Pension Tax-Free Cash vs Mortgage: The £112,000 Question
Should you use pension tax-free cash to clear your mortgage? A worked example starts £112,000 apart, but invest what you save and the gap narrows fast.
By Firoz Khan|27 September 2026|6 min read
£112,000. That’s the difference between two identical savers making one different choice at 55: what to do with their tax-free pension cash. One clears the mortgage with it. The other leaves it invested. Here’s both scenarios worked through with real numbers, so you can see which one actually wins.
The answer in 30 seconds
£112,000
Pension-only gap between clearing the mortgage and staying invested
£102,500
ISA Alex builds by investing the mortgage payment he no longer has to make
£9,400
What’s actually left once that ISA is counted, before tax
These are three stages of the same calculation, not three separate results. Once the freed-up mortgage payment is invested, the comparison becomes much closer than the pension-only £112,000 figure suggests.
Watch the video version
YouTubePension rules relevant to this example
From age 55, rising to 57 on 6 April 2028 (some people have a protected pension age and keep access from 55), most people can take up to 25% of their pension pot tax-free. The cap for 2026/27 is £268,275, known as the Lump Sum Allowance, subject to any relevant individual protections. Keeping the pension invested instead may result in a larger pension pot and potentially greater tax-free cash later, subject to the pension rules and your own Lump Sum Allowance at the time.
How you take that money changes what you’re allowed to do next. Take only the tax-free portion and leave the rest untouched, and your pension contributions carry on exactly as before. Take taxable income out at the same time, through drawdown for example, and you trigger the Money Purchase Annual Allowance, which cuts your annual pension contribution limit from the standard £60,000 down to £10,000 for 2026/27, for the rest of your working life.
What retirement actually costs
Pensions UK reckons a moderate retirement costs a single person around £32,700 a year. That figure doesn’t include a penny of housing costs. If you’re still paying a mortgage or rent into your 60s on top of everyday living, you need meaningfully more saved than that headline number suggests.
The worked example
Two people, Alex and Priya, both 55, both with the same starting point.
Worked-example assumptions
- Age
- 55
- Pension
- £250,000
- Mortgage balance
- £62,500
- Mortgage term remaining
- 10 years
- Mortgage rate
- 4.5%
- Monthly mortgage payment
- around £648
- Investment return assumption
- 6% after fees
- Further pension contributions
- none
- Early repayment charge
- none
Illustrative assumptions only. Investment returns are not guaranteed.
Alex takes the full 25% tax-free lump sum, £62,500, and clears the mortgage outright. Priya leaves the full £250,000 invested and keeps paying the mortgage on schedule. Neither adds another penny to their pension between now and 65.
How the numbers compare by 65
| Metric | Pay off mortgage | Leave pension invested |
|---|---|---|
| Pension at 55 | £250,000 | £250,000 |
| Tax-free cash withdrawn | £62,500 | £0 |
| Pension remaining | £187,500 | £250,000 |
| Pension value at 65 | approx. £335,800 | approx. £447,700 |
| ISA built from invested mortgage payments | approx. £102,500 | £0 |
| Combined investment position | approx. £438,300 | approx. £447,700 |
| Difference | — | approx. £9,400 |
Figures rounded to the nearest £100. Pension growth assumed at 6% a year after fees; the ISA assumes the freed-up mortgage payment (£7,775 a year) invested at the same rate.
The simple version
Difference: approximately £9,400 in Priya’s favour, before tax.
Why the £112,000 gap shrinks to about £9,400
Look at the pension value alone and Priya is roughly £112,000 ahead. But Alex isn’t paying a mortgage. That frees up around £648 a month, roughly £7,775 a year, that Priya is still sending to her lender. Put that saved money into an ISA at the same 6% growth, and it becomes another investment pot.
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The calculation
Simply comparing the pension balances makes the difference look far larger than comparing the broader investment positions. Alex is also sitting on a smaller original tax-free entitlement than Priya would eventually have (his was £62,500; hers would be roughly £111,900, because 25% of a bigger pot is a bigger number) — another reason the pension-only comparison overstates the gap.
Tax considerations
Alex’s ISA money comes out completely tax-free whenever he wants it. Priya’s extra pension growth, beyond her own 25% tax-free slice, is exposed to income tax when she eventually draws it. The real gap between these two outcomes depends entirely on how and when Priya takes her money, and what the tax rules look like by the time she does, which nobody can promise today.
Mortgage rate vs investment return
Paying off a 4.5% mortgage removes a known 4.5% interest cost. The assumed 6% investment return is uncertain and is not guaranteed. As the mortgage rate gets closer to the assumed investment return, the mathematical difference between the choices gets smaller. If the mortgage rate exceeds the assumed investment return, the numbers shift further towards mortgage repayment.
- Mortgage rate around 2%: a larger assumed gap between the mortgage cost and the 6% investment-return assumption, so staying invested looks stronger on paper.
- Mortgage rate around 4.5%: this is the worked-example rate above.
- Mortgage rate around 6%: the mortgage cost roughly matches the illustrative investment return, before tax and investment risk.
- Mortgage rate 7% or higher: the mortgage cost is above the article’s assumed 6% investment return, so clearing it looks stronger on paper.
Treat 6% as an illustrative investment assumption, not a guaranteed return, throughout.
Where people get this wrong
Mainstream advice treats "pay off your mortgage early" as automatically sensible, full stop, no maths required. It sounds responsible, so it goes unchallenged. But responsible and optimal are not the same thing. Plenty of people are quietly leaving five and six-figure sums on the table because nobody sat them down and ran two scenarios side by side. This isn’t complicated. It’s just rarely done.
Non-financial considerations
None of this is purely mathematical. Clearing your mortgage gives you a guaranteed saving and genuine peace of mind. Investment returns are never guaranteed. A bigger gap between what your investments earn and what your mortgage costs makes leaving the money invested look better on paper; a smaller gap, or a higher mortgage rate, flips that.
There’s a behavioural side too. If clearing the mortgage frees up hundreds of pounds a month, some people invest it the way Alex did. Plenty just spend it. If that sounds like you, the forced discipline of still having a mortgage payment might genuinely serve you better than the optimal spreadsheet answer.
Which circumstances may suit each approach
Paying off the mortgage may appeal more where:
- reducing a guaranteed interest cost matters to you
- lower monthly expenses in retirement matter
- being mortgage-free has significant personal value
- the mortgage rate is relatively high
Remaining invested may appeal more where:
- the mortgage rate is relatively low
- you have a long time horizon to age 65 and beyond
- investment volatility is something you can live with
- the freed-up money would genuinely stay invested rather than being spent
Middle-ground options
- Take only part of the available tax-free cash, rather than all of it
- Reduce the mortgage rather than clearing it completely
- Retain some cash as an emergency fund before committing the rest
- Keep paying the mortgage for a few more years and revisit the tax-free cash question later — the door doesn’t close at 55
Sources and methodology
Sources: the Lump Sum Allowance and normal minimum pension age figures are from GOV.UK, the Money Purchase Annual Allowance from GOV.UK, and the moderate retirement figure from Pensions UK’s Retirement Living Standards.
Methodology: the worked example is illustrative, built from the assumptions listed above, and independently recalculated for this article. Investment returns are assumptions, not guarantees; future returns can be higher or lower than 6%, and investment values can fall as well as rise. Tax treatment depends on individual circumstances and current rules, both of which can change. Inflation is not modelled and will reduce the real value of both outcomes over 10 years.
Related reading: Overpay Your Mortgage or Invest?, the Pension Contribution Calculator, and the FIRE Number Calculator.
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