Personal Finance | July 11, 2018

Should You Be Debt-Free Before You Retire?

Key Points

  • How much debt you can comfortably handle in retirement depends on your bigger financial picture.

  • It's not only a question of your assets vs. liabilities but also the type of debt you have.

  • Being debt-free before you retire is an emotional as well as a financial decision. Take the steps now that will allow you to strike the right balance later on.

Dear Carrie,

I hope to retire in about five years and am working on reducing my overall debt, including my mortgage. Should I put off retirement until I'm completely in the black?

—A Reader 

Dear Reader,

This is an excellent question, especially in light of a 2018 brief issued by the Employee Benefit Research Institute (EBRI) indicating that Americans approaching retirement today are more likely to have debt than past generations, with up to 68 percent of households headed by someone 55 or older having debt. The reasons are varied—from the high-cost of housing to ongoing student loan payments. Whatever the reason, carrying a lot of debt in retirement can impact your sense of financial well-being. So while being in debt and retiring aren't mutually exclusive, you're wise to be planning ahead.

To me, keeping control of overall debt is an important part of financial planning no matter what your stage of life. But a flat statement about eliminating all debt in retirement may be too simplistic. That's because the amount of debt you can comfortably handle is very individual and depends on your bigger financial picture.

Start by looking at assets vs. liabilities plus cash flow

Start with a simple net worth statement, listing your liabilities and your assets. This will put the significance of your total debt load in perspective. Do you have a high debt-to-assets ratio? That can be a red flag as you approach retirement.

Next, do a realistic estimate of your monthly retirement income and expenses. Add up your expected income from all sources—Social Security, pensions, real estate, savings, etc.—and subtract your estimated expenses. Don't forget to factor in recurring expenses such as taxes and insurance. And don't underestimate potential healthcare costs.

Ideally, you want to have enough retirement income to cover your expenses and debt payments without depleting your assets. If you have considerable retirement savings as well as other sources of reliable retirement income that will cover your expenses including any debt, then carrying a mortgage, for instance, may not be an issue.

Qualify the type of debt you have

Total debt is important, but so is the type of debt you have. Debt that is low-cost and potentially tax-deductible, such as a mortgage or student loans, may actually work in your favor. But high-cost consumer debt—things like car loans and, especially, credit card balances—can really derail you if you're not careful.

This is the type of debt you should try to get rid of no matter what your retirement plans are. I'd start with credit cards. If you're carrying multiple balances, prioritize your payments. Tackle the highest interest balances first, increasing payments if you can, while paying at least the minimum on your other balances. Work your way down the list until everything is paid off.

Consolidating balances on a low-interest card and maximizing that payment is another option. But beware of the potential high-cost and hidden fees of loan consolidation offers. Once you have your credit card debt under control—and hopefully eliminated for good—start upping the payments on a car loan.

Do the math on your mortgage

Whether or not to pay off your mortgage before retiring is an ongoing question. A 2018 study by Annamaria Lusardi, Olivia S. Mitchell, and Noemi Oggero notes that mortgage debt is a primary cause of financial vulnerability for today's retirees. I agree that making mortgage payments in retirement can be a budgeting challenge, depending on the percentage of your monthly income your payment represents. But in certain circumstances, if you have a low-interest, tax-deductible mortgage, it could actually make economic sense to keep it.

For example, if you itemize your deductions and have a fully deductible 5 percent fixed loan on your home and a combined federal and state tax rate of 30 percent, your mortgage is really only costing you 3.5 percent per year. On the one hand, paying it off would be equivalent to a risk-free 3.5 percent return on your money. On the other, you might be able to invest those funds elsewhere at a potentially higher return.

So it really comes down to dollars and cents. If your monthly mortgage payment is going to represent a big chunk of your retirement income, you're probably wise to try to pay it off in advance. However, if you're confident you'll be able to cover your mortgage in retirement without sacrificing other essentials, or if paying it off now would dangerously deplete your savings, it could make more sense to just continue making your regular monthly payments.

Consider your feelings

Numbers aside, if you're convinced that being debt-free in retirement will give you the greatest sense of security, then that should be your focus. Get rid of consumer debt first. Make additional payments on your mortgage, as you're able. And give yourself a realistic retirement timetable—one that will allow you enough time to plan and save for a comfortable future.


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