Mortgage payments, credit cards, car loans – the demands on our income are constant. To be approaching retirement age and continuing to worry about paying down debt can create enormous stress, but it isn’t unusual. Unfortunately, retiring with debt is or will be a fact of life for many. In fact, 77.1 percent of families headed by those ages 55 to 64 continue to have debt, according to the Employee Benefit Research Institute.
So, if you currently carry debt, it is important to prepare and attempt to minimize that debt as effectively as possible in the years leading up to retirement.
Folks, if you don’t know how much debt you have, you’re in good company. I recently met with a newer client, let’s call him Sam, to build out his Distribution Income Plan (DIP). Sam’s a good guy. He is 58, married with two grown kids, gearing up for retirement in 5 years. He recently relocated from Connecticut to Sandwich and was referred into us by a current client of ours. The first piece of information we need to build out a sound DIP is to understand expenses and debt. In Sam’s case, he couldn’t account for thousands of dollars a month in expenses related to his debt. After some digging, while it turned out they were legitimate expenses, over time Sam lost track of who was being paid for what. As you approach your retirement years, it is especially important to take stock of what you owe, to whom, and what type of debt it is. Having this knowledge can help you make decisions about how best to tackle your debt.
I explained to Sam that it is just as important to either create, update or revisit your budget. (Hopefully if you are a regular Cutter Family Finance reader, you already understand the importance of a budget and have one in place.) Identify your income, and more importantly, your recurring expenses – mortgage, insurance, utility, travel and entertainment, food, and any other so-called “normal” living expenses. Then try to find ways to reduce those living expenses – after all, if cutting down debt is your priority, creating more distance between what you make and what you pay could give you a little extra every month to redirect to debt repayment.
Just make sure, as you think about your budget, that you have a cash reserve on hand – or at the very least, assets that can be easily converted to cash if need be. It makes no sense to pay down debt only to increase the risk of incurring more debt in the future for an unforeseen expense.
Once you have a good handle on your budget, take an even closer look at any debt you owe. Account for credit cards, personal loans, auto loans, home loans, mortgages and medical bills. Identify the creditor, the type of loan, the monthly payment due, and the total balance. Finally, include the interest rate for each loan you have. Take a careful look at that last column – the interest rate. Paying down the loans with the highest interest rate first (while still making the minimum payments on the others) can be an appropriate way to save money long-term. Once you’ve paid off – or made a plan to pay off – your most expensive debt (that with the highest interest rate), focus on any debt that is not deductible, such as auto loans.
Now, when coming up with a strategy for your deductible debt, bear in mind that 2018 brought critical changes to the tax code, which may result in fewer people itemizing their deductions and taking a mortgage interest deduction. The standard deduction has been almost doubled. Personal exemptions have been eliminated and the mortgage interest deduction has been reduced. Under current law, you can deduct interest on up to $750,000 of mortgage debt incurred to buy or improve a first or second residence. Previously, you could deduct interest on up to $1 million of home acquisition debt. Now, there is also a $10,000 cap on the state and local tax (SALT) deduction. Understanding these new rules and knowing whether or not you will take an income tax deduction for your mortgage interest will help when deciding how to prioritize the repayment of debt.
Another thing to consider when coming up with a plan to reduce debt is the most efficient use of your resources and assets. If the cost of financing your debt is significantly more than the return on some of your lower-yield investments, such as bonds and CDs, consider liquidating those investments to reduce that higher-cost debt. Also, consider selling off unused or underused assets to help reduce your debt load.
If you have looked at everything and are still carrying credit card debt you can’t pay off right now, consider taking advantage of balance transfers to lower-rate cards. But if the lower interest rate is offered for a limited period, plan to pay off the balance before the introductory period ends. Also look at debt consolidation. Although interest rates are rising, there still may be opportunities for you to combine several debts into a single loan with an interest rate that is lower than the overall effective interest rate of the combined individual debts.
And remember that as much as you may want to get that monkey off your back, most people should avoid taking money out of retirement accounts to help pay down debt. If you do take money from a tax-deferred retirement account to pay down debt, not only will you reduce the power of compounding interest on your savings, but you will also owe income tax on any withdrawal. More importantly, you will be assessed penalties on any such withdrawals if you are under age 59 ½.
In the end, Sam did a great job building and working his budget into his DIP and you can do the same. While carrying some debt into retirement may be unavoidable, the earlier you develop a plan to lower your debt as you approach retirement, the easier it is to manage.
Be vigilant and stay alert, because you deserve more.
Have a great week.
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC. A wealth management firm with offices is Falmouth, Duxbury, and Mansfield. Jeff can be reached at firstname.lastname@example.org.
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