In an ideal world, everyone would retire without debt. Unfortunately for many, debt becomes one of those unexpected retirement expenses along with healthcare costs and taxes. Currently, the average baby boomer has $28,000 in nonmortgage debt and $191,000 in mortgage debt.
Carrying these debts into retirement reduces the monthly cash flow available for travel, leisure, or even health care. This means that you may end up running out of money earlier than expected or need to make cuts to your overall lifestyle, especially when the interest on credit cards outpaces the interest on retirement investments.
How to Approach Debt in the Years Leading to Retirement
If it is not possible to eliminate all debt before retirement, then you need to get strategic about how you approach it. You should prioritize paying off credit cards and other high-interest debt. Also, you need to account for your debt payments when you create a retirement budget. If you have a clear plan for paying off the debt with the income available to you, then you can avoid any nasty surprises down the line that can jeopardize your financial security. The key is to ensure that you will have enough capital and income to last for the rest of your life. If you feel this is not possible, you may need to work longer, reduce your budget, or consider making a financial sacrifice.
On the other hand, you may be able to pay off your high-interest debts if you create a plan. For many people, carrying low-rate debt like a mortgage into retirement is not cause for panic even if it is not an ideal scenario. First, figure out how you can pay down your other debts as quickly as possible. You may find yourself questioning whether you should put money in an IRA or pay off a credit card. Ultimately, you should think about the potential benefit or cost of each decision. If your IRA has an average growth rate of 6 percent, then it makes sense to pay off the credit card, which likely charges several times more than that in interest. The interest savings is greater than the growth in an IRA.
However, if you are choosing between retirement savings and a mortgage, you may make a different decision considering your mortgage interest rate is likely far below 6 percent. The other point to think about is that you likely still get a mortgage interest tax deduction, which can decrease the taxes you owe as a retiree. At the same time, if you cannot afford your mortgage after you retire, you will need to figure out a different solution, whether that means downsizing or waiting longer to retire.
How to Think about Debt if You Are Already Retired
If you are already retired and continuing to struggle with debt payments, it may be possible to use Social Security income, pension income, or retirement plan distributions to pay down the principal. However, it is important to think about the potential tax ramifications. Taking a large retirement account distribution to repay a debt will increase your income for that year, which means you could end up in a higher tax bracket. If you are in this situation, work with a financial planner to figure out a strategy to minimize the interest you pay as well as the taxes you owe.
When you retire with debt, you need to be strategic in how you repay it. Focus first on consumer debt since it likely has the highest interest rate. Then, repay any student loans you may still own. The final debt to tackle is a mortgage. Many people end up working part-time during retirement to help eliminate their debt quickly.
The other thought you may have is whether it makes sense to pay off these debts or just make the minimum payment and let them die with you. While this is a valid strategy, it is important to research the specific laws in your state. The options that creditors have after you die vary between states. Sometimes, creditors can make a claim against your estate for the amount you still owe. Typically, the estate must repay any debts before heirs receive money. The same applies to medical debts you may owe when you die.
Also, anyone who has cosigned on a debt or who is a joint account holder will be responsible for the debt once you die. Importantly, you may be able to avoid these issues by putting your assets in a trust, taking out a life insurance policy, or pursuing a different option. Be sure to talk about your plan with a financial planner to make sure it is secure and to ensure your heirs get what you intend.