Last week, a government employee reached out to me with a question that I hear all the time: “Should I settle my bond before I retire or resign now?” It’s surprisingly common, and I get it. Conventional wisdom says you should leave a bit open on your bond for emergencies. But here’s where it gets interesting: I’ve also had a number of members telling me that they’re holding onto their credit cards, loans, overdrafts, and other debts because they plan to settle them when they receive their lump sum payout.
So, the real question is: Should you settle all your debts before you retire or resign? In this post, I’m going to dive deep into this topic, answer the question, and share a nice surprise towards the end. I’ll explain what to watch out for when settling your debts, the unexpected risks of keeping debt after you leave, and what to do if you’ve already settled your debts but feel unsure about the next steps.
Let’s Talk About Debt vs. Investment: The Interest Game
Let’s start by talking about interest—specifically, interest on your debt versus the interest from potential savings. Pay careful attention, especially if you have debt or investments.
When you have debt, it could be from several sources:
- Bond
- Credit card
- Loan
- Overdraft
Pay Attention to Your Interest Rates
Start by reviewing the interest rates on your debts. Typically, bonds have a low-interest rate because they’re paid over a longer period (for example, 9%). But for other forms of debt, such as personal loans, credit cards, or overdrafts, the interest rates can be much higher (e.g., 20%, 19%, 18%, respectively).
Investment Interest: Is It Worth It?
Now, let’s compare that with the interest you could earn from an investment. If you decide to take a lump sum and put it into a bank investment or unit trust, ask yourself whether the interest exceeds the rates of your debt.
Here’s the catch: markets are unpredictable. If the market performs well, you could earn a great return. But if it drops, your returns could also decrease.
For example:
- Bond interest: 9%
- Credit card interest: 19%
- Loan interest: 20%
- Overdraft interest: 18%
The Bottom Line: Pay Off Debt First
Wouldn’t it make sense to settle those debts first, considering they are certain? The uncertainty of the market can put your investment returns at risk.
By paying off your debts first, you’re guaranteed to stop the interest payments, while investments may not always deliver the returns you expect.
Managing Income and Taxation
When you’re servicing debt, you’ll need a higher income to cover your expenses. But higher income means higher taxes.
For example:
- Living expenses without debt: R10,000 per month
- Living expenses with debt: R18,000 per month
In this case, to cover the extra R8,000 debt, you’d need a higher gross income, which could lead to higher taxes.
However, if you can settle your debt, you may reduce your income and therefore pay less tax, which also gives you more room to invest and grow your savings.
The Family Impact: Debt After You Pass Away
One of the biggest risks of leaving debt behind is how it can impact your family. Consider the following:
- Estate duty: A tax on the debt left behind.
- Capital gains tax: Tax on any assets, including property.
- Family inheritance: The debt could reduce the inheritance your loved ones receive. In some cases, institutions might claim off your estate, leaving your family with less than you intended to pass down.
The last thing you want is for your family to have to sell assets to cover your debts. Imagine leaving behind a financial legacy instead of financial stress – this is the gift you can give your loved ones with proper planning.
What to Do If You Can’t Settle Your Debt
If you’re not in a position to settle all your debt, here’s a strategy to follow: Focus on paying off the debt with the highest interest rate first.
For example, if your loan has the highest interest rate (20%), prioritize that. Even if you can only make small payments, like R20 or R50 extra each month, it will help you reduce the amount of interest you pay in the long run.
Once the highest-interest debt is cleared, move on to the next one. This “highest interest first” strategy will help you become debt-free faster.
What to Do After Settling Your Debts
Once your debts are settled, you’re in a great position to focus on saving more and maximizing your tax savings. If you want to know exactly how to do this and the best strategy for your unique situation, I’m available for one-on-one consultations to guide you through the next steps.
Remember, every step you take toward reducing debt and planning for your future brings you closer to financial freedom.
Disclaimer:
Retirement Wellness SA is an Authorised Financial Services Provider – FSP 31609. This video provides information, not advice.
Disclaimer: This information is not provided by or on behalf of the Government Employees Pension Fund (GEPF). We do not act on behalf of the GEPF.
