Bonus Dilemma: “Should I Pay Off My Mortgage or Boost My Pension?”

This is a question I’m often asked when a client receives a bonus, and both options have their benefits.

The best choice depends on your financial priorities, tax situation, and long-term goals. In this blog, we’ll explore the pros and cons of each approach.

Using Your Bonus to Overpay Your Mortgage

✅ Pros of Paying Off Your Mortgage

Guaranteed Savings on Interest - Overpaying your mortgage reduces the outstanding balance, meaning less interest paid over time. This is particularly beneficial if you’re on a high rate.

Financial Freedom Sooner - Paying down your mortgage early can help you become debt free faster, reducing your monthly outgoings and potentially allowing for earlier retirement or career flexibility.

Psychological Peace of Mind - For many people, having no mortgage is a huge relief, providing financial security in later years.

Avoiding Market Risk - Paying off a mortgage provides a guaranteed return in the form of interest saved, whereas pension investments are subject to market fluctuations.

❌ Cons of Paying Off Your Mortgage

You Might Lose Tax Advantages - Your bonus is taxed before you receive it, meaning higher-rate and additional-rate taxpayers could lose a big portion to HMRC before it reaches their mortgage.

Low Mortgage Rates vs. Investment Returns - If your mortgage rate is relatively low, the potential long-term returns from investing in a pension could exceed the interest savings on your mortgage.

Less Liquidity - Once you pay off your mortgage, that money is locked into your home. You’d need to remortgage or sell the property to access it again.

Overpayment Penalties - Some mortgage providers impose penalties for overpayments, especially on fixed-rate mortgages. Check your lender’s terms before making large payments.

Using Your Bonus to Boost Your Pension

✅ Pros of Paying into Your Pension

Tax Efficiency - Especially for Higher Earners - Pension contributions receive tax relief, meaning the government boosts your savings. For example, a higher-rate taxpayer (42%) in Scotland receives 42% tax relief - so a £10,000 bonus costs just £5,800 net when contributed to a pension.

Employer Pension Contributions (If Applicable) - If your employer matches pension contributions, you could get extra money on top of your bonus, further increasing your pension pot.

Long-Term Investment Growth - Pensions are invested in stocks, bonds, and other assets, which have the potential to generate returns in excess of your mortgage interest rate, although this isn’t guaranteed.

Compounds Over Time - The earlier you invest in a pension, the more time it has to grow tax-free, taking advantage of compound interest.

❌ Cons of Paying into Your Pension

Restricted Access Until Retirement - Pension funds cannot be accessed until age 55 (rising to 57 from 2028). If you might need access to the money before then (e.g., for an early retirement or hose purchase), paying off your mortgage may be preferable.

Investment Risk - Pension funds are invested, so their value can fluctuate depending on market conditions.

What About a Bit of Both?

If you’re undecided, you might consider a combination:

• Contribute enough to your pension to maximise tax relief and any employer matched contributions.

• Use any remaining bonus to make a lump-sum overpayment on your mortgage, helping to reduce interest payments while keeping long-term flexibility.

  
  

This balanced strategy allows you to boost retirement savings while reducing debt, giving you the best of both worlds.

There is no right or wrong, and as you will see it is very much about your personal circumstances. If you want to know more, or discuss your own situation then feel free to get in touch.

This blog is for information purposes and does not constitute financial advice, which should be based on your individual circumstances.

The value of pensions and any income from them can fall as well as rise. You may not get back the full amount invested.

A pension is a long-term investment and the value is not guaranteed. Any advice or considerations are personal to each individual’s circumstances.

Levels and bases of, and reliefs from, taxation are subject to change and their value will depend upon personal circumstances. Taxation and pension legislation may change in the future.

Your home may be repossessed if you do not keep up repayments on your mortgage.

Think carefully before securing debts against your home.