In a perfect world, the ideal goal is to be debt-free before you retire. However, few lives are perfect, and things can get in the way. For many people, the reality of managing debt in retirement is unavoidable.
Medical and higher education costs have soared. Retirees may still be paying for their student loans, especially graduate degrees, or have co-signed their children’s loans or taken out Parents Plus Loans to fund the high cost of a college edition for children or grandchildren. Student loans plus credit card debt, medical expenses, and a mortgage can derail your plan of a debt-free retirement.
According to the Transamerica Center for Retirement Studies, a division of the nonprofit Transamerica Institute, four out of ten retirees view paying off debt as a priority. Borrowing can play an essential role in financial planning but needs to be examined before retirement. So, what to do? Make a plan for the reality of managing that debt in retirement. Examine your debt to determine if it is good debt or bad debt.
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What? There is Good Debt?!
Yes, there is good debt! Good debt builds wealth over time. You can acquire assets that appreciate at a higher rate than the interest owed on the funds borrowed through it. Good debt includes items like a mortgage where you are building equity, home equity loans for updates and home repairs that will add value, and student loans for degree programs that can add to earning potential. The key is for these loans to be at a reasonable interest rate and fund things that add value. Mortgage interest rates are currently at an all-time low. Home equity loans are as well. However, no matter what the interest rate, it is crucial the payments fit your retirement plan.
What is Bad Debt?
In general, bad debt comes from borrowing money to purchase items that will depreciate. Examples of this are new cars, clothing, vacations, anything you would put on a credit card that you cannot pay off in full each month. If it doesn’t go up in value, you shouldn’t be borrowing money to purchase it. Most bad debt comes from living beyond your means. This is why you should take a good, honest look at your budget and examine your spending habits before you retire.
Does this mean you can never buy a new car? No, but there are facts to consider. Cars depreciate as soon as you drive them off the lot. It most likely will never be as valuable as the day you purchase it. How does a brand-new car with a loan and the associated higher insurance costs balance with your retirement goals? Can you make do with a model a few years older to buy outright or have a smaller loan? If you insist on a new car, work the extra costs into your budget to save and pay cash. Likewise, the key to vacation costs is to save before the purchase. Make car expenses and vacation line items in your monthly budget to make sure they are affordable.
Student loans and home equity lines of credit (HELOC) can fall into a grey good/bad debt area, depending on how you use these loans. A student loan for a completed degree that increased earning potential is good debt. A student loan for an uncompleted program or one with low earning potential is not. Likewise, a HELOC that paid for home improvements that added value is good debt. A HELOC that was used to pay off credit card debt (and you kept on overspending) is bad debt.
How to Manage Retirement Debt?
The best time to reduce retirement debt is before you retire. However, if that is not possible, you need to deal with the reality of managing debt during retirement once you are no longer working. Will your retirement income from all sources (social security, retirement accounts, investments, pensions) be sufficient for the lifestyle you want for retirement? Having a smart budget will help you examine this
Step 1: Examine Your Expenses
Examine your expenses and put together a smart budget. Take a hard look at your spending habits and reevaluate your budget for areas you can cut back. When you reduce your expenses, put the money saved towards the outstanding debt. Don’t spend it!
Step 2: Pay Down Your Credit Card Debt
Pay down your credit card debt. Two methods to reduce your debt are the debt avalanche and snowball methods. With the avalanche method, you pay off the account balance with the highest interest rate first. In this strategy, you would make minimum monthly payments on all your credit cards but pay extra towards the debt with the highest interest rate until it is paid in full. Then you move onto the next highest card. With the snowball method, you pay off the smallest debt first, then once that debt is paid in full, roll the payment you would have made to the next smallest debt. Think about which one would be most motivating for you. The debt avalanche method can often result in lower payments over time since you eliminate the highest interest rates first.
Step 3: Check Your Living Costs
Examine your living costs. Are you still living in the family home, although the kids are long gone? If your mortgage is paid, are your property taxes reasonable for your budget? Don’t forget about homeowner’s insurance, maintenance (cleaning and landscape), and utility costs. If you downsize your home, these costs may also be reduced. If you can’t downsize your home because of adult boomerang kids, ask them to pay their share of expenses and rent, if at all possible.
Step 4: Kid’s Student Loans
If you are still paying the kids’ student loans, can they take over the payments? This will free up the money you would have paid for the loan so it can go towards your other debts or living expenses. If the student loans you are paying are yours, look at the interest rates to see if consolidation is an option. Once you have paid off your credit card debt, which usually has higher interest rates than student loans, consider using one of the methods mentioned in Step 2 to pay down the student loans.
Final Thoughts – Reality of Managing Debt in Retirement
If you are having trouble getting out from under debt, consider postponing retirement a few years. Delaying the age when you start taking Social Security payments can result in higher lifetime benefits. By extending your earning years, you will also generate more income. Continue investing and saving while you are still working. If postponing retirement isn’t an option, consider a side gig or part-time job. Funnel this extra income towards your outstanding debt to pay them down. A retirement in which your income goes exclusively towards your living expenses and goals is ideal.
Free Resources for Retirees
Some of my favorite free financial resources for seniors online are:
National Council on Aging www.ncoa.org
The Transamerica Center for Retirement Studies https://www.transamericacenter.org
Women’s Institute for a Secure Retirement www.wiserwomen.org
You can also read Creating a Smart Budget for Seniors by the same author.
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Christine Seaver is a freelance writer that writes about personal finance, budgeting, and debt. She is a frequent contributor at Dividendpower.org. Christine works as an office manager by day and a cookie baker at night. She lives in Massachusetts with her family.