The pension changes that have just come into force have given many people over 55 a new option for paying off their debts, by taking money from their pension pot. I’ve looked at whether this is generally a good idea in Should you use your pension to pay your debts? but in this article I want to focus on people who are already in a Debt Management Plan (DMP).
This article is relevant for people who are over 55 (or approaching that age), who have a pension pot that they can access but have not yet bought an annuity.
A pension is safe in a DMP
A DMP is an informal arrangement between you and your creditors. There are no set rules and no concerns that your pension will have to be used to pay your creditors. Instead you have a new option – to use some or all of your pension to clear some or all of your debts.
Are your debts a long term problem?
Some DMPs are only expected to last a short while – until you find a new job, until your child care costs reduce etc. If this is the case for you, then you probably shouldn’t think of taking money from your pension. You are going to be retired for many years, don’t choose something which seems convenient now but which will reduce your income in retirement.
Is your DMP going well?
Are interest and charges frozen on all the debts? Are you paying a monthly amount that will see the DMP end in a few years? If the answers are YES and YES, then it would be foolish to disturb this good DMP – let it continue and keep your pension intact.
If some of your creditors haven’t frozen interest, there is more urgency in trying to deal with them. But read What can I do when a creditor keeps adding interest as there may be other ways of solving this problem!
Also check out how much tax you would have to pay if take money from your pension, see below – there is no point in reducing your interest costs but end up paying the taxman instead!
If your DMP however is going on for many years, or doesn’t seem likely to ever end, then you should look at ways to speed this up. Using some of your pension is one of these – it may seem like a great choice, letting the rest of your life carry on as it is and rescuing you from debt, but it has major disadvantages.
Four big disadvantages of using your pension
- You have to pay tax on the money you take out as though it is extra income – this may push you into a higher rate of tax so it may be a lot more than you are expecting, see the tables here.
- If you are getting any means-tested welfare benefits, then these may reduced if you take money from your pension to pay your debts, as this may be treated as “deprivation of capital”. This may sound bizarre but it is a real issue – if you are on benefits and you want to use your pension to repay debts then you need to take advice from Citizens Advice first, before you take the money from your pension.
- You are going to be retired for a long time. Don’t exchange a problem for a few years now for a shortage on income for decades when you retire.
- If you have a pension which is linked to your salary, to withdraw money from this you first have to convert it into a “defined contribution” pension. In doing this, you may get a very poor value for the conversion and you will be losing out on other future benefits such as inflation-linked rises in your pension and a pension for your wife or husband.
How to use your pension to clear debts in a DMP
If those four disadvantages don’t worry you (you aren’t on benefits, you are happy with the tax charge, your pension is large enough that you can “afford” to spend this money now) then you need to consider the practicalities of using your pension.
First talk to your pension provider about what your options are. Some may not let you move your pension into drawdown or withdraw part of your pension, – you may need to move your pension to a different provider. Find out what the costs are – some providers are charging per withdrawal, some limit the number of withdrawals you can make. Also find the timescales – from the moment you ask to withdraw some money, how long will it take?
Next would be a good time to talk to Pension Wise, the government service providing guidance on pensions – call 030 0330 1001. Even if you feel happy you know what you are doing, I really suggest having a phone interview with them. At Citizens Advice you could get face to face debt advice PLUS guidance on your pension.
If you have been on a DMP for a while your creditors may be happy to accept a Full and Final Settlement. The best way to propose one is probably to write to your creditors saying you are considering withdrawing money from your pension if they are prepared to accept £x,000 in full and final settlement of your debt. At this point you do not want to have withdrawn the money already – you will only do this for creditors that agree. Tell the creditor what the timescale will be if they accept your offer.
Other ways of speeding up your DMP
If those four disadvantages have put you off, what other alternatives do you have? Options to consider include:
- if you have a secure job with a stable income and you don’t expect any major changes in the next five years, consider an IVA – and read up about IVAs and pensions;
- if you have little spare income each month, you are renting and you owe less than £20,000 consider a Debt Relief Order – this could potentially be affected by your pension but Citizens Advice or National Debtline will be able to explain this;
- if you don’t qualify for a DRO, aren’t in a stable enough situation for an IVA, then look at bankruptcy. You may hate the idea, but look at the facts before dismissing it;
- selling your house.
None of those may appeal, but very long DMPs are not a great idea, even if your creditors are happy at the moment, the debts may be sold on to other creditors who go to court for CCJs etc.