Should you have any debt in retirement?

June 25, 2011 | By Steven DiGregorio

Debt isn’t a bad thing, just as long as you understand the differences between good debt and bad debt.

Many financial advisers have claimed when it came to debt and retirement: The only good debt is debt that’s retired!

No doubt, going into retirement without much debt has plenty of benefits.  Cash flow is better; it helps you sleep a little easier and often means that you can have a respectable net return on your investments.

Generally speaking though, debt is a negative asset.  Pay it off and it’s like earning the return of what the debt used to cost! Money back in YOUR pocket!

But with interest rates still near historic lows and the “cash is king” mentality approaching debt from a strategic perspective is a smarter play.  Choosing to carry certain debt in retirement, if it makes good financial sense, may not be bad.

You see, not all debt is necessarily bad debt.   The key is how to manage debt in retirement so it works to your advantage. So let’s look at some kinds of debt and see if it makes sense for you.

1.  Mortgage debt – Good, as long as you lock in a low rate and earn a better return on your money elsewhere!

The old advice was to plan your mortgage-burning party before your retirement party. That was when retirees tended not to move and interest rates were much higher, in the 9% to 12% range.  Now that people often move when they retire and 30-year fixed-rate mortgage loans are hovering at about 5%, owning the house outright is less of a priority. In fact, depending on your circumstances, you may be better off keeping your mortgage than paying it off.

Among other things, you’ll want to look at the after-tax effect of forgoing the mortgage-interest deduction. If doing so bumps you into a higher bracket, it could have broader implications, such as raising the taxes you owe on IRA withdrawals.

Also take into account how you will fund the payoff. It’s one thing if you have cash to spare earning less than 1%, but quite another if you dip into a high-yielding portfolio or worse by giving up saving in your 401(k) account to just to pay off the mortgage.

Keep in mind too that paying off your mortgage means giving up liquidity, and that can leave you in a more precarious situation, especially after retirement.  It’s always easier to dip into your savings than to go back and get money out of your mortgage, especially after you’ve retired.  In fact, for that very reason you may want to consider applying for a home equity line of credit before retiring.  Any credit is easier to obtain when you still have a steady stream of earned income.

Having that cushion can prevent you from cashing out of investments prematurely or having to rely on high-interest credit cards as a backstop.  Uniquely, you only pay interest on the equity you actually use, and any interest you do pay is, in most cases, tax-deductible. Just don’t treat your equity line as a bottomless piggy bank.

2. Car loan – Bad, unless you’re paying next to nothing in interest

From an asset perspective, there is no sense paying interest on something that loses value over time. After several years of weak car sales dealers have gotten aggressive about incentives, with many offering rates at or near 0%, so keep that in mind during your search.

That said, before you sign on the dotted line, compare the total cost of financing a car with paying for one outright.  You may getter a bigger discount if you pay cash.

3.  Student Loans – Let your kids bear the responsibility, you can always help.

There are more parents today nearing retirement age just as junior is graduating from college.  Those loans a scary thought?  Of course, it’s natural to want to help your child pay for a college education, but planners recommend avoiding parental loans whenever possible.

Here’s a better idea: Help your child apply for student loans in his or her name and then, if you must, help them out later when it’s time for them to make payments. Start by looking at federal student loans, which typically carry low fixed rates, offer income-based repayment plans, and can be deferred or even forgiven.

Even if you don’t think you’ll qualify for financial aid, you’ll still need to complete the Free Application for Federal Student Aid (FAFSA) to receive subsidized loans, which are based on financial need, as well as unsubsidized loans, which are not need-based.

Once you’ve secured loans in your child’s name, you can always help them make payments later. But this way you’re not on the hook for the loan and you’ve given you child a vested interest in his education.  Let’s hope my kids don’t hate me for that!

4.  Credit cards – Bad and bad.  No matter what, pay them off as quickly as possible.

When it comes to credit cards the question isn’t whether to pay them off before retirement but how. The wrong way is tapping into your retirement savings. This is not only short-sighted, it’s too easy. Likewise, don’t let big credit card debts stop you from contributing to your 401(k) or other retirement savings plan, especially if you’re eligible for a company match.

A better strategy: First, get a handle on how much credit card debt you have, the interest rate(s) you pay and your total monthly finance charges. Next, take a good hard look at what expenses account for the bulk of your debt.  Unless you can stop the bleeding there’s no point in paying off the debt.  Study your year-end statement for insight into where the money went.

Finally, devise a plan to pay off your credit card or other unsecured debt by the time you retire. If you expect a lump sum from a tax refund, a bonus or the sale of a non-retirement asset, put that money toward your cards. Otherwise, you’ll need to trim expenses and commit to paying a set amount every month. Treat that payment like any other bill.

If you have debt on multiple cards, consider paying off the lowest balances first. Then allocate that payment as an addition to the next lowest balance card, thereby paying that one off faster.  The snowball continues and before you know it….you’re debt free!  Seeing a zero balance on a card is often good motivation to ramp up your efforts on the next.

When it comes to the double-digit rates you may be paying on your cards, transfer your debt to cards with low or zero-rate offers.  Just make sure you cancel your old card too. If your debt is more extensive, call the credit card companies to negotiate a lower rate or work out a payment plan.

Ideally, you should want to delay retirement until you’ve closed the chapter on credit card debt once and for all.  Accomplish that small goal and you will surely rest easier in retirement.

For more information contact us at 845.563.0537 or Contact@CompassAMG.com

The author of this blog, Steven M DiGregorio is President of Compass Asset Management Group, LLC and an Investment Advisor Representative with Spire Wealth Management, LLC a Federally Registered Investment Advisory Firm.  Securities offered through an affilliated company Spire Securities, LLC a Registered Broker/Dealer and member FINRA/SIPC.

Tags: bad debt, car loan, cash flow, credit cards, debt, good debt, home equity, loan, mortgage, retirement, school loans, student loans

STEVEN M DIGREGORIO is President of Compass Asset Management Group, LLC and an Investment Advisor Representative with Spire Wealth Management, LLC.
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