Two or three decades ago, it was a foregone conclusion that people would be debt-free upon retirement. Student loans, mortgage debt, car payments—those were the concerns of younger individuals, barriers to entry to the golden years of life. Unfortunately, times have changed.
Per capita, debt among 65-year-olds increased by 48% between 2003 and 2015, according to the Federal Reserve Bank of New York.
Of all types of debt, student loans were the biggest culprit, with the per-capita student loan burden increasing 886% for 65-year-olds during that time frame. Second to student loans was mortgage debt, increasing 47% for those approaching retirement.
Ideally, individuals will have paid off their debts before reaching retirement. Doing so would free up precious resources for more desirable goals, and it would help ensure they don’t run out of money too soon.
If you still carry debt and you have the option to delay retirement for one or two years, that’s probably the smartest move. Not only would delaying retirement give you more time to earn and pay down debt, but it would also reduce the number of years you need to fund in retirement.
However, not all debt is bad, and some types of debt are better than others. Since carrying debt into retirement has become the status quo, it’s important for retirees to understand how to evaluate and manage their debt, so they can minimize its impact on their savings.
REVIEW THE TYPES OF DEBT YOU CARRY
In order to evaluate your debt, you’ll need to identify three attributes of each loan.
The loan’s interest rate
The most important thing to understand about your debt is the amount of interest you’re paying on it. Most secured debts, such as mortgage loans, carry relatively low interest rates—typically around 3% to 4%. Unsecured debt, such as the balance you may have accrued on your credit card, is usually subject to much higher rates, between 16% and 20% on average. Knowing these rates will help you identify which debts are doing the most damage to your retirement prospects.
The loan’s tax treatment
In addition to identifying your debt’s interest rates, you’ll need to determine which balances come with tax incentives that might work to your advantage. For example, mortgage interest you pay on your primary residence is tax-deductible up to certain limits. This deduction could make mortgage debt far less expensive to carry dollar-for-dollar than debts with no tax incentive.
The cause of the debt
Finally, evaluate what caused you to take on each type of debt in the first place. A mortgage loan is reasonable, even healthy debt—as long as you didn’t buy a house you can’t afford. But credit card debt or payday loans may indicate spending habits that could derail your retirement. Furthermore, student loans for your child or grandchild, while well-intentioned, may indicate that you need to put more thought into protecting your own finances, rather than propping up a younger loved one who has more time and other options to finance their education.
PRIORITIZE YOUR DEBTS FOR REPAYMENT
Once you’ve evaluated your debts, you can identify which balances need to be paid down first, or whether it’s better to invest your money instead. Of course, you should make the mandatory minimum payments on each of these balances to avoid late-payment penalties and damage to your credit. However, once those payments are set up, you need to know where to direct excess funds.
Some advisers recommend you pay off the loan with the smallest balance first and then move to the next smallest loan, creating a snowball effect until you’re debt-free. While this strategy might provide positive emotional feedback to those anxious about their debt and eager to see balances paid off, it’s bad advice mathematically.
Instead, you should prioritize your debts by the three criteria examined above, with an emphasis on paying down debts with the highest interest rate first, regardless of the size of its balance.
For example, let’s say you and your spouse have earned and saved enough to receive a total of $4,250 per month from Social Security and retirement fund disbursements. Your remaining retirement funds—and any new investments you make—earn an average annual interest rate of 6%. You have five years remaining on your fixed-rate mortgage, at $800 per month (and an interest rate of 4.32%). You also have $4,000 of credit card debt, which is subject to an 18% annual percentage rate (APR), and $12,000 of unsubsidized student loans, subject to a 6.8% interest rate.
Once all minimum payments are made on each of your loans and your basic cost of living is covered, you should direct any excess funds to paying down your credit card debt as fast as possible. It has the highest interest rate and offers no tax incentives.
Do you have cash stored in a rainy-day fund or a low-yield CD? Cash them in to pay off this debt. Do you have junk in the attic or a motorcycle you no longer use? Hold a yard sale or list items online to earn money and pay down your debt faster. But be cautious about overdrawing from traditional retirement funds or taxable accounts, which could push you into a higher tax bracket.
Additionally, ongoing credit card debt often indicates unbalanced spending practices. In this case, you should consider setting aside your cards and using only cash until your debt is paid off. If you resume using your card, commit to spending only as much as you can afford to pay off each month.
Next in line is your student debt. At 6.8%, it’s costing you a little more than your investments earn. But more importantly, your loan interest rate is guaranteed, while your investment returns are not. Take all of the money you were putting toward your credit card debt and use it to pay down these loans.
Finally, you have your mortgage. Since the rate applied to this balance is lower than the rate you’re earning on your investments, and since most or all of your interest payments are tax-deductible, it might not make sense to pay off this debt faster than scheduled. Instead, keep up with your required mortgage payments and invest the difference to generate returns.
CONSIDER A PART TIME JOB
Many retirees begin an encore career or part-time job during retirement. For some, this career is a passion project, which generates less income than their professional career but fulfills them in a new way. For others who haven’t saved enough, it provides supplemental income.
You might fall into both or neither of these camps, but if you’re retiring with debt, it’s not a bad idea to consider finding part-time work to pay off your debt faster. If you love to swim, consider becoming certified to lifeguard at a neighborhood pool. Or if you find yourself missing the office, consider part-time consulting work. Any extra income you can put toward your debt will help relieve you of stress when recreation, not finances, are supposed to be your preoccupation.