I have received £3,000 from my grandad when he died and I’m trying to decide whether to pay off some of my mortgage early or boost my retirement savings. I know you can’t tell me what to do as that would be advice, but what sort of things should I be thinking about?

Jason

Tom Selby, AJ Bell Head of Retirement Policy says:

I am often asked questions like this and the answer will depend on a range of factors. The first thing you should consider when choosing where to put any money is whether you have any higher cost debts that need paying off.

For example, it would make little sense to use a £3,000 windfall to pay off a mortgage charging, say, 4% interest if you have credit card debt accumulating interest at 40%.

If you don’t have any high-cost debts like credit cards, your next port of call should be your ‘rainy-day’ fund – a pot of money held in a cash account for emergencies.

It’s up to you how big you want this reserve to be, but generally holding three to six months’ fixed expenses in cash is a sensible target. Use websites like MoneySavingExpert to find the best paying cash account on the market.

Once you’ve paid off any high-cost debts and set up a rainy-day fund, you can start to think towards the long-term – which brings us to your question. Firstly, check your bank or building society allows you to pay off part of your mortgage early without imposing a penalty.

Assuming there is no penalty, usually when choosing whether to pay off debt or invest, the key is whether the returns you expect to get from your investments will be higher than your mortgage interest repayments.

So, if your mortgage has an interest rate of 4%, then your investments would need to deliver returns of at least this amount post-charges for the decision to pay off. Historically this hasn’t been a high bar for a diversified portfolio or fund to achieve over the long term, although there are no guarantees when it comes to investing.

Remember pensions benefit from upfront tax relief at 20%, meaning if you contributed £3,000 it would automatically be boosted to £3,750 in a pension.

What’s more, if you’re a higher-rate taxpayer you’ll be able to claim an extra 20% tax relief from the taxman, while an additional-rate taxpayer could claim an extra 25%.

The amount you can personally contribute to a pension is limited to 100% of your earnings, with a cap on total annual contributions – including any you receive from your employer – set at £40,000.

In addition, there is a lifetime allowance set at £1,073,100 in 2022/23, with funds above this level potentially subject to a lifetime allowance charge.

Provided you are happy to wait until age 55 to touch your money (rising to age 57 from 2028) and have sufficient annual and lifetime allowance to make a £3,000 contribution, money invested in a pension is likely to deliver a bigger bang for your buck than paying off your mortgage early.

If you want to invest your money tax-free but with easier access, an ISA might be a good alternative. If you’re aged between 18 and 39 and saving for retirement or a first home, a Lifetime ISA – which comes with a 25% government bonus – could be a good option.

You can read more about the difference between Lifetime ISAs and pensions here. 

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to asktom@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to
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Please note, we only provide information and we do not
provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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