Should I invest spare income into my pension or use it to pay down my mortgage? I am a 42-year-old man with no dependants and a 180,000 mortgage on a 1m-plus property. The mortgage is a tracker with a current rate of 4.55 per cent, with the deal running out late in 2009. I earn 60,000 a year and have a good workplace pension scheme with combined contributions of 16 per cent of salary. My pension funds currently total 160,000. Is there a "hurdle rate" which I would need to achieve to make it worthwhile going the pension route?
Laith Khalaf, pensions analyst at Hargreaves Lansdown financial advisers says your existing pension provision is already quite healthy; assuming continuing contributions of 16 per cent of salary, you are set for an inflation-linked retirement income of around 31,000 in today's terms.
And with so much equity in your house, you do not have to worry about negative equity or finding a lender with whom you can remortgage. Therefore, you have the luxury of approaching this situation as a pure investment decision: which option is going to give you a better return?
The answer may be somewhat surprising: looking at it over 25 years, a pension earning an average investment return of 6 per cent after charges works out better value for a higher rate taxpayer unless you are paying an interest rate of 10.5 per cent or more on your mortgage. This also assumes you are a basic rate taxpayer in retirement.
The main reason for the pension being a much better bet is the higher-rate tax relief boost for your pension contributions: for each 1,000 invested, you get 250 added to the pension, and 250 higher rate tax relief back - you're already 50 per cent up to start with.
Also, instead of paying 1,000 mortgage capital back now you could pay it back in 25 years' time, when 1,000 will actually be worth more like 500 in today's money.
The less interest you pay on your mortgage, the less of a saving you can make from paying it off, and consequently the more attractive a pension contribution becomes. Your mortgage rate is very low; and if you can lock into that deal again, the case for the pension becomes even more compelling. But the best current tracker rates start at about 5.75 per cent.
Assuming that you could pay an average of 5.75 per cent until you are 65, you would only have to achieve a hurdle rate of 3.75 per cent annual growth after charges to make the pension the better financial bet.
If you earned a more realistic 6 per cent after charges, a 1,000 pension contribution would give you an after-inflation, after-tax 2,250 (in fund value) at age 65, again assuming you are a basic rate taxpayer in retirement. Alternatively, paying 1,000 off your mortgage would save you the equivalent of just 1,500 (of which about 1,000 is saved interest and 500 being the inflation-adjusted reduction in the debt) over the same time period. Also, you may be hit with early repayment charges for paying down your mortgage.
CGT liability on children's policies
I have grandchildren aged 17 and 15 for whom, six years ago, I bought traded endowment policies - one each, to mature when they reached university age. As they were minors, the companies involved required that the policies be in the name of their mother. I have continued to pay the monthly premiums and will until maturity. But, will there be any capital gains tax liability for my daughter on the growth in the policies? As their trustee, can she claim the benefit of the grandchildren's CGT allowances, or is she restricted to her own CGT allowance?
Christopher Groves, partner at solicitors Withers, says that traded endowment policies (TEPs) are second-hand as they were taken out by someone else, normally on that person's life.
Most TEPs are taxed under the capital gains tax rules, rather than income tax, so on maturity of the policy any gain that is realised will be subject to CGT. The gain will comprise the maturity proceeds, minus the amount paid for the policy and any subsequent additions that have been made.
It sounds as if the TEPs are held by your daughter as a bare trustee (nominee) for your grandchildren, as they were (and are) unable to hold them directly, being minors. If this is the case (and it should be reflected in the documentation) then this means that the grandchildren's CGT allowances - 9,600 per child in the current tax year - can be used to offset any gain arising. Any excess above this amount will be subject to the new 18 per cent flat rate of CGT. Your daughter will not be subject to CGT on the maturity of the TEPs as she is only a nominee, but will be responsible for ensuring that any tax is paid. The insurance company will pay the maturity proceeds to your daughter as the policy is in her name. She can hold the proceeds for your grandchildren until they reach 18 and may invest the funds for their benefit in the meantime.
The advice in this column is specific to the facts surrounding the questions posed. Neither the FT nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.