Business Personal Finance

Monday 22 October 2018

Act now to boost your chances of enjoying debt-free retirement

Without planning ahead or rightsizing, many future retirees may face a battle to clear long-term mortages as income drops, writes John Cradden

Benedict Cumberbatch as Hamlet – Polonius may have exhorted the prince to ‘Neither a borrower nor a lender be’, but the rest of us will have had to deal with debt at some stage. Photo: Johan Persson
Benedict Cumberbatch as Hamlet – Polonius may have exhorted the prince to ‘Neither a borrower nor a lender be’, but the rest of us will have had to deal with debt at some stage. Photo: Johan Persson

John Cradden

Over the last 20-odd years it's fair to say that we have become more comfortable in accumulating and dealing with higher volumes of personal debt, such as through mortgages, loans and credit cards.

However, it's also fair to say this is often due to necessity rather than choice thanks to ever-rising house prices, cost of living increases, and losses (or poorer returns) on investments and savings.

But what about debt in retirement? Naturally, most of us would probably hope to enjoy a 'burden-free' retirement, particularly with the prospect of much-reduced incomes once you stop working.

However, a survey published last year by life assurance company Friends First revealed that just 56pc of respondents were confident that they would be mortgage-free when they retire.

Around 9pc felt it would take up to five years after retirement to clear their debt, with another 5pc believing it would take longer. Another 13pc of respondents felt they would still be renting and 17pc didn't know.

According to the firm's pensions and investments director, Simon Hoffman, this annual survey normally focuses mainly on pensions coverage and habits, but "we are interested in whether the ideal carefree retirement where you are debt and dependant-free was realistic, and so we ask additional questions every so often".

While the 56pc figure may have surprised a few, the reality is that many traditional key life stages are occurring much later for today's generation than they did for previous ones, such as the average age we now end our education, establish careers, find partners, have children and buy houses.

The mortgage issue exacerbates this further as, in the arms race between competing bidders of property, one of the weapons that is being used to make repayments manageable is increasing mortgage terms, said Hoffman.

"So the current generation of borrowers are taking out mortgages later than their parents, and taking them out for longer terms. This has a double whammy effect on the age when they become mortgage-free."

Furthermore, there may be other financial priorities right up to your early 60s that could push retirement savings further down the pecking order, such as providing for your children's college education or formal training, or weddings and other big celebrations.

"Compounding returns is a long-term investment's best friend, so the later we start the harder it is to accumulate sufficient pension funds," said Hoffman.

"Add to this the well-documented demographic issues around us living longer, and the consequential increase in the cost of retirement provision, it does look like the perfect storm is brewing."

Eoin McGee of Prosperous Financial said that many new or recent retirees may have found themselves unexpectedly in debt thanks to being forced to extend debt repayments due to hard times, "but for others it was always going to be this way and they possibly didn't think of the reduction in salary in retirement".

And there are always those who are possibly over-confident and perceive that things will sort themselves out in the distant future, he added.

Breaking the cycle

Unfortunately, there is no easy answer to dealing with debt in retirement, particularly if you don't plan ahead.

"You are on the back foot and your ability to get bonuses, pay-rises or other work-related windfalls is gone," said McGee. "This is as good as it gets financially. Unless you can break the cycle it could be very hard."

If you can't break the cycle and your private pension coverage proves inadequate, your capacity to upgrade your car or maintain your health insurance cover may be hampered.

"What was known as VHI's Plan B Options costs around €2,500 per adult, per year," said Bob Quinn of Kildare-based The Money Advisors.

"This is a colossal figure for anyone reliant on a State pension. We have also seen a significant rise in PCP car finance and people are learning fast about the pitfalls of easy and cheap finance."

There is likely to be a growing band of future retirees who intend to be renters when they retire, which may add to your income problems unless you've been putting enough into your retirement savings.

"With buying property becoming unrealistic for many people, especially in cities, they need to consider how they will be able to afford to rent when they are retired," said Jerry Moriarty, CEO of the Irish Association of Pension Funds. "It is crucial that people consider these issues early. "

Some mortgage application stress tests may well take into account pension contributions, but in retirement many underwriters will deem 35pc of your net disposable income as the absolute limit of your debt level, according to Quinn.

"This figure should also incorporate any necessary savings, such as a down payment for a new car in due course and an assumption that interest rates on debts will increase in time. If these rules are not adhered to, debt will remain a constant feature of retirement."

If your only income in retirement is the state pension, a debt level of 35pc of your net disposable income will be somewhere in the region of €300 per month. "The smaller the income in retirement, the more of a disproportionate impact this will have on your overall quality of life," said Quinn.

Options

But even if you have a reasonable private pension fund, there are still options if you are still grappling with a significant debt when you retire.

"For some reason it's a very unpopular one, but more retirees should give serious consideration to rightsizing," said Quinn.

"We all know the cost and energy required with maintaining homes that are essentially under-occupied.

"Given the general positive moves in the Irish property market in more recent times, it may be a timely move and will release cash from the sale. This should give retirees the ability to clear any debts at this point in their lives."

If you still have a whole-of-life insurance policy that covers you indefinitely if you die unexpectedly, it may well have an inherent value that can be cashed in, said Quinn. "These policies can be easily reviewed and may serve this purpose very well.

"We are also seeing some family members buying a bigger slice of inheritance by bankrolling their parents. The deal is simply - the child gives X-amount now, and in return the size of their inheritance (value from the house, etc) increases on death."

McGee says using the tax-free cash from your pension when you start retirement can clear down any outstanding debt.

"You effectively will have used before-tax income instead of after-tax income to pay off your debt. But if you need the money for the cruise you promised your partner, or the trip to see the kids who emigrated to Canada during the crash, then it can feel pretty sore using the tax-free cash to just clear debt," he said.

Hoffman says more of us will continue to work beyond the official retirement age if we are still able and willing, "and in much the same way as people are changing jobs and careers more frequently in early life".

"There will be less sudden retirement and more gliding into retirement where older workers might reduce the hours they work rather than stop," he said, adding that the rules around State and private pension should eventually evolve to allow a small amount of benefits being taken at conventional retirement ages to supplement ongoing earned income, in exchange for increased benefits on the amounts deferred.

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