How to pay off debt as you approach retirement

As you approach retirement, it’s a common goal to be entirely debt-free.

It’s easy to accumulate debt throughout your working life. But, when you reach retirement, your income will likely fall. As a result, paying off debt while maintaining your current standard of living can become difficult.

Worryingly, this is a larger issue than you might think. A projection from later-life lender More2Life shows that over-55s will owe £236 billion in 2021, up from £226 billion in 2020.

Debt can put a strain on your entire financial situation in retirement if you don’t find strategies to resolve it.

That’s why it can be useful to try and pay off your debt as you approach retirement.

Get to know your debt

The first step to tackling debt is to get to know exactly what it is that you owe. So, ask yourself: what debt do you have?

This could be anything from small debts such as credit cards or an overdraft, all the way to larger debts such as a mortgage on your home or a bank loan for buying a car.

Work out exactly how much you owe and, if possible, how much the debts will cost you in interest moving forward.

That way, you’ll have an accurate figure in mind of what you need to resolve to be debt-free.

Strategies for clearing debt

Once you know how much you owe, you can start looking at methods that will allow you to clear your debts.

Here are just a few of the possible strategies you could employ for clearing debt before retirement.

Start early

Realistically, the sooner you start thinking about clearing your debt, the more time you’ll be able to give yourself to do it.

Try to start thinking about clearing your debt at least 10 years before your retirement. This provides a long enough time frame to find the right strategies and to put them in place.

Don’t worry if you’re nearly at retirement and you haven’t yet managed to do this, as there are still plenty of options for you.

Target high-interest loans

The first kind of debt you should look to eliminate is borrowing with the highest interest rates.

For example, credit card debt can quickly drag you down if you only make the minimum payment each month as the interest rates tend to be so high.

According to Moneyfacts, the average annual percentage rate (APR) for a credit card in March 2020 was 25.3%. Therefore, over time, a small amount on your credit card can rapidly grow in value, as you’re charged interest on top of your interest.

Even though your total borrowing on your mortgage may be a higher figure, the lower interest rate means it likely won’t accumulate as quickly as high-interest debt does.

Look to clear these high-interest loans first.

Use a pension lump sum to clear debt

One way to pay off debt could be to use part of your pension pot.

The Pension Freedoms legislation allows you to take 25% of your pension as a tax-free lump sum when you turn 55, rising to 57 in 2028.

As a result, you may be able to clear the entirety of your debt when you retire by taking this lump sum and using it to pay off your borrowing in one go.

While this will mean you’ll have less in your pot to live on throughout your retirement, this strategy ensures that you’ll be debt- and interest-free during your post-work life.

Of course, if you already intend to use your lump sum to finance a specific part of your retirement, such as travelling, this may not be the right method for you.

You also need to be careful not to land yourself with a tax bill by drawing more than the 25% lump sum.

Use your home

If you own your home by the time you retire, you could consider using the value tied up in it to clear your debts.

For example, you could use equity release to take out new borrowing on your home. This essentially means taking out a new mortgage, giving you a cash sum to pay off high-interest debt.

Alternatively, you may want to consider downsizing to a smaller property that costs less, using the difference in value to clear your debts.

Consider working during retirement

Another option is to continue working while in retirement.

Rather than retiring fully, you could reduce your hours at your current job or find a part-time role to provide extra income for paying off your debts.

This can be a good idea if you’d prefer not to use your home or your pension to become debt-free.

Make sure you check your tax situation before you do this because if you’re drawing your pension and receiving a paid income, you may end up paying more Income Tax than you intend. It could also affect the amount you can contribute tax-efficiently to your pension.

Work with a financial planner

The very best thing you can do for yourself if you’re looking to clear your debt at retirement is to work with an expert, such as a financial planner.

Financial planners can look at the entirety of your financial situation, including your retirement goals. They can then design a plan for clearing debt that makes sure you’re still able to live the kind of life you want.

It may seem strange to pay for advice when you’re already in debt. But actually, having a professional in your corner can be far more cost-effective in the long run than trying to do it all on your own.

The government also provides impartial and free advice on addressing debt. You can find out more by visiting the StepChange or the Money Advice website.

Work with us

If you’d like advice on your debt from a professional financial planner, please contact us at Britannic Place.

Email info@britannicplace.co.uk or call 01905 419890 to find out more about how we could help you.

Please note

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.

Equity Release will reduce the value of your estate and can affect your eligibility for means-tested benefits.

Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.

Buy-to-let (pure) and commercial mortgages are not regulated by the FCA.

Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage.

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.