Good debt and bad debt for your retirement and Age Pension

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From the point of view of retirement, reliable income, and Age Pension there are really 3 types of debts that we need to discuss:  

1. Personal loans & credit cards 
2. Home-loans – mortgage against your family home
3. Investment loans – loans against the investment property or another type of investment scheme 

Very rarely I would say that having a loan during retirement is a good idea. At the end of the day, the repayments will be reducing your cashflow, therefore your income might not be as reliable and consistent as you would like to. But let’s go over those different types of loans one by one to understand the difference and why some might still be a good idea.  

“The best thing that money can buy is FREEDOM from worrying about money”
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There is so much truth in that little quote and a good retirement plan should provide you with just that: Freedom from money worries, certainty and clarity as to your income level and lifestyle and how long your money will last.  

And today’s chat is about loans before or during retirement and whether you should or shouldn’t keep it. 

1. Personal loan & credit cards

This is the most unaffordable type of the loan one can imagine, therefore if you cannot repay it by due dates, remove them altogether. Credit cards are great for convenience, for degree of security as you don’t have to carry cash in your wallet and for collecting additional benefits such as flight points or other benefits provided by the card company.  

But be sure to utilize those benefits, as at the end of the day you still pay for them. The bigger the member benefit, the higher the annual fee, so nothing is for free.  

But you have to be able to pay off the outstanding balance monthly, and I don’t mean the minimum amount listed on your statement, but rather the full balance you spent over the previous month. 

So if you don’t have sufficient cash balance of income to cover such a bill, do not use credit cards, as this will become a huge trap for you with the highest interest rate payable out of any types of loans.  

Personal loans – they are really not recommended to be used during retirement. They tend to be for such purchases as buying a car, or store loan to buy furniture for home, or a holiday.  

For example buy a new car of $30,000 value with the full purchase price as a 5 year loan at 8.5% (which could be much higher for retirees, as you have no employment income), will cost over that  period of 5 years $36,849, but after 5 years that car will be worth $12,000 based on average car depreciation.  

So in retirement, please stick to the purchases you can afford to buy for cash and not through borrowings with high interest. And most certainly, don’t go into loans to buy depreciating assets.  

What’s worse, from Age Pension point of view, Centrelink will count your new car as your asset and will totally disregard your loan, so this is a double negative for your Age Pension outcome. 

2. Home loan – mortgage against your family home. 

Please try to repay your home loan before your retire. If you have any loan outstanding, but you keep funds in the bank account, the balance of your cash will be counted under Income and Assets Test while the loan will be disregarded.  

The same will apply if you keep funds in the offset account. As those funds are accessible for you, Centrelink will calculate it as your asset and reduce your Age Pension payments accordingly.  

If you have an investment property, never ever secure it against your family home. Why? well the value of the property will be counted under Assets Test, but the value of the mortgage will be disregarded, so again your Age Pension eligibility will suffer. In a minute I will show you couple of examples to explain this point more clearly.  

So what can be done to improve the situation if you have the home-loan outstanding? 

  • Pay it off with the cash from your bank account
  • Use part of your super to pay off the loan
  • Sell your family home and downsize – this could work wonders for your retirement, your level of income, Age Pension and overall financial security.

Please read the Downsizer Contribution that will explain the strategy in more details and how it could help you.

3. Investment loans

If you have an investment property, any loan you have, should be against that property. I see this so very often when an investment property was purchased, but the loan has been secured against the family home. This is terrible planning, because:  

  • Centrelink will calculate the full value of your investment property
  • The loan secured by your family home will be disregarded, because the family home is an exempt asset for any means testing. 

To give you a comparison, let’s meet Peter, who is retired, single, and has the following set up: 

  • owns his home of $1MIL 
  • has a loan of $300,000 secured by his family home used to buy an investment property, with repayments of $10,500pa (and for simplicity let’s even disregard any other expenses associated with the rental property).  
  • has an real estate property of $650,000 with rental income of $25,000 

As the outcome of his setup, Peter’s retirement income is $25,000 – $10,500 = $14,500 and he is not eligible for any Age Pension based on Assets Test.  

And now let’s meet Steven, who is in exactly the same situation, but the loan is secured by the investment property and not the family home. 

Steve’s income consists of $14,500 of rental income plus $19,477 of Age Pension. That’s because under Assets Test, the property value is being reduced by the value of the investment loan. Therefore, Steven’s total income is $33,977. This might not be a fortune, but most certainly one can live on this level of income much more comfortably.  

As you can see a very similar situation you might say, but two completely different outcomes with Peter below the income poverty line, and Steven being quite comfortable and enjoying his retirement.  

Steven’s debt would be one of the very few examples, when having a debt is justifiable, as otherwise he would not be eligible for Age Pension under the Assets test. His overall income would have been higher that Peter’s but still lower than in a current scenario described, even with the loan running.  

And this is a very simple example of how a specialist retirement planner can assist and reshuffle your assets so you can access the highest benefit from Age Pension or other government benefits as well as setting up your savings with income certainly and security. 

 

By: Katherine Isbrandt CFP®
Money Strategist & Retirement Planner
Principal of About Retirement

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