Retiring with a mortgage: three ways compared

Many people reach retirement with some mortgage left. The usual choices are to keep paying it from retirement income, or to clear it with the tax-free cash from a pension. How the tax-free cash is taken changes the tax.

Worked example: someone retiring at 60 with a £500,000 pension, £20,000 in savings, and £60,000 of mortgage left at 4.5% interest: £675 a month for 9 more years. They want £24,000 a year to live on, after tax, in today's money.

The three ways side by side

	Keep paying	Clear it with all the tax-free cash	Clear it with some of it
Money lasts	To 95	To 95	To 95
Income tax	£82,568	£87,716	£82,375
Left at 95	£53,738	£53,006	£56,242

Income tax is over the whole retirement, and what's left is in today's money. All three are worked out by the calculator, with the same growth, charges and state pension.

What each way means

Keep paying. The mortgage is paid from retirement income until it ends at 69. Each withdrawal from the pension is a quarter tax-free and three quarters taxed. A payment of £8,100 a year stays the same while prices rise, so in today's money it's worth about £7,350 a year on average, which is what the calculator uses.

Clear it with all the tax-free cash. The whole quarter of the pension, £125,000, comes out tax-free at 60. £60,000 clears the mortgage and £65,000 goes into savings. Everything taken from the pension after that is fully taxed, and interest on savings outside an ISA can be taxed too.

Clear it with some of the tax-free cash. Tax-free cash is taken from only £240,000 of the pension, which gives £60,000, enough to clear the mortgage. The rest of the pension keeps its tax-free cash: a quarter of each later withdrawal from it is tax-free. Not every pension allows this. The provider can say.

Why they come out close here

The mortgage costs 4.5% a year in interest, and the pension grows at about the same rate after charges. When the two are close, clearing the mortgage and keeping it cost about the same. A higher mortgage rate makes clearing it worth more. Higher growth makes keeping it worth more. Your own figures can give a different answer.

Things to check first

• Charges for paying early. Some mortgages charge for paying off early or for overpaying beyond a limit. Many lenders allow overpayments of up to 10% a year without a charge.
• Money in reserve. MoneyHelper suggests keeping enough savings to cover at least three months before paying off a mortgage early.
• The tax-free cash limit. Usually a quarter of each pension, with £268,275 in total across all your pensions.
• Paying into a pension later. Taking only tax-free cash doesn't cut what you can pay in. Taking taxable money usually limits pension payments with tax relief to £10,000 a year.
• Benefits. If you get Pension Credit or Universal Credit, money taken from a pension can reduce or stop them.

If the mortgage ends after you retire

Lenders check that the payments are affordable from retirement income. For an interest-only mortgage that's ending, the lender can say whether the term can be extended.

A retirement interest-only mortgage is a home loan for older borrowers, often over 50 or 55. You pay the interest each month, and the loan is usually repaid when the home is sold, or when you die or move into long-term care. Lenders still check you can afford the interest, some deals have arrangement fees of up to £3,000, and the home is at risk if payments aren't kept up. See MoneyHelper's guide to RIO mortgages.

Try it with your own figures

In the calculator's "Income you want" step, add the mortgage payment to the yearly income until the age it ends, using its value in today's money. To try clearing it, set the pension's "25% tax-free cash" to "All at once as a lump sum" at the age you'd clear it, and enter the mortgage under "Spend from it straight away". To take tax-free cash from part of a pension, enter the pension as two pots. Try the calculator with your own figures.

Free, impartial help with your pension options: Pension Wise. MoneyHelper's guide to paying off a mortgage early is in the sources below.