If you’re approaching retirement with a pension and an outstanding mortgage, you may be wondering whether it makes sense to use part of your pension to clear the debt. The idea of becoming mortgage-free might be appealing, but it’s not always the best financial move.
On the surface, it offers simplicity: fewer monthly payments, lower interest costs, and the comfort of owning your home outright. Yet withdrawing a large sum from your pension early can reduce future income and limit your flexibility later in life. Additionally, there could be tax implications for withdrawals beyond the 25% tax-free allowance, and some lenders may cap overpayments or have an early repayment penalty.
Whether you’re planning a full repayment or partial overpayment, it’s important to understand the implications for your retirement income, tax position and long-term security.
A quick summary: the pros and cons of using pension savings
- Becoming mortgage-free may bring peace of mind but could limit growth potential and future retirement income.
- Only 25% of pension savings can usually be taken tax-free – withdrawals beyond that are taxable income.
- Mortgage products designed for later life can offer more flexibility than many retirees assume.
- Partial or phased pension drawdown can offer a more balanced trade-off.
- The right decision depends on your pension pot size, tax position, mortgage terms, and personal goals.
- If your mortgage interest rate is currently low, your pension might grow faster than the cost of the mortgage. In that case, keeping the money invested might be smarter.
- Using pension funds now means less money later. A smaller retirement fund could impact your lifestyle or lead to financial shortfalls.
Why paying off your mortgage with your pension is so appealing
The thought of being mortgage-free in retirement is a strong one, especially if you’ve spent years balancing monthly repayments with pension contributions.
Many in their 50s and 60s consider using a pension lump sum to reduce or clear mortgage debt. Removing a major monthly cost can offer both emotional relief and greater control, especially if you’re on a variable or high fixed-rate mortgage deal.
Some weigh up mortgage interest rates against pension growth potential. If your loan costs more than your pension returns, paying it down may seem sensible, particularly if you’ve already accessed your 25% tax-free lump sum.
What you might be giving up
However, using your pension to pay off your mortgage comes with an opportunity cost. Savings left in your pension can remain invested, giving you the potential for long-term growth. Taking those funds out early means you lose that future investment potential.
Flexibility is another key consideration. Pension savings can be accessed gradually and drawn on in different ways, giving you options if your needs change. Once those funds are tied up in your home, they become far less accessible unless you decide to sell or release equity.
It’s also important to consider sustainability. Using a large chunk of your pension to clear your mortgage early could leave you with less income in retirement and increase the risk of running out of money if you take a higher level of withdrawals.
The tax implications
You can usually take up to 25% of your pension pot tax-free, up to a maximum of £268,275. Anything beyond this is taxed as income at your marginal rate. For example, if you withdraw £60,000 and only £15,000 is tax-free, the remaining £45,000 is added to your income for the year and taxed at 20%, 40%, or 45% depending on your total earnings. Most providers apply PAYE, but emergency tax codes are common, meaning you may need to reclaim any overpaid tax from HMRC.
Some people manage this by using segments of their pension fund to take smaller lump sums across multiple tax years. One-off withdrawals, sometimes referred to as Uncrystallised Funds Pension Lump Sums (UFPLS), allow you to take part of your pension in stages, with 25% of each payment tax-free and the rest taxed as income.
It’s also important to factor in the Money Purchase Annual Allowance (MPAA). Once you begin taking taxable income (above the tax-free allowance), your annual pension contribution limit drops from £60,000 to £10,000, which can affect those still contributing to their pension.
You might not need to rush
Recent changes in the mortgage market mean you may have more flexibility than you think. Retirement interest-only (RIO) mortgages are becoming more common, and many now include longer repayment terms and the option to make overpayments without penalty.
In fact, a growing number of lenders let borrowers extend their mortgage into later life and make annual overpayments of up to 10%, helping to reduce the balance gradually without relying on a single lump sum from a pension.
Alternatives worth exploring
Before using your pension to pay off your mortgage in full, it’s also important to consider other strategies that may reduce debt while preserving long-term flexibility.
Some people choose to use their tax-free lump sum to make a partial mortgage overpayment. This can reduce the total interest paid over time without triggering an income tax charge. Others spread pension withdrawals across multiple tax years to stay within lower tax bands and avoid paying more tax than necessary.
If you have ISA savings or other cash reserves, using these first can be more tax-efficient than dipping into your pension. ISAs shelter interest and gains from tax, making them a useful tool for this kind of planning.
Downsizing could also help clear your mortgage, while equity release may offer later-life flexibility without needing to access your pension straight away. Today’s equity release products also include safeguards, such as no-negative-equity guarantees.
Exploring these alternatives could help you strike a better balance between debt reduction and retirement income.
Weighing up your options
There’s no one-size-fits-all answer, but the table below highlights some of the key reasons why either option might work better for you.
| When it might make sense to clear the mortgage: | When keeping the mortgage could be the better choice: |
| Your mortgage balance is small and clearing it won’t dent your pension income. | You’re on a low fixed-rate deal and expect your pension to outperform mortgage costs. |
| You’re risk-averse and want the reassurance of owning your home outright. | You want to keep your savings flexible in case your needs change. |
| You’ve already accessed your pension and don’t plan to contribute further. | Large withdrawals would push you into a higher tax bracket. |
| Your mortgage allows penalty-free overpayments. | You’re planning to leave your pension invested for future use or to support family later (although from April 2027, untouched pensions may be counted as part of your estate for Inheritance Tax) |
The takeaway: balance today’s goals with tomorrow’s needs
There’s no single right answer. For some, using a pension to pay off a mortgage brings comfort and simplicity. For others, it risks reducing long-term financial security and a lower income in retirement.
The key is to understand your position and weigh up the tax, growth and flexibility trade-offs, ideally with advice tailored to your circumstances.
Planning your next move
Deciding how to manage your mortgage in retirement is rarely straightforward. It’s not just about the numbers. It’s also about income needs, tax position, long-term goals and staying flexible as circumstances change.
Book a free discovery call with the Flying Colours team to explore your options as part of your wider financial plan, so you can move forward with clarity and confidence.
Please note:
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
A pension is a long-term investment not normally accessible until age 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Investments should be considered over the longer term (minimum of 5 years) and should fit in with your overall risk profile and financial circumstances.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
The Financial Conduct Authority does not regulate estate planning, tax planning, or cashflow planning.