Should I use pension drawdown to pay off debt?

Albermarle

So I guess it largely comes down to the OP's job security .

Malthusian

Brie said:

I found out when I considered taking a portion of a DC pension for a previous employer that this would adversely affect my current pension in that I would have a much lower tax threshold for current contributions. 

How large a portion? That would be the "money purchase annual allowance", and it only applies if you take taxable income flexibly from a pension. It does not apply if you only take the 25% tax free lump sum. And the OP's tax free lump sum would cover the £85k debt.

Thrugelmir

Albermarle said:

So I guess it largely comes down to the OP's job security .

People rarely spend enough time considering the downsides or negatives. Far too easy to assume green pastures lie ahead. When change comes, it's often swift, brutal and unexpected. As it will most likely be triggered by a yet unforeseen event. 

pensionpawn

Have you considered what sort of retirement income you need / want, and by when, as that is determined by the size pot you require. That's your starting place. Then, can you take the TFLS and replenish your pot to the required level in your original time-frame. Of course, by paying off debt you will have freed up income to re-invest, however be cautious of the recycling rules. Alternatively can you remortgage and consolidate the debt at never to be seen again rates?

jamesd

You should start thinking about retirement and whether you want to retire now. That's because net of debt assets of £300k-500k are enough for quite a comfortable retirement.

If your retirement plan needs more money then it's likely to be better to keep most of the debt.

There is a need to be comfortable that you can refinance or repay the debt. The loans are presumably on repayment basis and presumably easy enough because you're just repaying them each month anyway,

The cards require more managing, including being confident that you can rapidly repay any balances if you can't get new deals. So long as you can then all's fairly good on that front as well.

There are some potentially interesting niches to explore and use though. You can take up to 25% of any portion of a pot and place the remaining 75% into flexi-access drawdown. There are constraints on recycling tax free lump sums into new pension contributions but £7,500 per rolling twelve month period (not year or tax year)  is within those. You'll probably need to move the money to another scheme to do this.

Similarly, if reducing debt will let you increase your gross pension contributions by a similar amount then you can potentially benefit from this repeated tax break.

There's a card trick worth knowing about. Minimum payments often reduce balances at low rates. If you spend enough on the card so that the purchases are what the payments cover then you maintain a higher discounted balance. You'll pay interest between purchase and payment but this is often cheaper than letting a large deal gradually vanish and paying a fee for a whole new deal. It's also always available even if there are no offers on the card.

How's your pension contribution situation? If you're compelled to limit contributions, together with tax relief and matching employer contributions, then taking that 7.5k a year is likely to be a good move so you can replace it partly with tax relief and employer money.

I've already retired and have card debt that's similar to my mortgage amount. I could repay it in a few days but I don't because I like the borrowing and investing at the same time as I am. That's me but maybe not you.

AHack16

Thanks so much everyone for your consideration and insights.

And apols for leaving out some crucial information (not meaning to drip feed..) that we're not consistently able to service the debt each month at the moment as my partner works freelance and her income has not been reliable recently.  We also need to start paying university costs from Oct this year..  . We currently relatively often have to meet a monthly short-fall of between £1000 and £1500 by drawing down on an ISA we set up using a windfall last year (approx £7500 left in ISA now).  The monthly cost of servicing the debt is close to £1400 per month so with some belt-tightening we will be able to stay within household budget if we drawdown on my pension to pay off outstanding debt. 

I've no plans to retire anytime soon - although take the point that can't be complacent on job security.  I plan to continue to contribute to my pension at the same rate as now.

I'm normally pretty comfortable with risk and investment fluctuations and my pension has been growing at a better rate than the 3 - 4 % cost of the debt, BUT I have recently found myself more anxious about the debt and wanting to be free of it... 

I think I'm minded to go ahead with gradually drawing down my pension to pay off the debt and my main remaining worry is that since starting looking into the options I've been a little concerned reading headlines about people losing £000s by making wrong decisions re: taking 25% tax free too soon / in wrong way but never really understood how this could happen (but think must just be referring to lost investment income, and lost tax advantages if I drawdown now)?

jamesd said:.

There are some potentially interesting niches to explore and use though. You can take up to 25% of any portion of a pot and place the remaining 75% into flexi-access drawdown. There are constraints on recycling tax free lump sums into new pension contributions but £7,500 per rolling twelve month period (not year or tax year)  is within those. You'll probably need to move the money to another scheme to do this.

Similarly, if reducing debt will let you increase your gross pension contributions by a similar amount then you can potentially benefit from this repeated tax break.

There's a card trick worth knowing about. Minimum payments often reduce balances at low rates. If you spend enough on the card so that the purchases are what the payments cover then you maintain a higher discounted balance. You'll pay interest between purchase and payment but this is often cheaper than letting a large deal gradually vanish and paying a fee for a whole new deal. It's also always available even if there are no offers on the card.

