Tina asks: “I’m 24 y/o and saving for a house. If I don’t stop contributing to my pension, next tax year I’ll be paying 5%, and my employer will match that with 3%. Should I stop my pension contributions and only save for a house?”
Q&A 95 – Stopping Pension To Save For A House – Shownotes
I’m 24 y/o and saving for a house. I’m on £35k now and will likely continue to see a pay rise of £5k per 6 months as I have done for the past 12-18 months.
I have almost £20k saved already for the deposit, but I need much more.
I realise that I’ll need a much higher salary to afford a house in London (£300k-£400k). But I’ve done some calculations and estimates, and I could potentially be on £70k in 3 years’ time if my career continues goes well.
Therefore, I want to be in a position in 3 years’ time to have the deposit saved up.
The question – Is it worth foregoing the salary sacrifice? If I don’t stop contributing to my pension, next tax year I’ll be paying 5%, and my employer will match that with 3%. What are your thoughts?
Great question Tina – a real head scratcher on the surface. There’ll be people who quickly fall into opposing sides here, strongly arguing that you’d be a fool to give up the employer match and tax relief, whereas others will be saying that you should get your home sorted before you start thinking about a pension.
Personally, I don’t know the answer. So, let’s explore a little deeper.
What Are Your Pension Contributions?
Let’s set some assumptions based on your question. In 2016, we’ll assume you average £40k, in 2017 £50k, in 2018 £60k and in 2019 £70k. We’ll assume that your employer match will stay at 3% if you contribute 5% over that time.
These figures will fluctuate based on your bonus, whether you pay student loans, etc etc, but in a simple scenario your pension contributions will be as follows:
|Year||Your Contribution||Employer Contribution||Total||After-tax equivalent|
Here in lies the key for me. By stopping your pension, you will have an extra £7,000 in your pocket over the course of these 3 years.
However, by continuing your pension, you will avoid tax of £4,000 and more importantly you get £6,600 of FREE money from your employer. This is money that you simply wouldn’t get if you stop your pension.
The House Purchase
The equation doesn’t quite end there. Let’s have a look at your potential house purchase. You said in your question that you’d be looking for a house in the £300-400k range. With an income of £70k, traditional measures of affordability tended to lend up to 3-4 times annual salary for the mortgage. 3.5 times your proposed future salary of £70k would give you a figure of £245k. If we applied a 75% loan to value to this, you’d be looking at a property value of £327k.
So, whilst affordability may be tight, you could probably find something towards the bottom end of this range. Assuming the above purchase is affordable, it would require a deposit of £82k.
Therefore, with £20k currently saved, you’ll need to save another £62k in the next 3 years from your salary. That is equivalent to saving 33% of your gross salary, which would be no mean feet whilst living and renting in London.
However, there are government schemes (such as Help-To-Buy) which means that your first time deposit would be much less.
Additionally, and this is a huge variable, you need to try to calculate how much every year that owning would save you compared to renting in London (this might not be that much given the current inflated house prices and lower rental yields in the capital). If you are looking for an answer, you also should try to factor in the benefit of the leveraged capital growth of your property once owned through a mortgage.
Too Many Variables
In fact, there are a million and one extremely volatile factors at play here.
Running through this example has raised two key points to me:
- The only definite in this equation is that you are losing 3% of your salary by making your 5% contribution to your pension.
- There are so many other variables at play (house price changes, changing government policy, changing mortgage lending criteria, changes in your professional and social life, etc etc). With this many future variables, I wouldn’t like to make a decision based on what might happen 3 or more years down the line when it comes to potentially buying a house.
Therefore, if I were you, I would continue to make the required pension contribution to receive matched funding by your company, and then save like crazy with the remainder of your paycheck. Look to take advantage of the new Help-To-Buy (and lifetime) ISAs, keep an eye on the Help-To-Buy scheme if buying a house, and keep abreast of all other changes in the housing market.
Stopping your pension in the next three years would only give you £7,000 in your pocket (and cost you £6,600 in employer contributions) and you’ve got no idea at this stage whether that extra £7,000 would actually make a difference to your house buying decision in the future.
Therefore, my priority, after your pension contribution is made, would be to make sure you have your budget tightly under control and save like crazy whilst you continue to progress in your career and then reevaluate your decision to buy in a few years with a much healthier bank balance (and pension pot) sitting behind you.
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