Pension tax-free cash and the mortgage
Clients plan to use pension tax-free cash for a deposit or to clear a mortgage. How tax-free cash works, what taking it can set off, how lenders treat it, and where the pension decision has to come first.
Clients plan to use pension tax-free cash for a deposit or to clear a mortgage. How tax-free cash works, what taking it can set off, how lenders treat it, and where the pension decision has to come first.
A client may mention a pension plan in passing. A buyer in their late fifties says the deposit will come from their pension. A client remortgaging at sixty says they will clear the balance from their lump sum when they retire. The plan may be years old and untested.
The pension decision is irreversible once the money is drawn, and it comes before the mortgage. Your part is to recognise it and to make sure the client has had pension advice before you rely on the money.
From the minimum pension age, a member of a defined contribution pension can usually take up to a quarter of the fund as a tax-free lump sum. The minimum pension age is 55, rising to 57 from 6 April 2028. Tax-free lump sums across all of a person's pensions are capped by the lump sum allowance, which is £268,275 for those without a protected higher amount.
Defined benefit schemes work differently. The member usually gives up some of their annual pension in exchange for a lump sum, at a rate set by the scheme. The trade-off is a question for pension advice, and the scheme's figures are needed to answer it.
Anything drawn above the tax-free amount is added to the client's income for the tax year and taxed at their marginal rate.
The fund left after the lump sum pays a smaller income for the rest of the client's life.
Taking taxable income flexibly from a defined contribution pension sets off the money purchase annual allowance, which limits future contributions to defined contribution pensions to £10,000 a year. Taking tax-free cash alone does not set it off.
Drawing more than the tax-free part in a single year can push income into a higher band.
Money drawn from a pension and held as savings can count for means-tested benefits.
From 6 April 2027 unused pension funds count towards the estate for inheritance tax. Money moved from a pension into a home or savings stays in the estate in a different form.
The client needs advice on each of these before taking the cash.
A client with a defined benefit pension may be told that transferring it to a defined contribution scheme would give them more tax-free cash or more flexibility for a deposit. A transfer gives up a guaranteed income for life. Where the transfer value of safeguarded benefits exceeds £30,000, the law requires the member to take advice from an adviser with the specific permission before the scheme will make the transfer.
If a client mentions a defined benefit transfer in connection with a mortgage, record it and offer an introduction. Do not comment on whether it would suit them, and do not submit an application that depends on the transfer before the advice has been given.
Tax-free cash used as a deposit is the client's own money. Lenders and conveyancers will want evidence of the source, such as a statement from the pension provider showing the payment.
For affordability, the lender looks at the income that remains. If the client is drawing a pension income as well, the lender will want evidence of it and may assess how sustainable it is. A client who has drawn heavily on a pension may find that their remaining income supports less borrowing.
Using a lump sum to clear a mortgage at retirement removes the largest monthly bill. It also spends money that would otherwise have provided income. Whether to clear it in full, in part or not at all is a pension and planning decision.
The mortgage side is yours. Check the early repayment charge on the current deal and the overpayment allowance. Work out what a partial repayment would do to the monthly payment, and whether a smaller loan on a new deal or a retirement interest-only mortgage would suit the client's income. Give the client and their planner those figures, so the pension advice rests on accurate mortgage information.
The pension decision comes first. If you submit a mortgage application that relies on pension money before the client has had advice, the application may push them into a decision.
You can tell them the general rule. The amount available depends on the type of scheme, any protections and what they have already taken. Their provider confirms the figure, and a planner advises on whether to take it.
Taking tax-free cash alone does not set off the money purchase annual allowance. Taking taxable income flexibly from a defined contribution pension does.
Then the pension decision is made, and you can advise on the mortgage. A planner can still help the client with what to do with the rest of their pension and any cash not used.
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