More and more people are retiring with debts.

A Prudential study found that one in five UK citizens is expected to retire with an average debt of £33,900. Additionally, new research from more 2 life has revealed that unsecured debt amongst 55 to 74-year-olds rose by a third over the last four years – more than twice the national average.

And, research from L&C Mortgages has found that one in five retirees will still be paying back their mortgage after they stop work – equal to around three million people.

Being in debt at retirement can have an impact on your standard of living. It may reduce your disposable income if you have to continue to make payments to a mortgage, loan or credit cards. You could even end up with insufficient income in retirement.

Since new Pension Freedoms came into force in 2015, many people have chosen to use their tax-free cash to repay debts. But, is this a good idea? We look at the pros and cons.

Should I use my tax-free cash to repay debt?

If you’re thinking of using your tax-free pension cash to pay off debts, then you’re not alone. A new survey from Portafina has revealed that paying off debt is the most popular reason for retirees to take a lump sum when they stop working.

More than a third of people seeking advice on taking a tax-free lump sum were doing so to tackle ongoing debt, and over-55s took an average of £18,110 as a lump sum.

Considering that more and more people are entering retirement with debts, using your lump sum to repay debts might seem like a no-brainer. And, there are several situations where taking a tax-free lump sum to repay debts may be beneficial, including:

• If you are paying a high interest rate on your borrowing. If you’re paying 15-20% or more on a credit card or loan, it may make financial sense to clear these debts to avoid high interest repayments.
• If you are struggling to maintain repayments to your debt. For example, if you are in an IVA, then seeking agreement to settle it early with a lump sum may be a reason to use your pension cash.
• If you are in other forms of debt management and you want to propose a final settlement to your creditor(s).
• If you have an interest-only mortgage with no repayment vehicle. Repaying this debt may help you to remain in your home, although other options such as a remortgage or equity release may be more appropriate. Seek professional advice.
• If you have a secured loan. Again, failing to maintain your repayments may put your home at risk and you will likely want to avoid this.
• If you have other pensions which will provide you with the income you need in retirement (for example, a Defined Contribution (final salary) pension). You may, therefore, prefer to take a tax-free lump sum to clear debts, safe in the knowledge that your other pensions will provide the income you need.
• If your debts are causing you stress and worry. Some people find that repaying debts, reduce their stress level and helps them to sleep better at night. If your debts are causing you ill health, repaying them might mean that you enjoy your retirement more – even if your income is reduced.

Disadvantages of using your tax-free cash to pay debts

While there are some situations where using a pension lump sum to repay debts can be suitable, there are various issues to bear in mind.

• If you’ve already taken a 25% tax-free lump sum, then taking any further cash as a lump sum would be taxed as income when you withdraw it. It could even push you into a higher tax bracket and you could end up paying much more tax than you expected.
• Taking money from your pension now will reduce the amount you have available in later years. It may have the effect of reducing your income or, in the worst-case scenario, you could run out of money as you get older. Not only that, but taking a lump sum from your pension means that it’s no longer invested, and you will miss out on any potential investment returns it would have made had you left it untouched. You’ll also lose the tax advantages of leaving your pension invested.
• Taking money from your pension fund can affect the formal options for dealing with your debts if they become a significant issue.

There may be other options available to you for dealing with your debts. For example, if you have a balance on a high-interest credit card, it may be more beneficial to transfer your balance to a 0% deal with another card provider. This will give you the opportunity to repay these debts without paying significant interest, leaving your pension fund intact.

Switching your mortgage could also help you to reduce the repayments on your debt. A remortgage may let you take advantage of reduced repayments while equity release might free up capital from your home to allow you to repay what you owe.

Alternatively, it may be better for you to use any non-pension savings or investments to repay debts. For example, if you have money in a cash ISA then it may well be earning a lower return than the interest rate you are paying on a credit card or personal loan. Here, it can make financial sense to use your savings to repay debts and leave your pension pot intact.

If you’re one of the increasing number of people who are taking debts into retirement, we can help. Whether you need advice on the best ways to clear your debts before you retire, or you’re approaching retirement and you’re not sure how to deal with your debts, get in touch. Email enquiries@boolers.co.uk or call 0116 240 7070.