Sebastian Janssen, 61, has been an IT project manager for 33 years. He and his wife plan to retire in 2026, at which point they hope to have paid off the mortgage on their four-bedroom detached house in Berkshire.
“We just want to keep living healthily,” Mr Janssen says. “We want to do a bit of travelling and look after our home.”
Mr Janssen and his wife have three adult children. One son lives at home, while his daughter works as an au pair in France.
“We’re hoping that our children won’t need the same financial help by the time we stop working,” he says.
The couple want to pay off their £300,000 mortgage by 2026, when their fixed-rate deal comes to an end. They want to achieve this using a combination of pension tax-free cash and savings – Mr Janssen is happy to put £50,000 of his savings into his mortgage, while his wife wants to contribute £40,000.
They earn around £7,500 a month between them, after tax; Mr Janssen’s annual salary is £72,000. The couple would also like to have £50,000 a year for their retirement, which they hope to achieve using “drawdown” from pensions.
“Our pension pot is reasonably big, and our children live locally, so they will be around to help us in our retirement. We plan to spend about £3,500 a month once we finish working,” Mr Janssen says.
Ian Cook, a chartered financial planner at Quilter, says:
Mr Janssen earns a good salary and his wife brings in about £3,000 monthly. Their goal is straightforward: clear their £300,000 mortgage by September 2026 when their fixed rate deal ends and retire with an income of around £3,500 a month.
The couple have amassed pension savings of £920,000 and cash of £19,500. They are also both still contributing to their pensions, which they should continue to do. Their family home, a potential financial safety net, is valued at slightly more than £1m. Although they plan to pass it to their children, the possibility of downsizing in future may provide some added financial flexibility.
While it might be tempting to dip into savings or pensions to clear the mortgage sooner rather than later, it would be wise to hold off until their fixed rate matures. This avoids potential early redemption costs and gives their retirement pots time to grow further, increasing the potential for additional tax-free cash.
With their significant pension contributions, by 2026 Mr Janssen’s pension could be worth around £1.1m, based on 5pc growth, and his wife’s could be worth around £280,000. The personal tax allowance is £12,570, which they will both have, so they could draw £2,100 a month from these pensions after retirement, which would help them towards their £3,500 monthly target.
Any shortfalls can be covered using their cash savings, remembering though that it’s wise to set aside an emergency fund, typically three to six months’ worth of expenses, for any unexpected costs that might arise.
They could then use tax-free cash from their pensions to cover any shortfall outstanding on the mortgage. This would allow them to withdraw up to their personal allowances from the taxable portion of their pensions and should leave them some tax-free cash to cover the shortfall in monthly income.
They could continue this way until they received the state pension. Their pension pots would be used either to provide the remaining available tax free cash or potentially a taxable income.
A further consideration would be to look at buying an annuity once in receipt of the state pension to provide a guaranteed income linked to inflation. I would suggest an annuity to cover the amount of income required; this would leave some pension savings to provide a buffer or indeed some indulgences in retirement. I favour this approach, as it guarantees that all known lifestyle expenditure is paid for while giving them the flexibility of a significant drawdown pot.
The reasons for covering only the known income needs are that typically later in life the need for income reduces as we spend more of our time at home, although there is also the potential need for long-term care. If you used the whole pot to buy an annuity you could end up with income later in life that isn’t required; this could add to the future inheritance tax liability.
Leaving money in the pension would allow them the flexibility to draw further income as required, make gifts to the children or grandchildren, leave a legacy that sits outside the inheritance tax rules as they are now, while the money grows in a tax-free environment.
Plans are only as good as the flexibility they offer. Mr Janssen and his wife should be open to reassessing their financial strategy, especially in light of potential changes in government policy. For instance, future governments might make tax changes or reintroduce certain financial limits, such as the pensions lifetime allowance, that could affect their plans.
Labour has already indicated its intention to restore the lifetime allowance, so I would suggest the couple engage with a financial planner now to negotiate any transitional changes specific to their situation.
Remember too that, while most pensions are outside the inheritance tax net, after the age of 75 they do become taxable at the beneficiary’s marginal rate. It’s also important that the couple’s death benefit nominations reflect their wishes and that their pension provider allows for drawdown by the successor or beneficiary in the event of their death. If they don’t, the pot will pay out to the beneficiary and potentially be subject to tax.
Also, a future government could change inheritance tax legislation. This could be positive or negative.
Natalie Kempster of Argentis Wealth Management, says:
Mr Janssen is approaching retirement and wants to be mortgage-free within three years. He has £300,000 outstanding on an interest-only mortgage and savings of £120,000. He plans to use £90,000 of his savings to help repay the mortgage, leaving £30,000 as an emergency fund.
This is a healthy amount, but as he enters retirement he may want to consider increasing it to closer to a year’s expenditure.
He intends to fund the outstanding balance from his pension. This makes good sense, as up to 25pc of the fund can be drawn tax-free. It may not make sense to repay the mortgage now, as there is likely to be an early redemption penalty.
Additionally, he is likely to be able to achieve a higher rate on cash savings (for example, 6.2pc with NS&I fixed for a year) than the interest rate on his mortgage. Any surplus income between now and retirement could also be set aside for repaying the mortgage.
Now is a good time for him to start thinking about what retirement will really look like. Depending on his tolerance for risk, after taking out the tax-free lump sum from his pension he may want to leave the rest invested and draw a monthly income.
However, this isn’t the only solution, and it is important to consider all of the retirement options available.
Mr Janssen has estimated that his current expenditure is around £3,000 a month and that in retirement he’ll need about £3,500 a month. I would recommend a detailed analysis of current expenditure and what he will need in future. It is important to understand what your essential expenditure, lifestyle and discretionary expenditure needs will be.
Ideally, essential expenditure would be met by secure income such as the state pension and an annuity. The residual fund could then be invested in the stock market to provide money for the nicer things in life without the worry that you could run out of money or have to draw from the funds when market conditions are poor.
There will be a gap of around three years from retirement until the state pension comes into payment and it may be worth considering a fixed-term annuity to cover this period. Annuities have been seen as poor value in recent years but improving rates and increasing longevity make them an important building block to consider for any retirement plan.
A meeting with a financial planner who will do some cash flow modelling will give the couple the confidence that their pensions can meet their income needs throughout retirement.
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