March 23, 2023

Akash is a 58-year-old central government employee who wants to take premature retirement. He has been a diligent saver all his working life. He is confident of managing his retirement expenses well with the VRS payout, his other retiral benefits and the money he has invested. After retirement, he wants to travel abroad to be with his daughter. His only discomfort is an ongoing home loan that will run another five years. He wants to use some of the retirement benefits to pay off the loan and be free of debt. However, he has been receiving conflicting advice. Since the loan gives him a tax benefit on the interest paid, his friends say he should continue with it. Akash is confused and needs some clarity so that he can make his choice.

Akash, like most people, is uncomfortable with the idea of retiring without settling his outstanding loans. He does not want the liability of a monthly EMI in his retirement years. This is a decision that requires sound financial consideration. If his funds can be invested at a rate higher than the cost of the loan, it would make better sense to invest the funds rather than pay off the loan. But as a retired investor, he needs lower risk investments, which may not yield such high returns.

Akash has to consider the impact of the decision to pay off the loan on other aspects of his retired life. His retirement income will be lower and he may have to cut down on his frequent travel plans, if a portion of the funds are used to prepay the loan. But it helps him get rid of a monthly mandatory commitment of an EMI. It may be prudent to reduce the charges on retirement income, to enjoy higher flexibility.

The tax benefit from the loan may also be limited. Since only five years of the loan remain, the monthly EMI will have a higher principal component than interest. The tax benefit on interest will therefore be limited. The applicable tax rate on his income will become lower after retirement, which also means that tax saving from interest may not be significant.

The argument in favour of keeping the loan is weak. If he has a corpus (after loan prepayment) large enough to handle his expenses over the next 25 years, Akash would be better off paying off his outstanding loan. He can then look forward to a stress-free retired life.

Content on this page is courtesy Centre for Investment Education and Learning (CIEL).
Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.

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