matching in your pension (never leave free money)
- Second: Build a small emergency fund (3-6 months expenses)
- Third: If higher rate taxpayer, contribute more to pension up to the threshold
- Fourth: Split remaining between pension and mortgage based on your priorities
Consider Your Mortgage Type
Standard Repayment
Overpayments reduce your outstanding balance. Most lenders allow 10% overpayment per year without penalty.
Offset Mortgage
Savings sit alongside your mortgage and offset the interest. You can access the money if needed—best of both worlds.
Interest-Only
If you have an interest-only mortgage, you need a repayment vehicle. A pension could be it—but make sure you're on track.
Don't Forget the ISA
If you might need access before retirement, consider an ISA instead of extra pension contributions. You lose the upfront tax relief, but gain flexibility.
How Talk Through Wealth Helps
Model the trade-off for your specific situation:
- Compare outcomes: extra pension vs. mortgage overpayment
- Factor in your tax rate, employer matching, and mortgage rate
- See when your mortgage would be paid off under each scenario
- Model the impact on your retirement income
- Find the optimal balance for your goals
Find Your Optimal Balance
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