Decisions around debt free retirement

Comment on pension freedom has focused on the potential for over 55s to blow their pension fund on a Lamborghini. For most people reaching retirement age a sports car will remain out of reach as research has shown that paying off debt will be a priority for many people considering retirement.

Key points


  • Most people reaching retirement are unlikely to afford the expense of a sports car.
  • Decisions around debt are complex especially for those lacking a good grasp of financial basics.
  • A decision to pay off debt will depend on each individual’s circumstances.



Figures from the Association of British Insurers show that in 2013 the mean annuity purchase price was £35,600. To put that into context, a 65-year-old man would be able to buy an annuity paying approximately £1,900 a year, but this does not include any provision for a spouse or inflation proofing. The median was only £20,000, which means half of those buying an annuity had less than this amount.

Research from the Prudential showed that one in six looking to retire in 2014 had debts, the main sources being credit cards (56 per cent), mortgage (44 per cent), overdrafts (19 per cent) and bank loans (14 per cent). On average the amount owed in 2014 was £20,700 (women) and £28,400 (men). If half of all people buying an annuity used less than £20,000 to do so, there are significant numbers each year retiring who owe more money than they have in their pension fund.

The decision on whether to pay off debt will vary according to circumstances. For mortgage holders with a tracker deal it may be advisable to leave their pension fund invested, if the payments can be made from alternative sources of income. A diversified portfolio of equities and bonds should reasonably be expected to provide growth in excess of the current base rate in most years, but this assumes some appetite for investment risk. The interest rate on credit card debt is typically in the region of 17 per cent which means paying off lump sums wherever possible will generally be preferable.

Decisions around debt are complex, in particular for those without a good grasp of financial basics. The Pension Wise service is unlikely to provide the level of detailed guidance required to help make these decisions and paid for financial advice is beyond the reach of this group. The FCA has attempted to ensure consumers receive risk warnings and tax information from pension providers before they access lump sums. Despite this, it will be worryingly easy for individuals to make poor decisions about their future income when faced with concerns about debt.

With average levels of indebtedness exceeding average pension funds, many pensioners may find themselves relying wholly on the state for their retirement income. Indeed, this has proved to be the case in Australia where the government is considering reintroducing restrictions on pension withdrawals after a report found half those retiring took money as a lump sum and a quarter of those had run out of money by age 70.

What are the implications of using a pension fund to pay off debt?

The government has not released any plans to limit access to means-tested benefits for those who have withdrawn all their pension savings. If the UK experience follows that of Australia, it seems likely the state will be forced to provide additional support to pensioners in poverty regardless of whether they have used their pension fund to buy a Lamborghini, pay off their mortgage or they just never had one in the first place.

While welfare payments for pensioners in the UK could not be described as generous, there is additional support available from the government for pensioners without the means to support themselves.

The basic state pension in 2014/15 is £113.10 a week and up to £167.40 from the additional state pension (previously known as SERPS or S2P) is also available. Not everyone will get the full amount as this is based on national insurance contributions or receiving credits for periods caring for others or ill health. In addition to this, those over the state pension age can claim means-tested benefits. The guaranteed element of the state pension credit provides a minimum income of £148.35 a week (single person) or £226.50 a week for a married couple. Savings credit can provide a further payment for those with income between £120.35 and £190 a week. Housing benefit is available to those in rented accommodation and anyone on a low income or receiving benefits can apply for a reduction in their council tax.

Any income received from pensions reduces eligibility for these means-tested benefits. Where pension pots have not been accessed, the higher of the actual income taken or 100 per cent of the income an equivalent annuity would offer, is used to calculate the notional income. This means a pension fund always forms part of the means-testing calculations.

The minimum income from the state is therefore guaranteed to be at least £148.35 a week. This represents a minimum ‘top up’ of £35.25 a week on the full basic state pension. Anyone claiming the guaranteed element is also likely to receive a discount on their council tax and may also receive housing benefit.

In order to generate additional income of £35.25 a week, a 65-year-old man would need a pension fund of around £32,000. If he wanted to inflation proof his additional £35.25 a week he would need his fund to be approximately £49,500.

For someone with credit card or other debt to pay off, it would seem a relatively straightforward choice to use their pension fund to reduce their liabilities by releasing their pension fund rather than purchasing an annuity and trying to pay off their liabilities from income.

Of course, state benefits are subject to change and it is a brave person that relies totally on the state’s provision. However, for many people faced with a lifetime’s accumulated debt, using their pension fund to pay this off is the most sensible approach.

Type of debt What should I do?
Mortgage Check the details of arrangement as it may be beneficial to retain low-interest rate deals. Early repayment penalties may apply in some cases.
Credit card High interest rates mean it is usually best to pay off credit card debts as quickly as possible.
Personal loan Interest rates for personal loans vary depending on the size of the loan, your credit rating and the term. Early repayment penalties may also apply.

The article first appeared in FT Adviser on 18 February 2015.