Teacher wants a pension lesson

Ruth Thompson

Age: 56
Lives in: Surrey
Occupation: Teacher
Earns: About ?28,000
Mortgage: ?39,000
Debts: None
Investments: Isas and endowments
Pension: Occupational scheme and FSAVC
Aims: To pay off mortgage, help children through university and retire with enough to live on comfortably

Ruth teaches English as a second language at a college of further education. Her pupils are mainly refugees and asylum seekers. All are highly motivated and eager to learn, which makes teaching them very enjoyable, says Ruth. She is in no hurry to give up work and retire.

She needs to keep working beyond 60 anyway to repay her mortgage and maximise her pension, and she would like to know the best ways to achieve these goals. She took out her mortgage two years ago, after she was divorced. The loan is on an interest-only basis and has another eight years to run. It is partly covered by two Standard Life endowments which were transferred into her name as part of her divorce settlement. These are due to mature in July and she expects the total payouts to be about £20,000.

She is not sure what to do with the money. She asks: 'Do I pay off as much of the mortgage as I can and settle for lower repayments on the remainder, or do I pay off some and invest the rest of the money - if so, where? - to pay off the balance?'

When she first considered the investment option, the stock market did not look as shaky as it does now. In current conditions, she thinks paying off as much of the mortgage as she can is probably the best option.

As Ruth entered teaching later in life and took time out to have a family, she has not built up many years in her pension scheme. This was why she decided to save extra through additional voluntary contributions (AVCs), but instead of using her in-house scheme, she was sold a freestanding AVC (FSAVC) scheme. Fortunately, she managed to gain compensation as a result of being mis-sold this, but she has put the money towards the purchase of her home.

Ruth has continued to invest £100 a month in FSAVCs but has recently received a projection showing how little extra pension she is likely to receive at retirement after 11 years of saving, and is not impressed. She feels she may be better off if she cuts her losses and saves her £100 a month elsewhere, preferably where she would have greater flexibility and not have to buy an annuity. She has considered buying added years in her pension but feels the outlay is very high.

She has other savings - a Tessa which she converted into a Tessa-only Isa with Nationwide, two cash Isas worth £5,000 with Nationwide and a tracker equity Isa, also with Nationwide.

She has three children at university - two girls in their first year and her son who is about to graduate but is planning to go on to drama school. They have student loans but she is helping them with the cost of their accommodation.

Adviser 1: Gillian Cardy

Ruth should repay her mortgage debt with the proceeds of her endowments. A basic-rate taxpayer needs a gross taxable return of 8.75 per cent per annum to make it worth keeping a mortgage outstanding with interest at 7 per cent per annum. This means even tax-free Isas are not making enough to make it worth keeping the debt.

Unless Ruth has a specific purpose for keeping her Tessa and Isa funds in cash, she might want to use at least some of this money to repay more of her mortgage. If this is her emergency money or is for the benefit of the children, then, obviously, she should keep the funds where they are.

Whatever the balance of the loan, I think her best bet will be to switch to a repayment mortgage. If she continues to maintain the same total outgoings as she pays now (in interest and endowment premiums) she should find she can afford a short repayment term.

Ruth got compensation for taking an FSAVC for a good reason - they aren't as cost- effective as AVCs. She would have been better advised to buy added years from the start, but I am not sure if it is good advice to begin now. The only way to assess this is to establish the maximum contribution she could make and how many added years this would buy.

The main argument against additional pension planning is that all pension income is taxable. There is a case for building up tax-free funds in Isas to generate tax- free income in retirement.

Gillian Cardy works for financial adviser Professional Partnerships.

Adviser 2: Andrew Jones

I recommend that Ruth uses most of the sum from her Standard Life endowments to reduce her mortgage. She should probably convert the outstanding balance to a repayment basis.

She is right to question the wisdom of continuing her FSAVC contributions but she should make sure that there no penalty clauses apply if she were to stop paying the premium. The main advantages of the FSAVC plan are the tax relief available on the contributions and the advantageous tax treatment of the investment fund. Against this, she must weigh the requirement to purchase an annuity at retirement.

Her pension scheme has an in-house AVC scheme which she should consider as an alternative to her FSAVC. The new stakeholder pension is another viable option. Up to one quarter of the fund value at retirement may be taken as a tax-free lump sum, although the remainder must be used to purchase an annuity.

Alternatively, she could make regular contributions to an Isa. The proceeds could be taken as a cash sum at any time and need not be used to purchase an annuity. The Isa option therefore offers greater flexibility.

She needs to know exactly what she will be entitled to at retirement so that she can plan effectively. She should apply to the administrators of the Teachers' Pension Scheme for a pension forecast. She should also apply to the DSS for a forecast of her state pension entitlement.

Andrew Jones works for chartered accountant Blick Rothenberg.

Advice is for guidance only.

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