How's your pension contribution situation? If you're compelled to limit contributions, together with tax relief and matching employer contributions, then taking that 7.5k a year is likely to be a good move so you can replace it partly with tax relief and employer money.

I've already retired and have card debt that's similar to my mortgage amount. I could repay it in a few days but I don't because I like the borrowing and investing at the same time as I am. That's me but maybe not you.

Finally, sorry to be slow @jamesd but can you spell out above on potential tax break?  
  

Thanks again all

 

jamesd

The tax break is having at least 25% added to your pension contributions to give you the 20% basic rate tax relief. If taking 25% tax free from some of the pension pot will let you make new pension contributions to replace it then you could soon end up with more money than you started with.

What's your approximate income? I'm asking in part because as well as taking 25% tax free you're also allowed three times in your life to take all of a pot worth up to 10k with 25% of that tax free and 75% taxable. You're allowed to transfer to create these pots so depending on income it might be desirable to do one per tax year so that you're taking out some of the taxable money as well as some of the tax free. So knowing your current taxable income situation is relevant to avoid big tax mistakes, like potentially going over100k income and losing part or all of your income tax personal allowance. If you had none of the debt how much do you think you could make in net pension contributions now and with future university costs?

Do you have a mortgage? What term and mandatory minimum monthly repayment? I'm asking this because a longer term can be sensible sometimes to reduce near term financial stress and enable higher pension investing later.

Since you're having trouble servicing the debt then use of pension money seems sensible to get it to the point where it's manageable. But it's good to have a proper plan for what to do and when, and to do that can you please list for each debt the amount owed and the minimum monthly payment in Pounds as well as percentage as well as the deal expiration date and terms for cards and the loan end dates?

With the extra information it should be possible to target the areas that are most financially problematic or potentially becoming so, like say a big card deal ending from an issuer that's inclined to give nice balance transfer deals - an invitation to clear that deal soon to get a replacement deal that can tackle a different card. Loan monthly repayments might or might not be more problematic than cards, it depends on the percentage of the balance that is being paid each month and there's considerable variation in that for different card issuers and loan terms. Of course no replacement deals for loans, except tat cards sometimes do nice money transfer deals that can be used to repay loans and that deal could extend the term of borrowing and reduce near term risk of high borrowing costs..

Discussions relating to taking the 25% being a bad idea tends to be around two main assumptions:

1. that the money is being used for new spending
2. that it won't be replaced

In your situation 1 isn't true and 2 doesn't have to be true. Assisting with debt that has become troublesome is one of the appropriate uses.

There's also a potential issue with taking lump sums. Taking lump sums in the form of UFPLS or taking taxable money from the 75% that's placed in a flexi-access drawdown account when you take the 25% alone is classed as flexibly accessing the money and triggers something called the money purchase annual allowance. That limits your future pension contributions to no more than 4k a year. For someone with considerably higher pension contribution potential than that it's a substantial mistake. Taking the tax free 25% or using the small pot rule doesn't trigger the MPAA.

Sea_Shell

Have you identified the reason for the debt?   Was it for large one offs (like a car), or has it just crept up, on overspends over the years?


Have you now put a budget in place so that you won't get back into debt once you've cleared it?

The problem with using "future" money now, to pay it off, is all very well, as long as you've put a sustainable spending plan in place.   Both for your day-to-day spends, the big ticket items AND keep paying into your pension.

The worst possible place you could end up in is £85k (plus growth) short on your pension, with another £XXk of debt in 10 years time.

GibbsRule_No3.

Could you consider a DMP?

A good number of years ago I was merrily taking out £10,000 loans, paying them back, while accumulating more debt just thinking it was going to be fine because I was nearing pension age (luckily for me at the time I did not know that I could of accessed the pension at 55 or I might have been tempted) and I knew I had a nice lump sum coming my way to pay off the final loan. Then, bang, my application for the next £10,000 was turned down, bit of a financial shock.  Now I look back and it was the best thing that could of happened.  I did a DMP, lived within my means for five years and then the untouched private pensions kicked in. Allowing me to reduce my work hours in the run up to State Pension. Just make sure the DMP is set at a decent amount, don’t stint to payoff quicker, five to ten years is a long time to live a really frugal life after one of pleasure. I started to enjoy work/leisure balance, moved to my final retirement home, renting, so I will always need a fixed amount of yearly money. Continued to work after SP mainly due to Covid and not being able to travel as I wanted to do in retirement, so building up a little pot for when that does happen.

My retirement income is not far off my working income by not touching the pension early.  Unless you can trust yourself not to get into debt again, I would not touch the pension but find a different way to settle it.

jamesd

AHack16 a leading reason why bankruptcy and debt management plan (DMP) will have been mentioned is that your pension won't be touched. Your house isn't immune from bankruptcy, though. In your case it looks as though you can get more flexibility than a DMP given your circumstances.

Note that once you've taken the 25% tax free from a pension pot the 75% is then exposed to both bankruptcy and DMP as well as benefit means tests because it's then classed as accessible capital.