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We would all enter retirement with a home we own free and clear, at least $1 million in our 401(k), and zero debt to our names, if we lived in an ideal world.
Financial reality looks substantially different for many near and current retirees. Indications are that retiree debt levels are rising, with a substantial number of older Americans carrying debt.
- For example, one survey reported that nearly half of its retiring respondents had credit card debt with the average balance close to $9,000.
- That’s within an overall trend of more older adults are entering retirement with mortgage debt; the share of homeowners ages 65 to 79 with a mortgage rose from 24 percent to 41 percent over three decades, according to a Harvard analysis.
- Ominously, only about 37 percent of all retirees are completely debt-free, by some estimates.
Understanding the challenges of different kinds of debt in retirement can help those approaching their golden years from falling into these statistics. And for some, a MassMutual financial professional can help provide guidance on debt-repayment strategies as part of your broader financial plan.
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Consumer debt dangers
Carrying consumer debt into retirement will either reduce the monthly cash flow available to spend on priorities like health care, travel, and leisure activities or will necessitate drawing down retirement accounts faster than planned, creating the possibility of running out of money or facing significant lifestyle changes to make ends meet. And it is hard to get ahead when interest rates on debt outpace earnings on retirement investments. The stock market’s historic average annual return is a far cry from the average credit card rate.
Financial planner Benjamin S. Offit, partner with Clear Path Advisory in Pikesville, Maryland, said it is ideal for retirees to have all debt paid off by retirement, but especially “bad debt” such as high interest credit cards. But if one needs to carry any type of debt into retirement, it needs to be reflected in a financial plan that makes room to have enough income in retirement while paying off the amounts owed. (Related: Good versus bad debt)
Inflation further complicates debt management in retirement, potentially eroding fixed income while debt payments remain constant.
How to approach debt right before retirement
Workers who are rapidly approaching the end of their working years and want to get out of debt but are still saving for retirement may need to work longer, live on less, or make some sort of sacrifice to get the debt paid off before retirement, Offit said, unless it is possible to safely and securely pay off debt during retirement. Near retirees need to make sure they have enough capital and income so that their money outlives them instead of the other way around.
Paying off remaining debts strategically can help.
Kai Stinchcombe, chief executive officer and founder of True Link Financial, a financial services firm that helps advise retirees, said that in general, it is best to pay down high-rate debt as fast as possible, but for low-rate debt such as a mortgage, it is sometimes smarter to pay it down gradually. If you are choosing between paying down a mortgage faster or contributing money to an IRA — or leaving money in an IRA rather than withdrawing it to pay for your home — you will often end up ahead by prioritizing retirement savings.
“If your IRA grows 6 percent that year and your mortgage interest rate is 4 percent, for every dollar you put into savings instead of paying down debt, you'll end up with more money as a result,” Stinchcombe said. (Learn more: Retirement planning guide)
Credit card debt vs saving
But it rarely makes sense to save rather than pay down credit card debt. “Credit card debt is the worst. Pay it off right away,” he said. (Learn more: Handling credit card debt)
Another reason to make paying down the mortgage a low priority is if the loan has a fixed rate and you qualify for a mortgage interest tax deduction, said Rebecca Pavese, CPA, a financial planner and portfolio manager with Palisades Hudson Financial Group’s Atlanta office.
“That said, you may consider refinancing to a shorter term, lower interest rate mortgage if your cash flow will allow for the payments. If you can’t afford your mortgage payments when you retire, it’s critical to consider downsizing or moving to an area with a lower cost of living,” she added.
Of course, making such a move depends on the interest rate environment at the time of your approaching retirement. (Related: How interest rates work and affect you)
When it comes to student loan debt taken out for children’s educational expenses, “it might be time to pass the debt to them if they have established careers and are capable of making the payments themselves,” Pavese said.
Paying off debt during retirement
For those who have already retired but are weighed down by debt payments, one way to pay them off is to use proceeds from retirement plan distributions, Social Security income, or pension income. Tapping extra retirement funds can also be a solution.
Offit cautioned that taking a large retirement account distribution to repay debt will mean having to declare a larger income that year and pay more taxes. A financial professional can help determine whether such a strategy makes sense to pay off debt all at once or whether the debt can be repaid over time. (Need advice? Contact us)
Pavese said that those who do retire with debt should focus on consumer debt first, then student loans, and finally mortgage debt. Taking a part-time job during retirement can also help eliminate debt quickly.
But is it worth trying to get out of debt in your 60s, 70s, or 80s, or should you just make your minimum monthly payments and let your debts die when you do?
Laws vary by state, but after someone dies, creditors usually have a few months to make a claim against the deceased’s estate for what they are still owed. In general, the estate must repay these debts before heirs can receive anything. Medical bills that are unpaid at death are also the estate’s responsibility. And anyone who has cosigned a debt or who is a joint account holder will still be responsible for those debts after you die. (Related: What happens to your debt when you die)
However, accounts and assets with a designated beneficiary or payable-on-death designation usually will not be vulnerable to creditors. A life insurance policy is another possible way to ensure that heirs are left with something even if all of the estate goes to paying off creditors.
Finally, leaving instructions in a will on how debts should be paid after death can help the executor of the estate know which assets to liquidate first to repay obligations and which assets should ideally be left to heirs if financially feasible.
Taking control of retirement debt
While carrying debt into retirement isn't ideal, it doesn't have to derail your retirement plans. Developing a strategic approach now — whether you're years away from retirement or already enjoying it — is an important step.
Start by:
- Prioritizing paying off high-interest consumer debt first.
- Analyzing the pros and cons of maintaining low-interest debt carefully.
- Creating a comprehensive financial plan that accounts for both debt elimination and retirement security.
- Appreciating that professional guidance can help you navigate complex decisions about debt payoff timing, tax implications, and retirement account distributions.
Most importantly, don't let debt prevent you from taking action on your retirement planning. The sooner you address it head-on with a clear strategy, the more options you'll have to enjoy the retirement you've worked toward.
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This article was originally published February 2017. It has been updated.
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