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Without my asking my bank has offered me a £10,000 loan over 3 year at 3.8% APR fixed. They say that over 3 years the total amount payable will be £10,586.52. This sounds quite good VFM.

On the other hand my pension pot could do with a boost. On top of this my free bank account offers 5% gross interest on balances up to £2500.

Would the following make financial sense or suicide?...

Get the loan of £10,000 and pay £7,500 into my pension. Retain £2,500 into my bank and never touch it. I will earn around £100 per annum after (20%) tax meaning that in 3 years I will earn £300. At the end of the 3 years pay the remaining £2,500 into my pension also.

I'm willing to bet the pension gross will be bigger than the £286.52 I will end up paying the banks over 3 years for the benefit of having £10,000 up front. And I pay around £500 into my pension every month as it is, so that would cover the loan repayments and then some.

Is this financial sense or suicide? Of course, this is assuming pension growth is reasonable.

  • Note on your calculation: the 2500 you keep in the bank isn't worth the full 100 per annum, it's worth 100 less the net interest that you would have earned anyway based on your typical current account balance. Also, just to complicate things, the last budget changed the rules for tax on savings interest from 2016: thisismoney.co.uk/money/saving/article-3000721/… – Steve Jessop May 15 '15 at 10:05
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Interesting question, and I'm not sure there is one right answer, however my thoughts are too long for a comment so I'll put them in as an answer anyway.

Some considerations:

  1. Would you still be paying your regular monthly payment into the pension pot? If not, then you are not "boosting" your pension by making a one-off payment of £10,000 into it to replace 3 years of monthly £500 payments (which would have been worth £18,000). If you are still planning to make the monthly pension payments, can you afford both the loan and the pension pot repayments?

  2. There are limits on what percentage of your earnings you can put into pension in any one year. You would need to make sure you are not infringing those if you put a large lump sum in.

  3. The benefit of taking the loan and putting the lump sum into the pension, rather than just paying what you would have paid as loan repayments directly into the pension on a monthly basis, is that you're hoping the pension will outperform the loan interest. However, that is a fairly significant risk. Also, if you pay a lump sum into the pension you don't get the "smoothing" effect that you get with regular monthly payments.

  4. If you get made redundant or suffer some life changing accident or illness, you can stop making additional pension payments but if you took out a loan you are still liable to repay it (and you can't withdraw the money back out of your pension to do that).

Overall, I personally would not do this. If I was worried about my pension I would boost my regular payments into the pension instead. However, it doesn't seem like financial suicide either... just a risk that is not worth the small benefit it might bring.

  • (1) No, I would probably have to pay around £250/month on the loan and then pay the balance of ~£250 into the pension; I wasn't aware of (2) so will look into that; (3) yes I think perhaps the pension will outperform the loan; (4) yes this is a risk... I do find these financial gymnastics quite interesting though :-) – Pixel May 15 '15 at 9:04
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    "Overall, I personally would not do this. If I was worried about my pension I would boost my regular payments into the pension instead. However, it doesn't seem like financial suicide either... just a risk that is not worth the small benefit it might bring." I have to say I agree with this conclusion. The benefit is just not significant enough to undertake the hassle - and likely small but still potential risk. – Chris May 15 '15 at 9:06
  • Thanks, I think I'll just look at ways to increase my pension payments. – Pixel May 15 '15 at 9:07
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    It makes sense to do so. The tax relief that pension contributions attract is currently under scrutiny and is very likely to be made less generous in the coming parliament. Best to take advantage when it is still in its current form. – Chris May 15 '15 at 11:36

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