by Geoff George Paxton

Created on: April 23, 2010   Last Updated: April 24, 2010

Is it wise to borrow saved capital in any shape or form?

Your friendly banker would say ‘Yes!’ because if you do not use your own capital you will want the bank to lend you money.

Have you got lots of friends in the banking system, because they are what is known as ‘fair-weather friends’. Big smiles when things are going well, then do not want to know you when things are tight.

If you have saved money in a formal savings plan, such as 401(k), you have received the largesse of the tax system, as concessions are made to help people to save. If there were no incentive, why would anyone bother to save?

If you need to retire at, say, age 65 and have a certain life-style which is comfortable, you need to define how much capital you will need to retire on. How long are you planning to live after retirement? How long is your spouse likely to live after you have gone? How long is a piece of string? There is always going to be an element of guess-work, but it is better to plan for the worst (or best) scenario.

Let’s just work with some ludicrous figures ~ just to illustrate a point. Say your salary at retirement is 1,000 per month. If your capital provision is 10,000 you can live at the same level for ten months. Then what? If your capital provision is 1 million, you can live for 100 months, just over 8 years. But it gets more complicated. What capital you are not drawing should be growing at whatever rate you are able to get for investments, so if your 1 million is earning 10% per annum, 988,000 (1 million minus a year's salary / pension) should grow to 1,086,800. That is the good news.

The bad news is that there is something over which you have no control, called inflation. If inflation is being nasty, sitting at, say, 15%, your salary needs to go up by 15%, just to stay in the same place.

Now, if you decide to borrow against the capital that has been growing nicely in the background (earning whatever growth you can get for it), you immediately lose the amount you borrowed, plus what that would have earned if it was still invested. If your taxman is nasty he might say, ‘You have had tax relief on that money, now pay me the taxes you would have paid.’ That immediately means you have actually to borrow more than you originally intended to meet that.

Then, to be responsible to yourself, you need to make a plan to replace the borrowed amount, plus the interest it would have earned, as soon as possible.

Your friendly bank adviser may tell you to go ahead and draw the money. When, down the line, your pension runs out, will they step in and help you? No chance.

Drawing against capital saved is always a bad idea. I hope you can see it is much more complicated than, ‘I need X amount. My plan has Y amount, so I will just take some. It is my money anyway!’ And when things are tight again, you will do the same again.

At that rate you can never retire. Enjoy the rest of your working life, working, working, working!

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