Using pensions as loan collateral is becoming increasingly popular among people who are approaching their retirement years. For many, their pension funds are their largest asset.
If you are expecting to retire with an ample pension in a few years time, but need money now to pay off existing debts, make home improvements, pay for unexpected expenses or take advantage of an investment opportunity, this type of loan may be a viable option for you.
Some banks and other lending institutions will allow you to borrow an amount up to fifty percent of the value of your pension fund. But before you decide to use your pension fund as collateral, make sure you have thought it through and understand not only the advantages but the potential pitfalls of this type of loan.
A distinct advantage to taking out a loan against your pension, is that this type of loan is easier to get and less expensive than an unsecured loan. Many institutions don’t even require credit checks or proof of current income, providing you are able to provide proof of the value of your pension fund.
They will need documentation that you are vested in your pension plan(s), along with the date you can begin collecting your pension, the projected annual or monthly benefit amounts, and the most recent pension earning statements. In order qualify, your pension(s) must be from an employment based or private pension plan and be valued at a minimum of £30,000.
What to do about it
Before you apply for a loan, shop around for a bank or lender offering the most competitive interest rates. Also check the timeline during which you are allowed to use your pension as collateral, as it will vary from one lender to the next.
I would also suggest checking online for an annuity calculator so that you can judge what your retirement income is likely to be and how much the loan might affect it.
Most lenders have policies that require you be within five years of receiving a secured, fixed pension income, to quality. However, there are still many financial institutions that are wary when it comes to underwriting a loan based on pension income.
If your bank is reticent about allowing you to use your pension as collateral, consider taking a lump sum payment from your pension fund, if your pension plan allows it, and signing it over to the bank. You can also offer to purchase a life insurance policy covering the term of the loan.
It’s important to exercise due diligence before using your pension to secure a loan. Firstly you will generally be required to pay the first years interest on the loan up front and If for any reason, you are unable to pay the interest in subsequent years, the lender will add it to the balance due and increase your interest rate.
There are also a number of potential tax implications, particularly if you can’t repay the loan according to the terms of the agreement. So if you are considering using your retirement pension as collateral, proceed with caution. Get the advice of a good accountant and make sure this is the best strategy for you before you sign on the dotted line.