How to clear your debts

Harvey Jones / 18 September 2020

Read our guide to paying off your debt in retirement, and how to avoid costly mistakes.



Retirement is supposed to be the time when you finally kick back and enjoy yourself, but you won't enjoy total peace of mind if you have mortgage, credit cards, loans or other debts, and don’t know how to pay them off.

This is a problem facing a growing number of retirees, as divorce, illness, unemployment, and underperforming mortgage endowments destroy even the best-laid retirement plans.

There are a number of ways you could clear your debt.

Options include working on into retirement to raise additional income, consolidating debts on a low interest rate, tapping into savings and pensions, or raising money against the value of your home.

Which option works best for you depends on your personal situation, such as your age, whether you are a homeowner, and how much you owe. Here are some of your options.

Pay the most expensive debt first

Start by writing down everything you owe. This may be painful, but should focus the mind.

Then prioritise paying down the debt charging the highest rate of interest, while making sure you make at least the minimum payment on your other borrowings, to avoid penalties and protect your credit score.

Short-term borrowings such as overdrafts, credit cards or store cards tend to charge the most, with a mortgage the cheapest form of debt.

Once you have paid off the costliest debt, move onto the next most expensive, then the next, a process known as snowballing.

You could switch your credit card balance to a balance transfer card charging 0% for an introductory period, or consolidate debts with a personal loan. Lenders will carry out credit checks, to check your eligibility and decide what rate to charge.

Examine your monthly outgoings and look for savings, for example, switching utility supplier, car insurer, broadband and telephone provider could free up hundreds of pounds a year. Visit two or three comparison sites, to see if you are getting a good deal.

Then use any money you save to pay down that debt faster.

There is no point leaving money in a savings account paying little or no while incurring a far higher APR on debt. Consider using savings to pay money down, but always leave some cash on instant access, for emergencies.

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Boosting your income

As well as cutting back on spending, you could try to bring extra income in. More than a million people now carry on working beyond age 65, and the numbers are rising all the time.

You could continue in your own job, if you wish, or find work elsewhere, possibly part-time, assuming your health is good enough. You should also check you are claiming all your state benefits, such as pension credit.

Draw your pension

Let’s be clear, money set aside for your retirement is supposed to be just that – funds to keep you on the right side of the bread line when you are no longer working. That said, if you have urgent needs for cash, such as clearing debt, dipping into your pension may work.

The over 55s can take advantage of pension freedom reforms introduced in April 2015, and unlock money to pay off the debt.

You can draw money from personal pensions and the most common type of workplace scheme, known as money-purchase pensions or defined contribution schemes.

Just remember, this will erode the sums available when you retire.

You also have to remember that pension withdrawals are taxable. They are added to your total earnings for that year, and subject to income tax at either 20, 40 or 45 per cent.

If you are normally a 20 per cent taxpayer, but withdrawals push you into the 40 per cent tax bracket, then a fat chunk of your money will go straight to HM Revenue & Customs.

Pension withdrawals therefore do not work as well if you are already earning a taxable income.

You can potentially get round this by making a series of smaller withdrawals, spread over several years.

Or use you 25% tax-free pension lump sum, and leave the rest of your fund invested. With luck, this could go some way towards clearing your debt.

Final salary pension transfer

You may also be able to transfer money out of a final salary workplace pension, although this is more complicated and you need to tread carefully.

You will give up valuable benefits if you do this, such as index-linked retirement income for life. City regulator the Financial Conduct Authority has stated that most people should stay in their scheme, but if your debts are a worry, a fund transfer could clear them.

You will have to take independent financial advice for transfers worth more than £30,000.

Public sector workers in so-called unfunded final salary schemes, including NHS staff, teachers, armed forces, civil servants, the police and firefighters, are banned from transferring money out.

As with all pension transfers, beware unscrupulous salesmen trying to profit at your expense, and scams designed to rob you of your life savings.

Downsizing

If you are a homeowner, then another option is to downsize to a smaller property to raise money to pay off your debt.

This works best if selling a large family home in a desirable area, and buying something smaller where prices are cheaper.

Do your sums carefully, because the costs of downsizing will eat into your savings. These include estate agency fees when you sell, stamp duty when you buy, plus legal costs, removal fees, and the expense of doing up your new place.

You may get less for your home then you expect, while a new property may cost more, as bungalows and retirement flats are in high demand.

Plus of course most people like to stay in their old home, along with all their memories.

Equity release

Growing numbers of older homeowners are paying off their debts by taking out an equity release scheme.

An equity release lifetime mortgage allows you to unlock the spare equity sitting in your home free of tax, and turn it into ready cash.

The interest on the money you borrow rolls up over the years, and is cleared, along with the original capital, from the proceeds of your house sale, when you and any partner either die, or to care.

Reputable scheme providers offer a no-negative equity guarantee, which means you or your family will never own more than the market value of your home.

Equity release is a complicated decision, as it will reduce the size of any inheritance, so remember to involve your family.

Take independent financial advice from a specialist equity release adviser, and talk to an independent solicitor.

A good advisor should be able to discuss other options, such as retirement interest-only mortgages, a new product that is a halfway house between a standard mortgage, and equity release.

Is Equity Release right for you? Find out more here


Seek debt help

If your debts are out of hand, seek professional help, while avoiding commercial companies that will profit from your misfortune.

Finally, seek free professional help, either from the Money and Pensions Service (MaPS), Pensionwise, Citizens Advice, StepChange or National Debtline, while shunning those who charge fees.

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The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.