"More than 20,000 Irish mortgage holders are facing the prospect of carrying non-performing mortgage debt into retirement, figures from the Central Bank of Ireland show. ... The Central Bank data, in addition, shows that 21,276 mortgage holders aged 60 or above still owe more than €150,000 in mortgage debt"
Irish Times 18th November 2019
For many of us, making that stretch to a larger property is a desirable aspiration. It can also make sense when considered from a tax perspective given that there is no Capital Gains Tax applied to gains on your Principle Private Residence and you can rent a room for up to €15,000pa tax free.
However, a clear consequence of overstretched borrowing during the boom is showing up now with more people retiring with debts and mortgages to pay as the headline from the Irish Times vividly illustrates.
As a result, you may be tempted to dip into your pension pots early – but this decision requires serious consideration.
Most of us hope that when we retire, we will be free from financial worries but the reality of high house prices and rising living costs mean that many of us will face increasing financial pressures after the traditional retirement age.
Recent studies from across the Irish Sea show that a fifth of UK homeowners are likely to be paying off a mortgage after the traditional retirement age of 65, while one in 10 people over the age of 55 don’t think that they will ever be mortgage-free.
Life doesn’t always turn out the way we expect it to and not everyone manages to pay off their mortgage while they are still working. The stress of having a debt problem when you are thinking about retiring can be crippling, especially if your home is at risk.
For those with old occupational pensions which are generally accessible from age 50, using some of the money from your pension to pay off some or all of your mortgage is one way to deal with the difficulty of retiring while you still have housing debt. There are other options, however, including selling the house and downsizing to a smaller property to release cash.
It is also important to consider how paying off mortgage debt now could impact on your retirement later in life. Your pension needs to help fund your living costs for as long as you are retired, and many people significantly underestimate their life expectancy.
Furthermore, the taxation rules surrounding taking money from your pension can be difficult to understand. It is extremely important to ensure you fully understand the implications of your decision before you take it. Whether to access your pension pot early to pay off your mortgage is an important and life-changing decision for many, and the right answer will depend on the individual’s personal circumstances.
Lifestyle pension strategies typically move to more defensive assets as retirement approaches.
Source Irish Life
Conventional wisdom says that we should move some of our pension fund from equities to cash and fixed interest as we approach retirement.
But Cash and Bonds have zero /negative interest rates currently and the fixed interest market is negatively correlated with interest rates, rising interest rates therefore imply falling capital values, hardly conducive with wealth preservation.
By contrast, many people 5 to 10 years out from retirement still have mortgages and it’s very possible that the interest rate applied to these loans is higher than the interest rate available from cash and fixed interest investments within a pension.
Here, the risk is also rising interest rates which will require higher monthly payments putting stress on already stretched finances (although inflation reduces the real debt burden over time).
For some people over the age of 50 and able to access old occupational schemes (as distinct from the current scheme that they are paying into), it may make sense to wind up these schemes, take the tax free cash and repay loans.
This also frees up monthly income which was previously being used to meet mortgage payments and this can then be potentially used to fund AVCs with tax relief on the contributions.
In effect, we can partially derisk the current pension assets by putting the 25% lump sum into debt repayment which can be thought of as making an interest rate play on our own debt rather than Government or Corporate Debt and which can carry a higher expected return than much of the bond market. The remaining 75% remains invested in Vested PRSAs or ARFs (which can pursue the same investment strategy as before having taken some profit off the table) with no requirement to take taxable income until reaching age 61.
When combined with ongoing AVC contributions, we also have the potential benefits of Euro cost averaging plus the additional tax relief on the way in on the AVCs which allows for a higher equity exposure than one might feel comfortable with for a sizeable pension fund close to retirement and which therefore results in higher expected returns overall relative to a progressively derisked multi-asset lifestyle strategy.
Marc & Felicity moved to a larger house a few years ago and took on an additional Loan of €41,985. The current Interest Rate is 2.75% and the remaining term is 15 years
The monthly Payment is currently €265pm.
Projected Interest Savings at Current Interest Rates assuming we had €40,000 lying around to clear the loan.
Source Bank of Ireland
What about future interest rates?
Mortgage rates since 1975 have averaged 7.45%pa and nearly 4% over the last 15 years.
