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Debt can be a real drag on your plans for a comfortable retirement

by Joseph Arroyo | Contributor
October 13, 2020


Paying off debt and growing your nest egg is hard in the best of times. Doing it during a global pandemic might seem impossible. Too much debt too late in life can be a real drag on your retirement lifestyle. It may even prevent a true retirement. It’s important to find ways to lower your debt and maximize your income in retirement. Fortunately, there are some tips and tricks to be financially sound as you age.

Why is excessive debt a problem for retirees?

It used to be that retirees had some of the lowest debt levels in the American population. Like with so many other things, unfortunately, this is changing. Senior indebtedness has increased more than 500% since 1999.

Too much debt can be a problem when your payments on loans consume too great a percentage of your monthly income. This situation can make it difficult or impossible to retire. You face the dilemma of having to go without any of the extras you might have once envisioned for your retirement, and in the worst case, you could face the loss of your home if your debt is too out of control.

Debt is a growing problem due to the reduction or elimination of traditional pensions. As employers have turned to employee-driven 401(k) plans since the 1980s, the number of traditional defined benefit plans has shrunk. Without pensions, retirees are more reliant on Social Security and whatever nest egg they’ve built through savings. Social Security wasn’t intended to be the sole means of support for retirees, so the payments don’t cover high debt payments and other living expenses.

Even if you are fortunate enough to have a pension, a sizable nest egg, or both, too much debt reduces your margin of safety in retirement. If you have unexpected costs or expenses, your monthly income can be pinched if too much is already spoken for by debt payments.

What kinds of debt are a problem?

Mortgage debt on your primary residence is usually not considered bad debt, as long as it’s affordable on your retirement income. It would be far better, though, to pay your mortgage off as a part of the lead-up to your retirement. We’ll discuss working beyond age 65 later, but it would be worth working a few more years if it enabled you to retire without a mortgage.

Besides a mortgage on your primary home, the following debt accounts are arranged from “worst” to best:

Young couple struggling with their budget and debt
  • Credit cards
  • Student loans for your kids or grandkids
  • Store accounts
  • Variable rate debt (like lines of credit)
  • Car loans or leases
  • Student loans for yourself or your spouse
  • Mortgages on second homes or other real estate

The worst of these for your retirement are floating, or variable, rate debt products. Credit cards, store accounts and home equity lines of credit fall into this category. These kinds of debt are a problem for a couple of reasons:

  • Generally, lower or smaller amounts of your payments go to principal reduction with these kinds of loans.
  • Variable rate debt is vulnerable to a rise in interest rates.

Rising interest rates might not seem like too much of a worry in our current deflation-fearing climate. However, you might consider that while interest rates on government debt like treasury bonds might go negative, your personal credit account interest rates are not likely to get much lower. Therefore, all the risk is on the upside. Any kind of inflationary event could cause rates to snap back well beyond where they were before the pandemic. This could be catastrophic for those making variable rate payments.

What can be done about debt before retirement?

Far and away the best way to deal with debt is to eliminate it before you retire. Having none of your monthly income allocated to debt payments will allow you to use more of your income for the things you’d like to do in retirement.

This may not be possible for everyone approaching retirement age, so here are some suggestions for dealing with debt as you near retirement.

First of all, do no harm. Or, stop digging a deeper ditch. If you already have more debt than you’d like, try to avoid taking on more debt at all costs. This might even mean not refinancing during today’s historically low interest rate environment. At all costs, don’t refinance into an adjustable rate mortgage. You want to eliminate the uncertainty of floating rate debt. You should also try to avoid getting a car loan or lease in the years leading up to retirement.

Focus on trying to pay off as much debt as possible before you retire. You might accomplish this with a few different methods:

  • Pay off variable rate debt first
  • Pay off your smaller balances then pay off larger balances (debt snowball)
  • Work beyond age 65
  • Leverage existing assets like home equity with a home equity line of credit or a reverse mortgage

You could use the proceeds from a home equity line of credit (HELOC) to pay off all other debt. Likewise, you could consider a reverse mortgage, but these would be the last options to consider. Try to pay down your debt using existing assets and cash flow at all costs.

An option growing in popularity is to work beyond the traditional retirement age of 65. Part of this is driven by the increase in full Social Security retirement age to 66 for many people. Others just want to keep working. Or, they want to keep working but at reduced hours. This is a great option you can use to pay down debt before you retire to a fixed income. It may also have the benefit of helping you draw a larger Social Security check when you actually retire.

How to lower expenses and pay off debt before and during retirement

Traditionally the main way to lower expenses in retirement was through downsizing. Many people sell their bigger-than-needed family homes and buy smaller homes or condos with the proceeds. A great benefit to this is that you might be able to pay cash, or at least have a much smaller payment, on a smaller home.

You can take even more advantage by relocating to a lower-cost area. Traditionally, places throughout the South have had a lower cost of living. As a bonus, these states tend to have more moderate climates, without harsh winters, so they are considered desirable retirement hubs. Another bonus is that more and more families with younger children are moving to these mild-climate, low-cost Southern states, so you may be able to lower your expenses, and move closer to you children and grandchildren, too.

Other than lowering your debt and expenses by downsizing and moving to a lower-cost locale, look for savings in these areas:

  • Stop paying mortgage insurance if possible
  • Consider Medicare Advantage over Medicare supplement insurance if there are compelling plans available in your area
  • Change or eliminate cable TV subscriptions
  • Watch your digital subscription costs (Netflix, Amazon Prime, etc.)
  • Take advantage of senior discounts
  • Review your insurance coverage to see if you’re paying too much or paying for coverage you no longer need

If you take some of these steps to saving money, be sure you use the extra cash to pay off some of your debt. Paying the debt off may allow you to add back some of the luxuries you cut out of your budget.

Work with your financial professional to make a plan

It’s important to work through budgetary scenarios with your financial professional. You might be tempted to reduce savings or retirement plan contributions to pay off debt. This might be wise. But, it might also cause you to miss out on investment growth in your nest egg. A retirement income planner can help you run all the calculations and make the best choice for you. Make sure you work with your financial professional and keep them informed of any changes to your income and debts.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

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