With bonus season approaching rapidly, new analysis by Rathbones shows that prioritising pensions payments over mortgage repayments could make individuals wealthier over the long term.
The analysis looks at someone with a £200,000 mortgage over 20 years at a 4% interest rate, receiving a £10,000 annual bonus for five years. It compares using the bonus to overpay the mortgage with paying the same bonus into a pension, assuming annual investment growth of 7% after fees. The analysis excludes national insurance contributions.
While both approaches ultimately leave the homeowner mortgage free, the analysis shows the pension first strategy can still deliver higher overall wealth over the long run — even after accounting for mortgage interest.
A 40% taxpayer who pays the bonus into a pension rather than the mortgage ends up with around £57,000 more in their pension after 20 years. The uplift is similar for 45% and 60% taxpayers, despite the mortgage being fully repaid in all cases.
However, the biggest gains appear when tax rates change over time. For someone paying 60% tax today — often due to the £100,000 income threshold — but only 45% in future, paying bonuses into a pension now rather than overpaying the mortgage results in almost £86,000 more in pension wealth after 20 years.
The findings may also understate the potential upside for some families. For higher earning parents, pension contributions that reduce adjusted income below £100,000 can preserve eligibility for tax free childcare and free nursery hours — benefits that can be worth many thousands of pounds a year and dramatically increase the effective return on pension saving.
Even lower earners can benefit. A basic rate taxpayer today who expects to become a higher rate taxpayer later still ends up around £23,000 better off by prioritising pension contributions over mortgage overpayments.
4% mortgage interest, 5% annual return
The results are sensitive to investment returns, but the overall pattern remains intact even under more cautious assumptions. If the investment return net of fees was 5%, the pension first approach would still leave individuals around £16,000 better off in their pension for a higher rate taxpayer today.
This rises to around £43,000 more for someone paying 60% tax today but only 45% in future.
However, for those moving from basic rate tax today to higher rate tax later, the mortgage first approach could be the better option, leaving them around £16,500 better off than if they had paid their bonus into a pension.
Ed Wood, senior financial planner at Rathbones, said: “For anyone receiving a bonus and weighing up whether to reduce debt or save for retirement, the numbers show there can be significant long term advantages to putting at least some of that bonus into a pension now, rather than postponing pension saving until the mortgage is cleared.
“This isn’t just about investment returns. It’s about locking in tax relief at the highest possible rate and benefiting from long term compounding inside a pension. Recent falls in mortgage rates can also change the dynamic, possibly tilting the balance more in the pension overpayment as the debt interest burden eases.
“Becoming mortgage free is a major milestone for many people and understandably central to how they define financial freedom. But there’s no single right answer when it comes to choosing between overpaying the mortgage and saving into a pension. Both can strengthen your long term financial position, and the right choice will depend on your goals, your mortgage rate, your tax position and your attitude to risk.
“For those weighing up the two, it’s worth remembering that this doesn’t have to be an all or nothing decision. Many people may find a middle ground works best, using surplus income to chip away at the mortgage while also building up pension savings, rather than prioritising one at the expense of the other.”
