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Greg Tait

Financial Planner, RBC Brewin Dolphin

With interest rates much higher than they’ve been for many years, using your pension tax-free lump sum to pay off your mortgage might seem like a sensible course of action.

But while paying off your mortgage early could result in a welcome reduction in your monthly outgoings, the potential pitfalls involved mean that it requires careful consideration.

Understanding what’s right for you can be complicated and will ultimately depend on your individual circumstances, which a financial adviser can help you assess. In the meantime, here are some of the key points to think about.

What are the tax implications?

You can access most workplace and personal pensions from age 55 (or 57 from April 2028) and use the money as you wish. However, while you can withdraw the first 25% as a tax-free lump sum (capped at £268,275 for most people), any additional withdrawals will be taxed at your marginal rate of income tax. If your 25% tax-free lump sum doesn’t cover your outstanding mortgage, making a taxable withdrawal to pay it off in full probably won’t make financial sense as it would trigger a range of additional tax considerations.

How much interest are you paying?

When interest rates are low, you’re probably better off leaving your money in your pension. This is because the potential growth rate in your pension is likely to be higher than your mortgage interest rate. There are some instances where paying off your mortgage might be the better option, so make sure you seek advice on what’s right for you.

When interest rates are high, it isn’t quite as straightforward. It may still be the case that your pension fund has the potential to grow at a greater rate and benefit you more in the long run than paying off your mortgage early would.

It’s also worth bearing in mind that most lenders only let you overpay your mortgage by 10% each year. If you go over this amount whilst in a fixed-rate deal, you might have to pay an early redemption charge (ERC) of between 1% and 5% of the outstanding balance. Make sure you check when your deal is due to end before making any overpayments.

How will your retirement income be affected?

Taking money out of your pension to pay off your mortgage could have longer-term repercussions. A smaller pension pot will generate less income in retirement, which means you might be unable to afford the lifestyle you were hoping for or, worse, end up running out of money. This could far outweigh the short-term benefit of having lower monthly outgoings for a few extra years. By using cashflow modelling, a financial adviser can demonstrate how long your money will last in retirement and the impact that paying off your mortgage early would have on this.

Withdrawing money from your pension could be especially detrimental during a stock market downturn.

If you sell investments that have fallen in value, you could deplete your pension pot more quickly than you anticipated.

By leaving the money invested, your pension will have the opportunity to recover from dips in stock market performance and hopefully go on to produce a healthy and sustainable retirement income over the long term.

What other options are there?

If you do want to pay off your mortgage, there are other ways to fund this other than via your pension. ISAs, for example, let you withdraw as much money as you wish, completely tax free. ISAs also form part of your estate for inheritance tax purposes, whereas pensions typically do not; depleting ISAs before pensions could therefore make sense if you want to leave a tax-efficient financial legacy for your loved ones. In a stock market downturn, however, withdrawing money from cash ISAs and savings accounts could be a better option, as you’ll leave your investments untouched and give them the chance to recover in value.

Next steps

Understanding whether it makes sense to pay off your mortgage early is a complex decision that requires careful consideration – and that’s where getting some financial advice can help. A financial adviser can show what impact it will have on your long-term finances and plans for retirement.

If you do wish to pay off your mortgage early, they can also advise on the best place to withdraw your money from. That way, you’ll feel more confident that you’ve made the right decision for you.

Find out more from our dedicated customer support team based in Edinburgh by calling us on 0333 207 9003, or by sending an email to Opening hours: Monday – Friday 8 am to 6 pm, and Saturdays 8 am to 12 pm.



Disclaimer: The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Information is provided only as an example and is not a recommendation to pursue a particular strategy.

Greg Tait

Financial Planner, RBC Brewin Dolphin

Greg is a senior member of RBC Brewin Dolphin’s Cardiff financial planning team, specialising in advising family lawyers and their clients. Greg is an accredited family financial adviser and helps guide lawyers and their clients in cases where pensions are an issue. Click here for more.