Should I use my pension to settle debt? This and other readers questions answered

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How do I pay off my balloon payment?

Tshepo writes:

I have an outstanding balance on my car of R87 000 of which R50 000 is a balloon (residual) payment. Is it possible to increase my monthly instalments so that I can make sure my residual is paid in full at the end of my finance term?

City Press replies:

You can increase your instalment, but you need to speak to your bank if you want to specifically apply the extra funds to the balloon payment. We asked both Nedbank (MFC) and FNB (WesBank) to respond.

Anton Kleynhans: Head of Recoveries and Collections at MFC:

The terminology applied for a bulk instalment as a final instalment per an MFC agreement is “balloon”.

On presenting the agreement, the client is provided with options stipulated in the contractual terms and conditions, which allow the client to either settle the balloon/balance on expiry of the agreement or opt to refinance the balloon over an agreed term.

A request to refinance the balloon prior to the expiry of the agreement is feasible, and terms would have to be mutually agreed to on a case-by-case basis, by calculating the repayment of a balloon over the remaining term and taking into account the client’s affordability.

This is done by restructuring the agreement, after which an addendum is issued and covered under the MFC agreement.

WesBank:

The bank is able to increase the monthly instalment in order to reduce the outstanding residual amount.

Any extra payments paid on the account will reflect as an advance amount, however, when the residual is due, the advance amount will be used towards the outstanding balance.

Should an instalment during the contract period be missed, the advance amount will be used towards the arrears. However, it is advisable that you notify the bank’s customer services that you would like to do a capital reduction.

The bank would also be able to assist with the specific calculation as to how much you need to increase your instalment by to fully settle the residual balance.

Should I use my pension to settle debt?

MOSES WRITES:

Ihave resigned from my employer and will be starting a new job at the end of the month. I need to decide what to do with my pension fund, which is currently worth R880 000.

I am currently in debt of about R170 000 and I owe about R340 000 on my mortgage. I do not know whether to take some of my pension and pay off R170 000 debt and keep the mortgage, or take all the money and settle the house and pay all the debt and start life again debt free.

CITY PRESS REPLIES:

There are two issues here: tax and having enough money in retirement.

In terms of taxation, if you take the full withdrawal, you will pay about R144 000 in tax.

This seems like a waste of money to pay over to the Receiver when it could be used for your retirement income. To put that in perspective, your investment would most likely double over the next 10 years, so in ten years’ time the true cost of that tax bill would be R300 000.

You also need to see if you are on track in terms of your retirement savings. As a rule of thumb, depending on how many years you have been working, you should have the following saved:

  • After five years, 1 x your annual salary
  • After 10 years, 2 x annual salary
  • After 15 years, 3 x annual salary
  • After 20 years, 4 x annual salary
  • After 25 years, 6 x annual salary
  • After 30 years, 7 x annual salary
  • After 35 years, 10 x annual salary

Keep in mind, any amount you withdraw now will affect your tax-free withdrawal of R500 000 at retirement. For example, if you withdraw the R880 000 you will have no tax-free withdrawal at retirement.

Rather create a debt repayment plan by sticking to a budget and paying in extra money each month than use your very valuable pension assets. You can withdraw up to R25 000 tax-free. This will still reduce your tax-free withdrawal on retirement, but you will not pay any tax today. You could use this amount to pay towards your R170 000 debt.

This would lower your monthly repayment on your debt which would now be R145 000. The key is to continue to pay the same instalments as per the full R170 000; this way you pay off the debt sooner. Once that debt is repaid, you could increase your mortgage repayments to pay off your mortgage faster. This is known as the debt snowball effect.

What most people find when they cash in their retirement fund to settle debt is that, five years later, they are back in debt and then have no retirement savings. It is about learning to manage your money on a day to day basis, rather than relying on windfalls.

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