How Debt Can Affect Your Retirement Carmichael Hill

Many Americans are approaching their golden years with some level of debt. In 2016, nearly 61% of US citizens were transitioning into retirement while still bearing debt.[1] While one might assume that expenses would naturally decrease after retiring, that isn’t always the case.[1] Variable rate debt, such as Adjustable-Rate Mortgages (ARM) and credit cards, can add unpredictability to your finances when interest rates rise. Extinguishing debt in other cases can free up cash flow, but it may come at the cost of fewer assets with which to fund your retirement. Whatever the case, a strategy to manage your debt is likely to be beneficial when establishing your retirement plans.

Credit Card Debt Can Stack Up

For starters, keep tabs on your credit card debt. Credit cards are notorious for their steep interest rates, which can dent cash flow and make it seemingly impossible to escape from under the weight of their debt. It’s not generally advisable to retire while carrying high credit card balances as these balances have a way of leading to long-term financial trouble. You may consider working a little longer to get your cards into a manageable position, or in a worst-case scenario consider working with the credit card companies to negotiate down your debt. The latter is known as a charge-off and comes with steep consequences that are beyond the scope of this article. Consider it only as a last resort option.

Long term debt has drawbacks, too

It’s also worthwhile to reconsider your long-term debt, such as student loans and mortgages. Interest rates have risen significantly in the last couple of years. If you are on an Adjustable Rate Mortgage whose terms will adjust in the next few years, then budget for this carefully. Your costs could rise more than you realize. For example, a $400,000 thirty-year mortgage at 3% works out to about $1,686/month before taxes and insurance. The same note at 7% is about $2,661/month. That’s a large adjustment that will eat into a significant portion of your discretionary income in retirement. You may need to save more or consider refinancing the terms of the note to sidestep the impact of the increased debt payment.

It’s becoming more and more common for parents to retire with PLUS loans they took out to help fund their children’s education. Unlike traditional student loans in the name of the student, these loans are in the name of the parent and aren’t eligible for any of the income-driven repayment plans. If you have a PLUS loan, your only options are full repayment or and income-contingent repayment plan. If you qualify for an ICR plan, payments could be forgiven after 25 years of payments. If not, then you’re looking at a situation in which your assets may be drawn down faster than anticipated as you repay these notes. Plan carefully and consider your cash flows in retirement as you determine when and how to pay down your debts!

With the Right Strategy, Retirement Funds Can Help Address Debt

An alternative approach might be to address your debts using a portion of your retirement savings. However, it’s important to note that this method is complex and requires you to understand the tradeoffs of paying off debt in the short term with funds that are meant for your long-term retirement. Some debts, especially “cheap” debt under 3.5%, may be worth holding onto and paying off slowly over time. Other higher rate debt may be worth taking a hit in your retirement accounts to pay down.

You may also consider your Social Security claiming strategy and timeline as a factor in helping you reduce or eliminate your debt in retirement. The extra income could be the added boost you need to get your debt level trending down and potentially eliminate it.

The complexity of weighing near-term cash flow needs with long-term savings does not necessarily mean you shouldn’t explore it; it merely means that determining which choice serves you best can be challenging. A wrong move for you could be financially costly.[1]

If you’re seeking advice on the optimal way to manage your debts, savings, and cash flow as you enter retirement, then give us a call. We’ll schedule a complimentary consultation to address your concerns and get you on the best path forward given your specific circumstances.

 

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