More Americans are retiring in the red. Before joining them, figure out how much your bills will hinder you.
Not so long ago “debt” was a four-letter word when spoken in the same breath as “retirement”. Before waltzing into their golden years older Americans paid off their loan, then celebrated by burning the mortgage.
How things have changed! Now a third of folks 65 and older have a mortgage vs. 20% two decades ago, according to recent Census data. Median balance:$56,000. Meanwhile, seniors 65 and up carry an average $10,235 on credit cards, think tank Demos reports. The affluent are not immune, either. Among household headed by those 65 and up with incomes over $100,000, 25% have nonmortgage liabilities, says the Center for Retirement Research at Boston College.
You don’t have to be totally debt-free before your golden years, to be sure. But financial planners caution that too much red ink, and the wrong kinds, can diminish your standard of living. Make sure IOUs won’t weight you down by taking these steps before retirement:
See how you’d manage
Remember that your income is likely to decline once you leave the workforce. You don’t want to go into retirement with more obligations than you can honor. So use the Retirement Income Planner at troweprice.com to estimate what you’ll get annually from pensions, Social Security, and investments. Then total up the monthly nut on mortgages, car loans, and other installment loans; add on what it would take per month to pay off your credit card in three years and your HELOC in five (you can use the debt-reduction planner at CNNMoney.com/tools to calculate both). Divide the sum by your projected monthly income.
In your working years, you shouldn’t spend more than 25% of gross income on mortgage debt, 10% on other debt. In retirement, when you’re living at least partially off your investments, your mortgage should consume no more than 15% of income, other debt 5%. Think you’ll be above that? Speed up paydown in the years before quitting. You may also have to work longer, take on a job in retirement, or move to a less costly home.
Eliminate the worst bad debt
Just because you could handle your debt in retirement doesn’t mean you should. In particular, try to wipe out credit card balances. Plastic usually carries the highest rates, now an average 15%. Since you’re unlikely to get as high a return on your investments, you’re better off taking a lump sum from savings to pay the bill. Rather not? Ask the issuer for a better APR or transfer the balance to a lower-rate card while you chip away at the debt. Once you’ve zeroed out cards, pay down other “bad” debts, - those that carry high rates, that aren’t tax-deductible, or that paid for assets that lose value, like cars.
Determine if good debt is good
In today’s low-rate environment, as long as you can continue making payments on your mortgage, you may benefit from keeping the loan. This is especially true if your savings are mostly in tax-deferred accounts and you are still getting the interest write-off. The reason: Cashing in assets in tax-sheltered accounts to pay the balance will cost you. Generally federal, state, and local taxes and possible tax penalties negate interest savings on the mortgage.
Have money outside tax-deferred accounts? In the long run stocks should produce more than the 3% to 4% you’re paying on your mortgage. So if your stash is in equities, you may want to let it ride. Or, wait until your yearly portfolio rebalancing – and if your stock stake has risen above your target allocation, sell some equities and put the proceeds toward the debt. For those whose money is mostly in low-interest, fixed-income investments, paying down the loan could be prudent. Ideally the lost mortgage payments should be greater than the lost income from the asset that you sold.
Will your debt be a burden?
What’s fine to carry now may not be fine in retirement, when your income is likely to drop 20% or so. Take this scenario with $30,000 in liabilities:
