Zopa, Funding Circle, RateSetter: why peer-to-peer lending is a better way to fund your retirement

Some retired people are using peer-to-peer lending sites like Zopa as an alternative to getting an annuity.

Have you ever thought of lending money to other people and living off the interest? Probably not, but some retirees have.

It can be hard to get a decent, reliable income when you stop working or reduce your hours of employment, especially if you also want to hold on to your hard-earned pot of money and perhaps pass it on to your family when you die. Annuities, income drawdown and similar plans just don't appeal to lots of people, or don't quite meet their needs.

Some investors recommend you buy a portfolio of shares and live off the proceeds. However, choosing individual stock market investments is a business best left to those who know how to value companies, and so that excludes most people.

Here's where Zopa comes in

For those who have saved a substantial amount outside of pensions, or perhaps in addition to a pension, there is a newer idea.

The idea is simply to get your retirement income from peer-to-peer lenders like Zopa. We've explained how these work before, but in short it is individuals lending to and borrowing from each other. Borrowers can get better loan rates than at the banks, and you, as an individual lending your savings, can achieve a better interest rate than you would get in savings at the bank.

5.2% per year after tax

In seven years, I have rarely seen the returns for Zopa lenders go below 6% per year and it has often been 7% or 8%. By my calculation the average return since launch is 6.7% and that is even after deducting fees and losses from borrowers who fail to meet repayments.

Most retirees will pay tax on that at 20%, so that means Zopa lenders could get post-tax returns of around 4.5% to 6.5% per year, with an average return of between 5.2% and 5.4%, if Zopa's very short history were to repeat itself precisely.

A change in the amount of bad debts or in interest rates could easily lead to different returns, however – for better or worse. The owner, Giles Andrews, claimed in response to a recent critical article that Zopa has the safest loan book in the country “by far”, with a default rate of less than 1%. The old, traditional lenders suffer much higher bad debt.

It beats a typical annuity

Average annuity rates are currently just slightly higher at 5.6%, according to Moneyfacts, but that is still before deducting tax, which could reduce a pensioner's take to 4.5%.

In addition, Zopa lenders should get their pots back to access for themselves in later years if they need a boost, or to pass what's left to their heirs. That is not something that most people who are currently retired are able to do, since they have traded their pots in permanently for an annuity or are being paid a retirement income by their former employers.

Consider the potential cons too

Some of the downsides to lending your money are that this will not have been a tax efficient way to reach a retirement income when compared to some of your other options, unless you are using the 25% tax-free cash from your pension to fund your lending. You have to consider this early, before you retire, when deciding how to continue saving for your retirement. You might need to get help with the maths.

Peer-to-peer lending is also a new form of unregulated investing. That means if the whole operation fails, you lose your money without being compensated by the government through the Financial Services Compensation Scheme. Personally, I believe that with the main, established companies in the business, especially Zopa, the risk of this is small.

It's important to consider all your options and to think about using more than one way to pay your way in retirement. An annuity or other way to get an income from your retirement savings might be more appropriate in your circumstances, so do your research.

More on social lending and pensions:

Compare annuity rates

Encash: a new rival for Zopa, RateSetter and Funding Circle

Annuity mess cuts average pension by 30%

Phase your pension drawdown

How to make a pensions complaint