Should You Enter Retirement Debt-free? I Am Not So Sure.

Person holding white printer paper with a foreign language printed on it

Over the years, you’ve likely heard me discuss the concept that no one retirement is the same. How you plan to spend your post-work days, with whom, and with how much in savings is truly unique to every individual and couple. Some have a healthy appetite for risk and will invest in higher risk market-based investments, whereas others may take a less aggressive approach and are willing to set aside more money to reach their goal.

So, it should be no surprise that the question of how much debt to carry into retirement is also a unique factor. It always surprises me when I see industry articles and opinions recommending everyone pay off every debt – including a mortgage – before entering retirement. A one-size-fits-all approach like this can be dangerous at its worst, and in some cases require an individual to delay retirement much longer than necessary in search of this goal.

Take a recent conversation I had with a couple I met with a few weeks back, I’ll call them Eddie and Natalie. They are a couple in their upper-50’s from Seconsett Island and came in for help to get their finances in order for retirement. After decades of saving in their companies’ 401k plans and socking money away in their Roth IRAs, they’ve almost reached their savings goal. But they have one nagging concern – their mortgage.

You see, they still owe about $150,000 on their original $550,000 mortgage. They’ve did some online research and so much of it points to the idea of retiring debt-free. They agree that this would be the ideal scenario for anyone, but for them it means an additional 3 years in the workplace to achieve. They could do it, but they’d really rather not. Natalie in particular has recently been suffering from arthritis and this makes it more challenging to spend long hours at her computer each day. 

We first discussed shifting from an accumulation investment strategy to a distribution strategy.  Once I showed them how to incorporate downside risk mitigation into their strategy . . . they got it.  We then discussed whether it made sense to use some of their retirement money to pay off their mortgage, and then work the extra 3 years to make this back. This opened up a discussion of the types of things that many pre-retirees have to consider when faced with this situation. So, this week let’s look at a few ways to approach this dilemma.

Now, there’s no doubt that debt-free living can give you a certain sense of freedom. I get it, not owing anyone anything can be a great retirement dream scenario. But as we all know, reality can be a bit different.  There’s a common distinction made between “good debt” and “bad debt.” But you must know the difference. And to keep debt from ruining your plans, you also have to figure out how much debt you can comfortably handle in retirement. Here are some ways to go about it.

First, consider the types of debt you have. For example, there are some types of debt that create opportunities can actually work for you. It helps if it’s also has tax advantages. For instance, with mortgages or home equity lines of credit, you’re borrowing to own a potentially appreciating asset. On top of that, home loans may be tax-deductible. So this falls into the category of good debt.

Things like credit card debt and car loans fall into the “bad debt” category. For example, think about the high monthly payments for a new car that decreases in value the minute you drive it off the lot. This is the kind of deb that really works against you.  If you believe that being debt-free as you enter retirement is not realistic, then the goal should be to pay down any bad debt while keeping the good debt working for you.

One approach is to prioritize your debt payments. Instead of trying to tackle every bill at once, develop a repayment “plan”. For example, if you have credit card debt, this should probably be your top priority. Focus on highest-interest debt first, increasing the payment if you can, while continuing to at least make minimum payments on the rest. Work your way down until everything is paid off. You could also consolidate them on a low-interest card and pay the maximum that you can afford each month. But be very careful of loan consolidation offers. While some are legitimate, others have up-front fees and hidden costs.

And luckily, paying down debt and saving for retirement doesn’t have to be an either/or proposition. The two can work together. Once again, you have to prioritize. For example, be sure to continue saving enough in your 401k to receive your employer’s entire match.  You’ll also want to ensure that you have an emergency fund that can cover a minimum of 3 to 6 months’ worth of expenses. 

Lastly, assess your mortgage. For most of us, our mortgage is probably our largest debt. With the current low interest rate environment we’re in, you might benefit by putting potential “extra” mortgage payments into your investments to give your money a chance to grow. You might also consider a shorter term (say fifteen years), which will carry a lower interest rate.

Taking money out of a 401(k) or an IRA to pay off your mortgage is almost always a bad idea, especially if you haven’t reached age 59½. You’ll owe penalties and income taxes on your withdrawal, which will likely offset any benefit of an early payoff. If you’re age 59½ or older, letting the money stay in your account and continue to grow can still be a better option if your rate of return is higher than the interest rate you’re paying on your mortgage. Don’t forget, a large withdrawal to pay off your mortgage could catapult you into a higher tax bracket.

As you can see, there’s no one approach will work best for everyone, so don’t rely solely on what you read – investigate all of your options to always put yourself in the highest probability for financial success!

And as always – be vigilant and stay alert, because you deserve more!

Have a great week.

Jeff Cutter offers investment advisory services through Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield. 

Jeff can be reached at Insurance products, including annuities, are offered through Cutterinsure, Inc., (MA insurance license #2080572). Cutter Financial Group and Cutterinsure are affiliated and under common control but offer services separately. Members of Cutter Financial Group’s management receive revenue directly from Cutterinsure. Any compensation received is separate from and does not offset regular advisory fees. Cutter Financial Group does not charge advisory fees on any insurance products. We do not offer tax or legal advice. Always consult with qualified tax/legal professionals regarding your own situation. Investing in securities involves risk, including possible loss of principal. Insurance product guarantees are backed by the financial strength and claims-paying ability of the issuing company. This article is intended to provide general information. It is not intended to offer or deliver investment advice in any way. Market data and other cited or linked-to content in this article is based on generally available information and is believed to be reliable. Please contact us to request a free copy of Cutter Financials’ Form CRS, Form ADV 2A and applicable Form ADV 2Bs.