For many people chasing financial independence, clearing the mortgage ASAP is a key early retirement milestone. And if that’s your plan, then the notion of paying off your mortgage with your pension instead might sound painfully slow.

But have you actually run the numbers?

Recently, I’ve been considering moving to a more expensive house.

There’s a snag, though: I won’t be able to pay down a larger mortgage over 25 years. Or even over 30 years. Not without stopping my ISA and pension investments, anyway.

And I’m not willing to give up on my laissez-FIRE early retirement dreams just yet.

I’ve realised though that I don’t necessarily need to pay off that bigger mortgage. I just need to service the debt while living in the house for as long as we want the extra space.

Once our kids have grown up – and their vacated rooms begin to suck in exercise bikes, old books, forgotten toys, and a ton of other clutter – then I can sell it.

At the same time, when my kids have grown up… well, I’ll also be eligible to access my pension if I want to.

Which is a slightly scary thought. But it does come with some side benefits.

It’s not the prospect of a free bus pass that I’m excited about. Rather, it’s the possibility of using my pension to pay off my mortgage.

I’ve done my sums, and I think this could potentially save me 50% on my mortgage payments.

And what old age pensioner doesn’t love a chunky discount?

The mechanics of taxation are key

Tax is simple in theory. But when you get into the weeds of gross and net payments, it can start to feel a lot more complicated.

Roughly speaking, if someone earns £60,000 gross, then they receive roughly £45,000 net into their bank account, after tax, under the current tax regime.

So if they choose to use £450 of their bank account cash to overpay their mortgage, it has actually cost them £600 of their gross earnings.

Most of the time this doesn’t matter. Feel free to stand at the counter in Costa Coffee and point out that your £4.50 coffee actually cost you £6 in gross earnings. I doubt the rest of the queue will care too much.

With pensions, though, it matters tremendously.

That’s because pensions – both defined benefit and defined contribution – allow you to mitigate and/or delay your income tax bill.

How pensions work

I won’t dive into how defined benefit pensions work, because you could easily write a book on the topic. But the principles with respect to taxation are similar.

I’ll just use defined contribution pensions as the example today.

The central point:

• If you’re in, say, the 40% income tax bracket and you decide to put £1,000 into a pension, then that money goes in free of all income tax.

That might be because your company puts money into your pension before even subtracting any tax – so-called salary sacrifice. In this case, you now have £1,000 in your pension instead of £600 in your bank account.

Alternatively, you can transfer taxed cash into a SIPP, get an automatic 20% top-up from HMRC, and then claim another 20% back on your tax return.

Either way, for now you’ve avoided paying 40% marginal income tax on that £1,000.

However it’s very hard to say precisely how much tax you’ve saved by moving money into a pension in the long run.

It’s not just income tax you need to consider

For instance, at earnings of £60,000 to £80,000, with children, you might need to pay the High Income Child Benefit Charge (HICBC):

• The HICBC could put up your effective marginal tax rate to 57%.
• At earnings of £100,000 to £125,140, you’d face a higher marginal tax rate of 60%.
• With children in nursery, the withdrawal of support can mean effective rates above 100%.

You’re also paying 2% – and your employer is paying 15% – in National Insurance.

At least until March 2029, however, you can sidestep National Insurance on earnings diverted into a salary sacrifice pension. Your employer might even be generous and share some of its 15% savings with you, too.

The point is, you can lose a lot in tax for each extra £1 that you earn.

Good things come to those who wait

Let’s set up a good old personal finance example scenario.

Meet Ingrid and Hans – a high-earning couple with children.

Ingrid earns £80,000 after matching pension contributions. Ingrid pays a marginal tax rate of 57% due to the HICBC the couple pay for their three children.

Her husband Hans earns £70,000 after matching pension contributions. His marginal tax rate is 40%.

They’ve borrowed £750,000 as a mortgage to buy their family home. Assuming a 5% rate over 35 years, they are paying £3,787 per month in repayments.

Ingrid and Hans are quite frugal elsewhere in their lives. They project that they’ll be able to put aside £40,000 this year.

What should they do with this surplus cash?

Making mortgage overpayments

Hans’s first instinct is to use the £40,000 to make an overpayment on their mortgage. That’s well within their 10% annual mortgage overpayment allowance.

