My specific situation is:-
- Early 30s
- Software contractor via a ltd company
- Resident in Scotland
- Higher-rate taxpayer
- Mortgage at ~5% (variable 4.5% above BoE), LTV about 75%.
- I'm allowed to overpay my mortgage by up to 10% in a calendar year
- I'm working under the assumption that I'll be a basic-rate taxpayer at retirement
I'm trying to figure out whether I should be taking additional dividends to overpay that 10%, or instead put that money towards my pension.
As I understand it:-
If I take, say, an additional £10,000 dividend, I pay a total of 25% dividend tax, giving me £7,500 capital to put towards my mortgage. According to a mortgage calculator, that saves me about £17,500 in interest over the term of my mortgage, assuming that the interest rate stays constant.
If instead I put that money towards my pension, I am eligible for corporation tax relief at 20%, giving me £12,500 capital to put towards my pension. At retirement I can take 25% of that as a lump-sum tax-free, and then I pay the basic rate (20%) on the remainder pretty much regardless of how I draw it down giving me an effective marginal tax rate at retirement of 15%.
That means that to match my mortgage overpayment (worth £25,000) my pension contribution would need to be worth about £30,000 after 25 years, i.e. gaining about 3.5% annually.
Am I missing anything important in my calculation?
My unprofessional intuition in this case leads me to believe that paying down the mortgage is the better option:-
- Less risky e.g. mortgage rate likely to go up, pension returns not guaranteed
- More flexible e.g. if I want to retire early
- Substantially less paperwork, giving me more time to do my day job
- Doesn't incur the risk that the government will change the pension rules between now and when I retire
Is that a reasonable assessment?
Note: I intend to take professional advice before investing, but I want to be clued up before I do.