Retired and in debt? Don’t worry, it’s fixable
Americans are more likely to enter retirement in debt than ever before.
And that, according to researchers and financial planners, poses some concerns. Why so?
Well, in addition to decumulating wealth, aging Americans now need to manage and pay off heavy debt burdens in retirement, according to Annamaria Lusardi, a professor at George Washington University; Olivia Mitchell, a professor at the University of Pennsylvania; and Noemi Oggero, a researcher at George Washington University, authors of The Changing Face of Debt and Financial Fragility at Older Ages.
So, how might you deal with debt — be it credit cards, student loans, auto loans and/or a mortgage — in retirement? ❚ Check your financial fragility. First, consider what Lusardi, Mitchell, and Oggero call your financial fragility, whether the amount of debt you have could be a problem.
So, you might be financially fragile if you have a total debt to asset ratio greater than 0.5; have a primary residence loan to home value ratio above 0.5; have another debt to liquid asset ratio above 0.5; and have a total net worth lower than $25,000, which, the authors noted, “is approximately half of median income, and it could be thought of as the minimum one might need to weather a health shock or other costly financial emergency.”
❚ Create a plan. If you are or are close to being financially fragile, create a plan to pay down your debt.
“The simplistic, financially accurate answer is to do whatever provides the highest after-tax return,” says Todd Tresidder, a financial coach with FinancialMentor.com.
In simple terms, he says, that usually means: ❚ Pay off your highest interest debt first. Lusardi agrees with this approach. “Try to repay first the highest cost debt since interest rates charged on non-collateralized debt — for example, credit cards — are normally quite high,” she says.
❚ Liquidate other assets to pay off debt if the return on investment is lower than the carrying cost of the
debt. “For example, many CDs are paying substantially less than debt financing costs, so it might make sense to liquidate the CD at maturity and use the proceeds to pay off the highest cost debt,” Tresidder says.
❚ Consider selling off any personal assets that you don’t use regularly and aren’t bringing you great joy, and
use the proceeds to pay off debt. “For example, consider selling that boat you haven’t used for the last two years or that fancy jewelry that sits in the safe deposit box,” Tresidder says.
❚ Think about debt service. Generally, the assessment of “too much debt” is made relative to “too little income,” says Don St. Clair, president of St. Clair Financial.
Now most retirees — at least those who can’t work part or full time to pay down their debt — think about reducing their overall debt. But that may be the wrong approach, St. Clair says.
In retirement, this often comes at the expense of taking additional IRA withdrawals.
❚ Consolidate your loans. “Reducing your debt service probably won’t reduce your debt,” St. Clair advises. “Consolidating a car loan, credit cards and/or stretching out your mortgage term won’t help you pay off the debt any sooner. But it can cut your monthly debt service and put more back into your monthly money. And maybe even spare your IRA from a premature death.”
❚ Want to be debt-free? Consider using either the debt snowball or a debt avalanche strategy to pay down your debt, Tresidder says. With the snowball, you would pay off the smallest debt first while making only minimum monthly payments on all the other debts.
With the avalanche, you would pay the minimum payment on each debt and devote any remaining debt-repayment funds to repaying the debt with the highest interest rate, according to Investopedia.
Tresidder favors the debt snowball strategy.
“It’s the most cost-effective, fastest and emotionally satisfying way to get out of debt,” he says.
❚ Consider a reverse mortgage. If you have a traditional mortgage, examine whether replacing it with a Home Equity Conversion Mortgage (HECM) makes sense, says Jason Branning, owner of Branning Wealth Management.
❚ Other options. Consider downsizing, moving to a low tax state and tapping retirement accounts. Lusardi also recommends avoiding late payments, which can affect credit scores and also generate higher debt payments in the future.
Robert Powell contributes regularly to USA TODAY, TheStreet and “The Wall Street Journal.” Got questions about money? Email Bob at rpowell@allthingsretirement.com.