Debts and debt collectors are very much a part of our modern lifestyles. More people than ever are retiring with significant amounts of debt – some reports say that one in four retirees will still have debts to pay off.Coupled with the fact that UK pension annuities are under threat due to plummeting rates, many people have been led to ponder if they can take an early advance from their pension and retirement funds to cover their debt.
While this seems like a quick fix and could be a tempting option, there’s more than meets the eye. We take you through a guide to whether it’s a good idea to borrow from your retirement fund to pay off your debt.
The current rules around retirement funds
In 2015, a series of new changes came into play regarding pensions. These ‘pension freedoms’ meant that you are now able to take up to 25% of the value of your pension as a tax-free sum. You can also take more if you want to – but doing so will result in you paying income tax on this.
In 2017, some of these rules were revised by the Financial Conduct Authority (FCA). These rulings included early exit charges being capped at 1% of the value of the pension.
Many people may see these new pieces of legislation as a way to repay your mortgage or even other debts. But is this a good idea?
Taking money out of your pension
You may think, having considered the new rules and regulations surrounding your pension, that you can borrow from your retirement funds to pay off your debts. Taking money from your retirement fund could leave you in a worse position than you expected, however.
Before you take any money out, you should consider three important things that might affect you now and in the future. These three things are:
- The impact on your benefits
- The impact on your tax position
- The impact on your pension
The impact on your benefits
If you borrow from your retirement funds to pay off your debt, you may reduce the amount of money you can get from social security benefits both now and in the future. This is because some benefits are based on the income you receive, and can be affected by the savings you have.
Not only that, but your benefits can also be affected by taking money out of your pension and using it to pay your debts.
Benefit decisions can be really complicated, and you can find more information by following this link to a handy document published by Age UK, or to this link from the Department for Work and Pensions (DWP).
The impact on tax
Borrowing from your retirement funds to settle your debts can also affect the amount of tax you pay, as well as the amount of tax relief you get. If you take more than 25% from your pension, you may have to pay tax on everything more than the 25% amount.
This could end up being quite a large tax bill, and you could end up with significantly less than you expect. When it comes to tax relief, if you have taken more than 25% from your retirement fund, it could mean you are affected by the Money Purchase Annual Allowance.
This means that the government limits the amount you pay back into a retirement fund, and the amount you get as tax relief.
The impact on your pension
Taking money from your retirement fund for your debts also means that you won’t have that money in your pension when you retire. You’ll end up getting less monthly income from your pension, and the options on how to use your pension will be more limited.
It’s a very tricky but necessary process to weigh up the usefulness of borrowing money from your retirement fund now or to keep the money for later. Reducing the size of your pension can also be really complicated, and you’ll usually require regulated financial advice to understand them fully.
That’s the basics on what might happen if you borrow from your retirement funds to pay off your debt. We’ll go through some of the other pieces of information you should consider.
Look at your pension statement
The company that provides your pension should send you a pension statement every year. This will tell you everything you need to know about your retirement fund. You might need to contact your provider to get an up to the minute balance.
You may have paid money into more than one retirement fund. You will need to get in touch with each pension provider in order to find out how much each fund is worth.
Pension policy details
If you’ve misplaced or lost the details of your pension policies, you can use the GOV.UK website to find the contact details – follow this link. You could also contact old employers to see if you still have a pension with them or find out who your provider was.
Make a list of all your income and their sources. This should include your wages, any benefits you might receive, the amount you might hold in savings accounts and all the assets you have too.
Below, we will go through some of the more frequently asked questions in regard to borrowing from retirement funds in order to pay your debt.
Are there different kinds of pension?
Yes. There are two distinct types of pension – defined contribution pensions and defined benefit pensions. Defined contribution pensions are affected by the pension freedom changes we mentioned above, whereas defined benefit schemes are not.
Is it a good idea to use my retirement funds to pay off my debts?
In short – it isn’t advisable. There are many implications for the present and the future if you do decide to use your retirement funds to pay your debts. However, this doesn’t mean that you can’t. A lot will depend on your circumstances , so be sure to gather as much information as you can.
Are there any other places I can get more information?
Yes. There are several different services available for free that will offer you advice about what to do if you are worried about your debts and your retirement fund. Head over to the Pensions Advisory Service, who have lots of information and a useful live webchat service. You can also head over to Pensionwise, who offer face-to-face appointments if need be.