Oct 13, 2020
Paying Off Debts With Your Pension
This is a common request we have from people. But how do you do it and should you do it?
Pensions are more flexible than ever and you now have access from the age of 55 to be able to take income or lump sums from them at any point.
But you should be careful of tax and also how taking a lump sum then impacts on your pension (and therefore your retirement).
I remember back when pensions freedom first started that the regulator was worried that people would start raiding there pensions to go out and buy a Ferrari and be left with nothing to live on in retirement!
This didn’t really happen. But what did was that people started using their pension to make more positive impacts on their life ‘before’ retirement. And paying off debts is potentially one way.
Lets deal with tax first.
With most pensions 25% of its value is tax free. So you can take that out without paying any tax on the money.
The remaining 75% of the fund value is taxable as income tax. So any withdrawal you make over a tax year is added onto of any other income you have and then taxed at the marginal rates.
So say for example you are a basic rate tax payer and you take a lump sum. Providing you don’t go into the higher rate tax threshold then you will pay 20% tax on the withdrawal.
If you do go into the higher rate tax band. Then you will pay 20% up to the start of the higher rate tax band and then 40% for the amount in the higher rate tax band.
It is possible to take money from the pension with no tax providing you have enough personal allowance to do this.
But should you do it?
There are a couple things to consider here.
What positive impact will it have on your life? This usually means by paying off the debts you no longer have to make the monthly repayments.
If you are in the situation where you are struggling to make the monthly debt repayments, or the interest rate you are paying is very high and by paying it off it would make financial sense, then it is something to potentially consider.
The potential drawback is that by withdrawing the lump sum, you are reducing the size of your pension.
What impact does this have on the retirement income you need?
Do you still have enough to live on?
Ultimately these answers would be very personal to an individual’s circumstances and I would recommend you seek advice to not only help you understand the right answer, but also to help you find the right drawdown provider to be able to do this.
If you would like to talk to us more about this click here