Managing debt in retirement requires planning, discipline
Owing money in retirement isn’t ideal — but most people do.
Seventy percent of U.S. households headed by people ages 65 to 74 had at least some debt in 2016, according to the Federal Reserve’s latest Survey of Consumer Finances. So did half of those 75 and older.
Paying debt usually gets more difficult on a fixed income. Mortgage debt, especially, can be a huge burden in retirement. Retirees may have to withdraw larger amounts from their retirement funds to cover payments on debt, which can trigger higher tax bills and increase the chances they’ll run short of money.
People have the most options to deal with debt if they create a plan before they retire, financial planners say. Refinancing a mortgage, for example, is usually less of a hassle while people are still employed. It’s also typically easier to generate the extra income that may be needed to pay off debt.
“It is much easier to keep working for another year or two than to try and come back into the workforce when they are older and the employer needs have changed,” says Linda Farinola, a certified financial planner in Princeton, J.N.
Here are three loans to consider before you stop working:
Refinance (or recast) your mortgage
Certified financial planner Rebecca L. Kennedy, of Denver, would prefer that clients pay off their mortgages before they retire. But paying off a mortgage may not be feasible or advisable, especially if it would mean taking a lot of money from a 401(k), IRA or other account.
“Often the majority of the assets are pretax, so it would require a much larger withdrawal to net the after-tax amount needed,” Kennedy says.
People also could consider downsizing to eliminate or reduce mortgage debt, Farinola says.
For retirees determined to stay put, refinancing or “recasting” the loan can lower payments, says Serina Shyu, a certified financial planner in Atlanta. While refinancing requires taking out a new loan, with substantial fees, recasting means keeping the same loan, but using a lump sum to pay down the balance and lower the payments. Recasting is offered by some but not all lenders.
Another option, if the mortgage balance is less than half of the home’s value, is using a reverse mortgage to pay it off. Reverse mortgages allow people 62 and older to tap their home equity without having to pay the money back until they move out, sell the house or die.
Consolidate debt
Credit card debt indicates people may be living above their means. That’s not something that tends to get better when incomes drop in retirement, Farinola says.
“I find that if people cannot pay off debt when they are working, they certainly cannot when they retire and the cycle just continues,” she says.
People with good credit scores, and sufficient discipline, can use zero-percent balance transfer offers to consolidate and pay off their credit card debt. Those who need more time to pay off debt might consider a personal loan with a fixed interest rate and fixed payments.
Get a HELOC
A home equity line of credit is like a credit card that allows you to borrow against the value of your home. If that sounds dangerous — good. It should.
HELOCs shouldn’t be used for frivolous spending, but they can be a good backup to an emergency fund. HELOCs also can fund home repairs or longterm care.
A HELOC probably isn’t a good option for people who aren’t disciplined about their spending. And they have another big pitfall: Payments on any borrowed money can spike after an initial interest-only “draw period” ends, usually after 10 years.