Just as we don't know for sure what future returns will be from the Bond market, we can never know what our mortgage interest will actually amount to over the remaining term of the loan.
But there is a clear risk here that if interest rates do rise, then the cost of servicing the debt will increase. If we assume an average mortgage rate of 4% over the next 15 years, which is simply the average mortgage rate over the last 15 years, then the projected interest savings are as follows:
Source Bank of Ireland
Mortgage payments are made from post-tax income
Therefore, at a marginal rate of tax of 52% the real cost of servicing the loan at different interest rates is as follows
For example, an average mortgage rate of 4% at current tax rates costs 8.3%pa of gross income to service. The difference of 4.3% is simply the tax deductions that are lost to the family to cover the cost of servicing the debt.
What if the monthly mortgage payment could be directed to AVCs?
Monthly mortgage payment is currently €265pm
If we took €40k from a pension and cleared the mortgage, we would be able to save what we were paying in mortgage payments into AVCs.
A Total monthly AVC contribution of €445pm would have a net cost of
Net cost €267 (approx same as the mortgage payment)
And would receive income tax relief @40% of €178pm
So now our monthly mortgage commitment is earning an additional €178pm in pension tax relief plus the monthly interest saving of €74pm (assuming average interest rate of 4%)
A total return of €252pm on a €41,000 investment = 7.4%pa. In addition assuming the ARF and AVC contributions are invested in the same strategy as before, the returns on this money will be the same as before the capital was withdrawn.
If we contrast this with say taking 25% of the pension fund and investing it in the Vanguard Global Bond Index Fund Euro Hedged, the Yield to Maturity on the fund is currently 0.83%.
The current yield gives you a decent indication of what you might earn over time, according to the late John C. Bogle, founder and former chairman of Vanguard Group. Since 1926, the entry yield on the 10-year Treasury explains 92% of the annualized return an investor would have earned over the subsequent decade had he or she held the bond to maturity and reinvested the coupon payments at prevailing rates.
So, clearly a projected return of over 7%pa looks better than a projected return of 0.83%pa.
For illustrative purposes only
We have assumed constant growth assumptions for the current pension fund whereas in reality if the current pension fund is derisked to Fixed Interest and cash or divested under a lifestyle strategy the expected return should also be reduced.
When can I access my pension?
You need to be 50 years of age to draw down from an occupational pension, however, this may vary depending on the individual scheme rules and you will need to obtain your employer’s consent.
The age limit of 50 also applies to Buy out Bonds.
However, you must be 60 years of age in the case of a PRSA although this is age 50 for an employee leaving service.
Personal Pensions can be accessed at age 60 if you are ceasing employment.
Some professions such as sportspeople can also access their pensions early.
Revenue rules also allow you access to your pension if you are permanently unable to work due to serious illness.
Can I continue to work?
If you are a company director, you are normally required to sell your shares in order to access your pension benefits in Ireland. This is not the case if you transfer your pension benefits overseas.
If you start taking one or more pensions you can continue to work and pay into another pension.
What are my options when I access my pension?
On retiring your pension, you can take up to 25% as a lump sum of which
- The first €200,000 is tax free and;
- The next €300,000 is taxed at 20%
The balance must be allocated as follows:
Either an annuity income providing a guaranteed income of €12,700pa or
€63,500 must be placed into an Approved Minimum Retirement Fund (AmRF). You can only take income up to 4% of the fund value from the AmRF.
At age 75 the AmRF converts to an ARF.
The balance invested into an Approved Retirement Fund (ARF)/Vested PRSA
Note that from age 61 a minimum annual withdrawal of 4% of the value of the fund is imputed. This increases to 5% of the value once you reach the age of 70.
When is it better to leave the pension alone?
If you are in poor health early access of a defined contribution or money purchase scheme could leave your family in a worse financial position in the event of your death.
This is because death benefits are a 100% return of fund with no income tax and no excess pension charge for funds in excess of the Standard Fund Threshold.
Note that a spouse can inherit an ARF but must pay income tax on the distributions.
Note that this is the opposite advice to someone with a defined benefit or Final Salary pension.
Are there any Social welfare implications from early retirement?
Some social welfare payments are means tested such as the non-contributory state pension and jobseekers allowance.
If you take early retirement, your pension income could result in you failing the means test and having your state benefits reduced.
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