My husband and I have just inherited £150,000. We have an outstanding mortgage of £99,000, a car loan of £4,000 and no other debt. We have not built up much of a pension fund. I am 37 and he is 47. What should we do with the capital?
First of all, spend some of it. Saving for the future is clearly important but it is also important to get some enjoyment from it today.
I am not suggesting you go mad and blow the whole lot but I am sure that whoever left you the money wanted you to get some immediate enjoyment from it. What about that dream holiday you could not quite afford?
The second thing I suggest that you do is pay off the outstanding car loan. You will typically be paying a rate of interest for this loan that greatly exceeds the interest you could earn if you left £4,000 in a bank or building society bank account. Paying off this loan will also free
up some of your monthly disposable income.
The third thing I suggest you do is write what will probably be the biggest cheque that you will ever write in your lifetime and pay off your mortgage. I can see a number ofbenefits to you both in doing this.
There is a non-financial benefit in paying off the mortgage. Just imagine how it must feel. By paying off the mortgage early, you will save a phenomenal amount of interest that would have been paid over the remaining term of the loan. Even if you do not pay off all the outstanding mortgage capital, whatever amount you do pay off will save you a good deal of money.
Some people are reluctant to use up capital to pay off debt. They rationalise this by thinking about how hard it is to create capital and that if they use it to pay off a mortgage, then they are somehow losing it. An alternative might be to consider an offset mortgage where you keep the capital and earn no interest on it but instead pay no interest on your mortgage.
If you pay off part of the mortgage and continue paying the same amount each month to the lender, assuming you have a repayment mortgage, you will at the very least reduce the outstanding loan term.
If you partly or completely pay off your mortgage, you might then apply the savings you make each month as a pension contribution.
You could also put the monthly savings from paying off the car loan towards building up a pension fund.
The opposite approach is also worthy of consideration. Instead of paying off the debt, you could simply keep paying it off each month. You then invest the capital you have inherited to build up a pension fund.
Which of the two routes is most likely to produce the best result? I favour paying off the debt and building your retirement funds from regular savings. This allows you to take a greater degree of investment risk with the regular pension contributions. As you buy investments each month, you need worry less about their volatile nature than would be the case if you invested all your capital in one go. In investment terms, the greater the degree of investment risk you take, the greater potential return. Remember, however, that your savings can go down in value as well as up.
As the capital you have inherited exceeds your outstanding debt, you might decide to make a one-off contribution to boost your pension funding. Pension contribution rules these days are much more generous than they used to be, so you should have little difficulty paying almost as much as you want into a pension plan. An added attraction of paying a lump sum as a pension contribution is that income tax relief will be added to your payment.
If you invest £1,000 in a pension, the Revenue will add £282.05 to it. If either you or your husband are higher-rate taxpayers, then it might make sense to apply any one-off contribution to that person’s plan to secure 40 per cent tax relief rather than just 22 per cent.
Ask your financial adviser to calculate how much you need to save each month to create a pension fund big enough to produce a desired level of income at retirement. You may be surprised just how much you both need to set aside to produce a decent retirement income. If you can save money now by getting rid of debt, then in the long run you stand a good change of building a sizeable retirement fund.
Of course, it is about discipline. You need to save regularly and you must make sure that, having paid off the debt, you do not acquire more in the future.
Nick Bamford is managing director of Informed Choice