Many folks approach and enter retirement with questions about debt. That's not surprising since about 46% of Americans expect to retire in debt, according to a recent survey. Knowing how to handle debt takes on extra importance given many retirees' fixed income.
Here are a few FAQs that I receive from my clients who are near retirement.
Q: Should I pay off my mortgage before retiring?
On the face of it, paying off your mortgage before retirement sounds appealing. But the right course of action depends on your specific circumstances.
Generally, you might want to repay your mortgage early if:
- You want to reduce your fixed expenses: Your mortgage may be your most significant monthly expense. You'll be able to live on less income by repaying debt, which is especially helpful if that income is limited.
- You'd like to stop paying interest: Early repayment allows you to reallocate your future income to other purposes. Bear in mind that you'll lose the mortgage-interest tax deduction, but it may not be much of a loss since payments to mature mortgages apply mainly toward the remaining principal.
- Your mortgage rate exceeds the risk-free rate: Paying off your mortgage is like earning a risk-free rate of return equal to the mortgage interest rate. You'll be better off financially by repaying a mortgage if its rate is greater than the after-tax rate of return on low-risk investments.
However, you might not want to repay your mortgage early if:
- You want to contribute more to your retirement accounts: This should probably be your highest priority, especially since your retirement accounts earn tax-free or tax-deferred income.
- You have low cash reserves: You should first ensure you have enough cash put aside for emergencies before using your money to retire your mortgage.
- You have other debt that costs more: Generally, you want to pay off the most expensive debt first, especially non-deductible debt.
- You'd rather invest your cash elsewhere: Instead of using your money to repay your mortgage, you may do better by investing it in a tax-sheltered retirement account. Doing this also diversifies your portfolio of assets to concentrate less on your home.
You might do best by repaying more than the amount due on your mortgage each month. This method will save you interest and shorten the remaining lifetime of the mortgage without leaving you short of cash.
Q: What do I do about necessary debt?
Unplanned debt can arise in many ways, including unexpected medical bills, natural disasters, expensive repairs, etc. A combination of savings and insurance is called for to meet this challenge. You should have at least six months of expenses put aside in a risk-free savings account. You should also review your insurance to ensure you are adequately covered.
Start with your medical insurance. If you're on Medicare, consider Medigap and Medicare Advantage policies that will cover more of your out-of-pocket costs. If you're younger than 65, check whether you can remain on your employer's group plan. If not, look for a high-qualify plan from the ACA Marketplace.
Other areas to explore include government flood insurance, natural disaster riders to your homeowner's insurance, maintenance contracts on your vehicles and appliances, and adequate life insurance to protect your family. Some folks find long-term disability insurance worthwhile, but you have to be careful not to overpay.
Q: How to pay off high-interest credit card debt?
There are a few ways to repay your credit card debt. The first is to make minimum payments to all but your most expensive card, which you then repay as quickly as you can. This strategy is called the avalanche method and usually saves the most money. Conversely, you might try the snowball method, in which you concentrate on paying off the smallest balance first.
Alternatively, you can consolidate your credit card debt through a personal loan or by transferring your credit cards balances to a new card that offers a 0% introductory APR on balance transfers. Consider the overall interests and fees when deciding on a debt reduction plan.
Q: Is low-interest (school loans, etc.) debt bad?
Typically, we consider debt good when the proceeds are invested in assets that increase in value over time. Mortgages and business loans are two examples. Bad debt is the opposite – its proceeds pay for something that drops in value over time, such as credit card debt, auto loans, cash advances, and so forth.
Student loans have good and bad aspects. They helped you achieve a higher income over your work career. However, if you still have loans as you approach retirement, you might simply want to get rid of them. A lot depends on whether the loan is a low-interest federal one or an expensive private one. The latter is clearly worth repaying quickly.
Thankfully, most of my clients no longer have any outstanding student loans.
Q: What are the benefits of retiring debt-free?
Without debt to sop up your income, you have more cash to spend on the lifestyle you envision. You also have greater freedom to make changes, such as where you live or how you spend your time if you don't have to divert funds to debt. The peace of mind brought by a debt-free retirement is priceless.
Q: How do I navigate retirement with debt?
Your financial advisor can help you navigate through your retirement in many ways, including how to handle your outstanding debt. Without a doubt, planning based on reliable information and sound strategy is the best way to prepare for retirement.
The planning doesn't end when you finally stop working. Life is constantly evolving, and so should your plans. Debts may suddenly appear, but careful planning should help blunt their impact and reduce their scope. I invite you to make an appointment to consult about your debts and other essential aspects of your retirement, whether it's approaching or has already arrived. Let's ensure you are in the best possible financial situation to enjoy your golden years.