After tax – and after handing over £40,000 to the mortgage lender – they’re left with £68,122 in spending money:

	Pre-tax income	Net income	Mortgage over-payment	Net income remaining
Ingrid	£80,000	£56,961	£20,000	£36,961
Hans	£70,000	£51,161	£20,000	£31,161
Total	£150,000	£108,122	£40,000	£68,122

Making extra pension contributions

What if they instead put £40,000 into their pensions via salary sacrifice?

Now they’re left with £88,150:

	Pre-tax income	Net income	Child benefit	Net income remaining
Ingrid	£60,000	£45,361	£3,268	£48,629
Hans	£50,000	£39,521	£0	£39,521
Total	£110,000	£84,882	£3,268	£88,150

In each scenario they’ve effectively invested £40,000, just in different ways:

• In the first scenario, the £40,000 went towards mortgage overpayments. (Remember, paying off a mortgage is a form of saving.)
• In the second, the money went towards pension contributions.

Due to the tax savings however, with the second strategy they also have around £20,000 more in their bank accounts.

This makes sense when you consider that they have a marginal tax rate of around 50% between them.

Later taxes paid on pension withdrawals have an impact

Before you run down to your pension provider’s office to start stuffing banknotes through the letter box, I should acknowledge it’s not all quite so simple.

This is mostly because pensions don’t completely avoid tax. Rather, they delay it and potentially reduce the rate you pay.

So yes, Ingrid and Hans now have an extra £40,000 in their pensions.

But even when they turn 55, 57, 58 or whatever the legal age of access might be at that point, they can’t just withdraw the entire pot unscathed.

Rather, at that point they must pay tax on the money they take out.

The first 25% of pension cash can be taken out tax-free (up to £268,275) thanks to the tax-free lump sum.

But on withdrawals beyond that, they’ll pay income tax at their prevailing rates.

Paying down the mortgage from a pension

Let’s imagine a slightly different scenario.

Assume Ingrid and Hans have been working on their plan for many years. They are now turning 57, and the time has come to reap the benefits.

For the last two decades, the couple had an interest-only mortgage. That meant their monthly mortgage payments were lower – simply covering the mortgage interest.

On the plus side this meant they could direct the spare cash into pensions and ISAs. As high-earners who saved hard and invested well, they each amassed seven-figure pension pots.

The downside is they still owe the full £750,000 on their mortgage.

Step 1: the lump sum

At 57, both Ingrid and Hans have access to their pension balances for drawdown. Their pensions qualify for the maximum £268,275 tax-free lump sums, which they both take.

This totals to £536,550, which they send to their mortgage lender, immediately reducing their outstanding mortgage to £213,450.

The monthly interest due drops to £890.

Step 2 – the pension drawdown

They decide to pay the remaining mortgage down over ten years. This way it will be paid off entirely by the time they are 67. 

This means they’ll need to withdraw £9,605 in the first year for the interest payments and another £21,350 each year to pay down the outstanding balance:

	Over-payments	Balance	Interest due	Total payment
Opening Balance		£750,000
Lump Sum	£536,550	£213,450
Year 1	£21,350	£192,100	£9,605	£30,955
Year 2	£21,350	£170,750	£8,538	£29,888
Year 3	£21,350	£149,400	£7,470	£28,820
Year 4	£21,350	£128,050	£6,403	£27,753
Year 5	£21,350	£106,700	£5,335	£26,685
Year 6	£21,350	£85,350	£4,268	£25,618
Year 7	£21,350	£64,000	£3,200	£24,550
Year 8	£21,350	£42,650	£2,133	£23,483
Year 9	£21,350	£21,300	£1,065	£22,415
Year 10	£21,300	0	0	£21,300

The first year is the toughest. They need to find almost £31,000 from their pensions. They’ll presumably have living expenses as well.

But things do get easier as their outstanding mortgage balance falls and the interest payments come down with it.

Even pensioners can be liable for tax

Unfortunately, with their tax-free pension allowances totally used up, HMRC now wants a cut of this couple’s pensions withdrawals.

However the way income tax is structured, this isn’t as painful as you might think.

The 40% band doesn’t kick in until at least one of them is withdrawing more than £50,271 from their pension. Splitting the withdrawals and mortgage payments between them means they almost certainly won’t need to pay 40% tax on any of their income.

