“Should I use my pension to clear my debt at age 60?”
A reader wants to pay off her credit cards, but it may be short-sighted to withdraw cash from her pension.
I am nearly 60 years old and have £5,000 of credit card debt, but only have £2,000 in a Cash Isa to pay towards this.
In the early 1990s, I contracted out of Serps and paid into a private pension scheme with Zurich instead. There is £12,220 in the plan after I took a 25% tax-free lump sum in May 2016. Should I cash in the pension to clear my debt?
If I don’t, should I leave it in the Zurich Managed AP fund or transfer it to a self-invested personal pension (Sipp)?
I’m also paying into my company pension and have a buy-to-let property.
“There are two financial planning priorities to deal with here,” says Nathan Long, senior pension analyst at Hargreaves Lansdown. “One is to pay your credit card bills and the second is to save for your retirement.” He stresses that how you clear your debts could have a significant impact on your retirement savings.
Pension health check
Clearing your debts with your pension is an easy option, but weigh up the ramifications. The pension is in flexi-access drawdown and, as you’ve already taken the 25% tax-free lump sum, the remainder would be taxed as income when withdrawn.
Michael Owen, director, financial planning at Brooks Macdonald Financial Consulting, explains: “Withdrawing the remaining fund as a single payment would add £12,220 to your taxable income for this tax year and be subject to tax at your marginal rate.”
If you’re a basic-rate taxpayer at 20%, withdrawing the full pot would mean you would get 80% of the pension pot – £9,776. But if you’re a higher-rate taxpayer taxed at 40%, you’d receive £7,320.
Emergency tax treatment
“If your pension is taxed under the emergency tax code, HMRC will think you will receive £12,220 every month for the remainder of the tax year and deduct the tax based on this assumed higher amount,” warns Mr Owen. “This will see more tax deducted than you need to pay.”
If this happens, you can claim it back using a form P55 from HMRC or through your tax return. But it could take months to get a tax rebate.
Taking cash out of this pension could affect saving into other schemes.
Mr Long explains: “Accessing the remainder of your Zurich pension will trigger the money purchase annual allowance, limiting future pension contributions to £4,000 a year. This could cause problems for your company pension.”
The minimum workplace pension contributions are rising from 2% to 5% in April 2018 and to 8% in 2019. So it is important to assess whether the £4,000 allowance would be enough to cover future pension contributions.
Debt pain relief
Ian Price, divisional director, retirement proposition at St James’s Place, says: ”Accessing the £2,000 available in your Cash Isa would improve your net financial position.”
This would leave a shortfall of £3,000 credit card debt, for which Mr Price suggests finding a new home.
“It’s worth exploring balance transfer deals to reduce the interest you’ll pay on the outstanding balance,” he says.
Another option is to take out a mortgage or increase borrowing on your rental property.
Mr Owen says: “This may be possible, but you will be swapping one type of debt for another.”
Your company pension scheme could provide a debt clearing option.
Mr Long explains: “Drawing just the tax-free lump sum means you don’t need to pay any additional tax and you avoid triggering the money purchase annual allowance – but not all schemes offer this flexibility.”
If you leave your £12,220 pension where it is, consider your investment strategy. “Think about when you may retire and how you might draw your pension as these factors will influence your investment choices,” says Mr Long. “If you’re planning to remain invested while drawing an income from your pension, gradually move into funds that you’d be happy to use in retirement. If you intend to buy an annuity, look for a fund that invests in gilts and bonds to shelter you from any stock market turbulence.”
To weigh up your options, ask for details of the annuity from Zurich and your company scheme, including any enhanced rate you might get.
Mr Owen says your Zurich scheme offers you the flexibility you need.
“With a pension pot of £12,220, the costs of a Sipp would outweigh the advantages of transferring.”