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Should I Use My Pension Contributions To Repay High Interest Debts?

by on November 6, 2012

in Debt Help

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Pensions are designed as savings for the retirement years but many UK residents are finding it difficult to maintain them. High interest debts like payday loans can become substantial if unpaid for a long period.

Pensions are no longer viewed as the savings of the future. Early this year, the Association of British Insurers announced that pensions are not the answer for everyone.

ABI chief Otto Thorensen even admitted that repaying student debts with pension savings was a smart idea.

Auto enrollment is not appropriate for many modern-day workers, millions of whom earn low wages. Until pensions are redesigned to make them suitable, these workers must opt out of pension savings. Though there is general agreement that increasing savings is a good idea, pensions present disadvantages for some workers. Young people, workers who are in substantial debt, people saving for a home, and older workers with low wages may have savings or debt repayment goals that they cannot meet. Their money is locked in pension scheme contributions and cannot be accessed until many years from now.

On the other hand, when workers do not make pension fund contributions, neither do their employers. Current policy does not require employers to contribute to other types of savings used by workers. Therefore, if a worker uses income to repay high interest debts, the value of this money is reduced because the employer does not contribute and tax relief is typically not provided. On the other hand, the individual saves money through reduced interest accumulations.

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Rather than leaving a pension scheme entirely, workers can put pension contributions on hold. According to research conducted by Prudential in 2011, 35 percent of British adult workers stopped their pension scheme payment, 27 percent doing so because they could no longer afford these contributions. More than two-fifths of those who ceased payments reported that they did not plan to resume them, despite the retirement income impact. Missing just one year of gross contributions totaling £2,400 can result in a £7,000 reduction in the final pension fund.

Abandoning a pension should be viewed as a last resort for debt repayment. People facing serious debt should compare the loss of total savings to the interest and other charges that would accrue on their unpaid debt. If interest and fees during the expected repayment period exceed total savings lost by suspending pension contributions, then the money should be used to repay debts.

Only approximately one-fifth of the people responding to the Prudential survey reported being on track financially for retirement. Since they are already off their initial plan, suspending pension contributions to repay debts will not be as difficult for them to handle. They can resume contributions once they have repaid their debts and they may even explore other savings methods.

With 16 percent of survey respondents choosing not to focus on post-work finances, suspending pension contributions to repay debts may not be shocking for them. Repaying high-interest debts gets finances under control during the working years. This makes it more comfortable for people to live within their means.


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