If together they withdraw £30,000 for living costs and £31,000 to cover the mortgage and overpayments in year one, then individually they’ll be drawing down £30,500 from their pensions.

And after their personal allowances for income tax, they will each pay only around £3,600 in taxes – or approximately 12% of the money they withdraw.

The difference between tax rates is key

This example neatly illustrates why paying off your mortgage with a pension can work so well.

When this money was first directed into their pensions, they deferred paying roughly 50% in income tax.

Then, when it came time to draw it out, the lump sum incurred no tax at all, and the remaining withdrawals only cost them around 12%.

What’s more, in terms of the total money used to pay down the mortgage balance, more than 90% of this cash – pre-tax – went towards doing so.

That’s a huge difference compared to paying it down earlier in their lives, when up to 57% would have gone to HMRC before the overpayments even landed with their lender.

Risks are everywhere

Of course nothing is totally risk free, and this strategy has plenty.

A big one is that it is dependent on the current tax rules as they stand.

But the rules around the tax-free lump sum have already changed a few times. And the treatment of National Insurance for salary sacrifice pensions will alter in April 2029.

The minimum pension age could be moved up again from 57, too, delaying when you can withdraw your lump sum.

The point is there’s no guarantee that this method will still exist in the same shape by the time you come to retire.

Another issue is that interest-only mortgages are perfect for this scenario, but if they are structured in a way that at the end of the term you either pay off the full balance or you have to sell the house, then tax changes might force you into an unwanted sale.

Getting a mortgage that lasts into your 60s or even 70s can mitigate that, because you’ve got more time to come up with a plan. But that isn’t bulletproof.

Also, interest-only mortgages themselves aren’t so widely available these days.

Finally, investment returns in your pension are by no means guaranteed. If you invest the money in the stock market, then it’s possible that even over a couple of decades your returns could be lacklustre.

By contrast, paying down a mortgage delivers an immediate and certain return.

Summary of mortgage overpayments versus using your pension

	Mortgage overpayments	Pension repayments
Tax efficiency	None. Paid out of net income that has already been taxed up to 57%.	High. Contributions reduce gross income, unlocking Child Benefit and avoiding 40%+ tax.
Liquidity and control	Locked in bricks & mortar. Hard to get back unless you equity release or downsize.	Locked in pension. Unaccessible until age 57, but highly liquid and investable once inside.
Growth potential	Overpayments return a guaranteed 5% (by avoiding mortgage interest).	Pension investments can compound in global equities, potentially beating 5% over 20 years.
The end game	Mortgage steadily drops to £0 over 25–30 years.	Mortgage remains flat, then gets potentially wiped out in one go with tax-free cash at 57.

The bright side

Of course you don’t have to push quite so hard as Ingrid and Hans.

For starters, not everyone can amass over £1,000,000 in a pension to max out the tax-free lump sum withdrawal.

You might instead choose to stick with a repayment mortgage, but decide that you’ll shovel spare cash into your SIPP rather than make mortgage overpayments.

And when you reach retirement age, if you can then pay off the balance with a tax-free lump sum then, well, congratulations!

But if not – perhaps because the tax-free lump sum has been done away with, you’ll just crack on – and withdraw money from the pension at 20% tax.

It’s not as good as you’d hoped for. But if you saved 50% tax on the way in then you’re still doing well.

It’s not for everybody

Some people love the freedom that a fully paid-off mortgage gives them.

No arguments from me there.

But if you’re already planning to invest heavily to build up a healthy ISA and pension balance, then it might be worth cracking out a spreadsheet.

• The Investor wrote an article on paying down your mortgage or investing. It doesn’t explicitly take taxes into account. But it’s a good place to start on the risks and the potential rewards, and there’s a spreadsheet you can duplicate for your own use.

For us, since we view our next home as a temporary venture, the pieces slot into place more neatly.

We’d be quite comfortable with needing to sell up in our fifties. If downsizing and utilising our pension lump sums lets us become mortgage-free, then that’s perfect.

Equally, if our lump sums let us take a huge bite out of the mortgage, and we can easily afford the monthly payments for a few more years whilst we decide where to move to, that’s also fine.

What if the government has eliminated the tax-free lump sum or increased tax rates on pension withdrawals by then?

Well, then we won’t benefit as much as we had originally hoped. But investing is all about taking calculated risks.

The point is that I’ll be prioritising my ISAs and SIPPs ahead of making mortgage overpayments over the next few years.

