Should You Reduce Debt as You Approach Retirement?
Peggi Burdick, 58, is a personal coach who helps motivate people to make smart money decisions and tackle their debt, but she wasn’t always an expert when it came to her own finances. In fact, when she was 48, Burdick found herself with $50,000 in credit card debt.
Her journey to eliminate her debt before retirement took her nine years, but she finds great comfort in knowing her retirement is more secure now that her debt is behind her. “It makes me feel more confident to know that I’m going to be able to take care of myself,” she said.
According to the New York Fed, between 2003 and 2015 the average debt per capita of those over 65 increased by 48 percent. That doesn’t surprise Luke Sturges, CFP®, a wealth management advisor for Northwestern Mutual, who has seen concern over debt grow among those approaching retirement.
“For my clients closing in on retirement,” he said, “the debt question is one of the most pressing concerns that they have.”
Sturges believes that some types of debt should be more of a priority to pay down prior to retirement than others. For that reason, it’s important that you evaluate your debt as you approach retirement to come up with strategies to reduce debt so that it won’t limit your planned retirement lifestyle.
What Types of Debt Should You Ditch?
While Sturges helps his clients create plans to pay off some or all of their debt before retirement, he believes that not all debt is created equal. “It’s important to distinguish among different types of debt, as well as the applicable interest rate being charged,” he said.
For example, there’s a big difference, according to Sturges, between debt that is tax deductible and debt that is not tax deductible. Some loans on your home as well as student loans (below certain levels of income) allow for the interest or a portion of it to be deducted on your tax return. Calculating the after-tax cost of that debt is a good place to start. In today’s low interest rate environment, debt such as mortgages or student loans may be advisable to keep in certain situations. However, high interest debt like credit cards and medical loans may be worth paying off.
“I usually advise clients to pay down or pay off entirely any debt that costs over 6 percent before retirement,” he said.
Even if his clients want to have no debt in retirement, Sturges often reviews with them whether it might be more appropriate for them to keep some of their low interest debt and maintain greater liquidity. The money that would have gone to paying down debt can be kept liquid and invested within your financial plan in order to build or maintain retirement assets. Depending on how low your mortgage interest rate is, you likely can make more money than you’re paying by investing in a well-thought-out and -designed investment portfolio.
“The American Dream may be to walk into retirement 100 percent debt free,” said Sturges, “but that’s not always possible for everyone.”
How to Avoid Debt in Retirement
Many people who are paying off debt before retirement worry about potentially going into debt again as they age.
“I think it’s critical that people have an emergency account,” said Burdick. “You never know when your car or your laundry machine will break down.”
Sturges agrees and believes retirees should have a bigger emergency fund if they want to avoid debt in retirement, since the types of emergencies you might experience as you get older can be more expensive.
“A younger person should have three to six months worth of savings in his or her emergency fund,” he said, “but retirees should have one to two years worth of cash to deal with unexpected expenses or to cover expenses during market downturns when they won’t want to sell their investments.”
Sturges also recommends working with an advisor to develop a retirement budget and income strategy so that retirees know that they aren’t underestimating how much retirement income they will need to maintain their lifestyle in retirement.
Be Proactive About Your Debt
If you have debt as you approach retirement, it’s important that you start now to evaluate it and determine whether you should focus on reducing debt prior to retiring.
“I recommend sitting down with an advisor to learn what your options are,” Sturges said. “They’ll help you figure out a plan for how to pay off your debt.”
Getting your debt under control will help you feel more confident about your retirement.
“It definitely makes me feel safe to be debt free,” said Burdick. “It makes me feel good that I have control over my finances as I approach retirement.”
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNERTM and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.