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Wednesday, 17th April 2024
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Pension mortgages now more attractive Back  
Alison Coffey on how to buy a property, maximise tax relief and have your business pay for it.
If you are thinking about buying property, how would you like to get tax relief on your interest payments, as well as on the money used to pay back the loan? This may sound too good to be true, but with a pension mortgage it’s possible.

Pension mortgages have been available for a long time, but recent changes in pension legislation have extended the options for self-employed and many company directors at retirement.

A pension mortgage works on the basis that you only pay back interest on your mortgage loan every year. At the same time you take out a pension plan into which you make regular payments. The aim is that at the end of the mortgage term, you will use your retirement fund to pay off your loan.

If you are wondering why you would intentionally pay so much interest over the term, the real advantages are the tax relief. By using this approach you can maximise all the available tax relief on mortgage interest, and at the same time get full tax relief on your pension premiums, which are essentially your capital repayments.

Why now?
Limits on the level of pension premiums which can qualify for tax relief were increased significantly last year giving more people access to pension mortgages.

The introduction of new flexible retirement options has also opened the doors to pension mortgage investment. In the past, you could only take part of your retirement fund as cash, and the balance had to be used to buy an annuity which would pay you an income for the rest of your life. This restricted the amount of money available to pay off a mortgage when you retired.

Under the new retirement regulations if you have a personal pension or are a director with more than 5 per cent shareholding in your company you can take 25 per cent of your pension fund tax free at retirement. You are no longer obliged to buy an annuity with the balance. Instead you have the option of putting your money into new retirement investment products called Approved Retirement Funds (ARF), or of withdrawing money as cash.

If 25 per cent of your retirement fund is not sufficient to cover your mortgage, you can withdraw some of the balance and use it to repay the loan. Any cash in excess of the 25 per cent tax free sum will be taxed at your marginal rate of income tax. Unless you have a guaranteed annual income of at least ?10,000 you must leave ?50,000 invested in an Approved Minimum Retirement Fund until age 75 as security for your retirement. The balance is available for you to invest or withdraw as you choose.

Paying off your pension mortgage
Pension mortgages work particularly well for directors with more than a 5 per cent shareholding in their company. Rather than using extra cash in the company to buy a property which then belongs to the company, you can use the cash to fund for a pension. The difference is that you can then buy the property in your own name and the company benefits from tax relief on the pension premiums. Irrespective of what happens to the company, the property is your personal asset, and the pension fund is held in trust for you.

Costs compared with a regular mortgage
Assuming that you will want your business to pay for the purchase of this property, the table below compares the cost of a commercial property loan of ?500,000 under the conventional capital and interest repayment method, and a pension mortgage. The potential savings are impressive.

The risks
If you opt for a pension mortgage, you should consider your pension investment choices carefully. As the value of funds can vary you may prefer a fund which smoothes returns and reduces volatility, or one which has guarantees. If the fund does not perform to your expectations you run the risk of not having a large enough fund at retirement to pay back the full mortgage.

As many of the cost savings of a pension mortgage come from maximising tax relief, withdrawal or reduction of the reliefs available could have an impact on your costs. The Government has indicated an intention to continue encouraging pension contributions by providing tax relief. It is more likely that relief on mortgage interest payments could be removed or reduced in the future and the impact of this change would be less expensive.

Setting up a pension mortgage
The agreement to use part of your retirement fund to pay off your mortgage must be made between you and your lender. As a pension cannot be assigned as security to the lender, a separate contract with the lender is required. Norwich Union has been actively highlighting the advantages of pension mortgages to financial intermediaries but it does not provide mortgages. It is however in the pensions business and has a transparent product with wide fund options.

If you are interested in a pension mortgage, you should talk to your broker. Putting a pension mortgage in place can be quite complex and requires good financial advice from the outset. An independent adviser will be able to assess your situation and guide you through the complexities of mortgages, pensions and tax.
It’s worth getting independent advice now as, for many people, pension mortgages offer an exciting new way to buy a property, provide yourself with a pension, and pay less tax.

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