And I’ll be crossing a few fingers for a couple of decades!

I like walking. Fortunately, so does my wife.

Our longest walk is the South West Coast Path. It took us seven years to cover all 630 miles, fitting in a week here and there while we worked full-time.

Our second longest walk is the Camino Francés, a more modest 500 miles. We completed this in one go, over a leisurely couple of months earlier this year.

Why all in one go? Because we can. We don’t have to work now.

This is why I invest.

My interest in investing is not for its own sake but because it will allow me to go for long walks. Really long walks.

Against the flow

The Camino Francés runs from the French side of the Pyrenees, through northern Spain to Santiago de Compostela in the west of the country, where traditionally pilgrims would visit the shrine of St James.

But, to the surprise, amusement – and occasionally horror – of other pilgrims, we walked it in reverse. Somehow it felt more natural to be walking away from civilisation and towards the mountains.

This meant we would typically start and end our daily walk alone but meet a lot of people going the other way around the middle of the day.

There must be a contrarian investing metaphor in there somewhere. 

The cost

You don’t need the investing success of Warren Buffett to walk the Camino. It’s possible to get by on very little if you choose the right hostels.

And when your path takes you through El Bierzo, La Rioja, and Navarra you can always find a decent red to go with your paella, whatever your means.

We didn’t scrimp – I like a nice room and a decent meal after a long walk – but we still ended up spending less in those two months walking than we normally do living at home. We don’t need more money to go walking.

If my preferred pastime was motor sports or polo then I would need a very different financial plan (and probably to have worked a different career).

But it’s not. I like walking. And I’m happy about that.

The Meseta

The heart of the Camino Francés is the Meseta; a vast high plateau of beautiful monotony. If you’re going to have an epiphany on your pilgrimage, then this is where it will happen.

It took us eight days to walk across the Meseta, from León to Burgos. Plenty of time to think about life. Many of the people we met were grappling with some sort of work, relationship, or existential conundrum.

For the most part, my inner thoughts would not be of much interest to you – and may be embarrassing for me.

But I did dwell for a while on the nature of my retirement.

Retirement

I’m still uncomfortable with the word retirement. It seems too negative, like I’ve just given up. Even now, I hesitate awkwardly when people ask me what I do.

I stopped working a couple of years ago. It was the right time. I’d worked hard, done some long hours, had some success, and the joy in it was beginning to ebb.

And, of course, our investments had reached the point where paid work was optional.

I wasn’t short of advice on what I should do when I gave up work. Some of it solicited, some of it not.

One thing everyone was sure about was that I would need to keep myself busy. I should work part time, or do some consulting, or volunteer for a charity. At the very least I should keep a structured routine.

I was warned that many people became bored and depressed when they retire – and end up going back to work or spiralling down into a Cash in the Attic torpor.

But despite this advice, I didn’t take on anything new straightaway. We were already renovating a house and had just had a new grandchild. I gave myself some space (as the self-help books like to say) to think about things for a while.

I quite enjoyed that space. And then we went walking.

Out on the Meseta, I decided that I would ignore all the advice. Simply put, I really like not working. I don’t want another job, or objectives, or more dates in my diary.

The only routine I value is the simple rhythm of a long trail: walk, drink, eat, sleep.

The least important things hold my interest; the smallest things give me joy. I’m not the same person I was when I worked.

FIRE, aim, ready

Perhaps you know exactly what you’ll be doing when you finally stop work. But I’m figuring it out as I go along.

Who knows, maybe I’ll change my mind again and retrain as an accountant next year.

It’s prudent to occasionally remind yourself of your reasons for investing. It’s hard to make good investing decisions if you’re not clear on why you’re doing it.

That doesn’t mean though that you need your future mapped out in detail and set in stone.

You’ll get plenty of advice on retirement. Some you may even find useful. Feel free to discard the rest. Only you will know what’s right.

The end?

On our last day on the Camino, it rained. The beautiful views on the descent to Saint-Jean-Pied-de-Port were lost behind low cloud.

That’s part of walking. Some you win and some you lose.

The next day I started planning another walk: the Via di Francesco, from Rome to Florence through the Apennines.

I’m confident my money will last. What I don’t know is how many years of pack-carrying trail walking I’ve got left in me.

I intend to make the most of them while I can.

Buen Camino!