Debt and Retirement

Debt and Retirement

An increasing number of Americans are facing an uphill battle just trying to save enough and earn enough on their savings to be able to retire on time. Carrying much higher debt burdens than previous generations, many pre-retirees have had to put their savings on the back burner to focus on debt reduction, which, for practical purposes is smart, but it is also the primary reason why some will need to delay retirement or drastically downsize their retirement lifestyle. In retirement, cash flow portfolio is king and every dollar of debt is a direct drain on cash flow.  But, it’s never too late (nor too early) to take counter measures that will help you get back on track.

Should I try to pay off my mortgage before retirement?

The days of mortgage-burning parties are nearly a thing of the past. As a result of the home refinancing hey days of the last five to ten years, 67% of homeowners in their 50s and 60s are now carrying mortgage debt well past the age of 70. *

Financial planners are divided on whether it’s a good idea to try to pay down your mortgage as soon as possible.

  • In retirement, the primary objective is to have a long term positive cash flow.  For example, a household which has a retirement income of $75,000 from all sources and total expenses including the mortgage of $65,000 is in a positive cash flow position and the mortgage is not a concern.  If that same household has a gross income of $60,000 and expenses of $65,000 including the mortgage has to make some difficult choices and decisions.
  • Some say that it may be a disadvantage to lose the mortgage interest deduction. The reality is, however, that many retirees don’t have enough personal deductions to be able to use their mortgage deduction with most only qualifying for the standard deduction. Also, if you enter retirement with 10 or 20 years paid on your mortgage, the interest portion has declined to the extent that it’s not generating enough of a deduction for many people.

 

Ultimately there is no perfect answer to this question, but there are criteria I would suggest taking while making this decision. 

  • If the mortgage can be paid off before or at retirement from cash flow, this can be beneficial.  However, making additional payments on the mortgage after retirement generally make no sense to me.  For example, if a household were to retire at age 65 with 15 years remaining on the mortgage, a goal of paying off the mortgage at age 75 normally means using cash flow which otherwise would be used for lifestyle and enjoying retirement.
  • Regarding using investments to pay off the mortgage, it is important to determine if it is an emotional decision compared to an investment decision. 
    • If the household simply feels better by paying off the mortgage and improving cash flow that is a legitimate decision.
    • If it is an investment decision, then the process is to compare the interest rate on the loan to the expected earnings on the investments.  For example, if the mortgage interest rate is at 4% and the investments are held in minimal or low risk accounts with an expected return of 2% or less, then it is best to pay off the mortgage.  On the other hand, again assuming a 4% mortgage interest rate and a moderate growth to growth portfolio with an expected return of 7% or better, then it is better to keep paying on mortgage and maintain investment portfolio. Taxes may be a factor, but normally close to a wash.    

Do I save for retirement or pay down credit card debt?

Sadly, this is turning into a classic dilemma faced by a majority of Americans. Unquestionably, you should try to pay off all consumer debt which includes credit card debt before retirement.  Eliminating consumer debt before retirement improves cash flow and long term financial security.  Every penny you are paying towards debt needs to go towards your financial security, so you can’t begin implementing your debt payoff plan soon enough:

  • Get on a budget: Set a monthly target for debt payments (and make it a stretch goal) and then budget everything else around that. Eliminate non-essential expenditures. Find ways to stretch your essential expenditures. Downsize your lifestyle now. Your goal should be to pay off your debt completely within a year. Oh, and STOP USING YOUR CREDIT CARD!
  • Pay off smaller balances with the highest interest rates first: It’s easier and more motivating to check off the smaller targets first. It will help you build momentum as you tackle the bigger ones.

 

Once the credit card debt has been paid, first make sure going forward credit cards are only used as a convenience and balance is paid at the end of each month.  Second apply the cash flow previously used for eliminating credit card debt to savings and investments.  Finally, with a couple of exceptions a house or car for example, if you cannot pay cash, you cannot afford it

*Retirement time bomb: Mortgage debt. Securian research reveals growing burden for boomers and retirees – April 2013

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2014-2015 Advisor Websites.