How (and Why) To Minimize Debt In Retirement

Debt plagues many Americans, and retirees aren’t immune. NerdWallet’s annual analysis discovered that the average debt per household in the US climbed to $137,729. This study includes many forms of debt from mortgage to home equity line of credit to auto loans to student loans to credit cards to personal loans to medical costs and more, all of which can impact retirees.

While most household income growth has outpaced the cost of living increases (30% as compared to 19% according to the same NerdWallet study), retirement income doesn’t benefit from that luxury. Social Security does have a cost of living adjustment, but pensions and other investment accounts don’t, meaning retirees need to properly plan their spending to ensure they have enough money to last them through their golden years.

Debt impacts your spending, saving, and investing plan. Too much debt may dictate some of the things you can and can’t do in retirement, hindering your lifestyle. Today, we are going to talk about how to eliminate debt before you retire. 

Know the debt you have

The first step to managing your debt is to list the types of debt you have, the amounts, their corresponding interest rates, and any amount already paid. This information will let you and your financial professionals know where you are, and make a plan for moving forward. 

Let’s look at a hypothetical example. Meg and Bill Barron are both 60 years old and are about five years away from retirement. They have the following debt:

  • Mortgage, $200,000, 3% interest rate for 30 year fixed, 85% paid = $30,000 remaining plus interest.
  • Credit card, $10,000, 15% interest rate, 15% paid = $8,500 remaining plus interest.
    • Unpaid medical bills
  • Auto loan, $30,000, 3.5% interest rate for 60 months, 50% paid = $15,000 remaining plus interest.

This is a significant amount of debt, but not uncommon for their age. A 2019 Experian survey estimated that those aged 56-74 average nearly $97,000 in total consumer debt. 

Not all debt is built alike. Some debt actually furthers your financial future like a mortgage or even business loans. Homeownership allows you to build equity and offers many tax deductions from mortgage interest to property taxes and more; a business loan may help you grow your company. Other types of debt don’t help you build on your financial future, like an auto loan or credit card debt. 

Now that the Barron’s know the debt they have, how should they work to pay it off? 

Two debt reduction strategies to consider

Once you know the type of debt you have, you can then determine the best way to pay it off. The top two strategies to consider are,

  • Debt snowball 
  • Debt avalanche

The debt snowball strategy encourages you to pay the minimum on all your debts, then put extra money toward your smallest debt first to get it out of the way before moving onto the larger debt. The snowball method is great for people to see quicker progress, but can leave some higher-interest debt accumulating longer than necessary. 

Debt avalanche still asks you to make minimum payments on all your debts, but to put any extra money toward the debt with the highest interest rate. Eliminating those big-ticket items will cost you less in interest over the long run and can help you get out of debt faster. For the Barrons, that would mean prioritizing their debt in the following order:

  • Credit Card
  • Auto
  • Mortgage

Their credit card debt is a hefty sum with an interest rate to match. Getting that bad debt out of their lives will help free up cash flow and simplify their retirement income plan. 

The right debt reduction strategy for you depends on the type of debt you have, interest rates, your time horizon for paying it off, as well as your income.  

Understand your retirement lifestyle needs

Excess debt can put some of your retirement plans on hold. It might mean you have to work longer, delay an out-of-state-move, postpone an extended vacation, and more. You don’t want debt to hold you back, so in the five years or so leading up to retirement, take a serious look at your debt and how to get rid of it. 

Take another look at your spending. If you find yourself suffering from too much debt, revisit your spending plan, and work to bring intention to your spending strategy. Ask yourself, 

  • Does this purchase further your goals? 
  • Will this purchase bring you joy? 
  • How does this purchase help or hinder your plan? 
  • Is it a need or a want? 

Aligning your spending with your larger plan will help you connect these ideas and see how they fit together. By connecting your spending with larger goals, values, and future vision, you’ll likely start to spend money better, which can help keep you out of debt. 

Revisit your retirement budget

It’s critical that you make and stick with a retirement budget that works for you. Test drive your budget to see how it works and what adjustments need to be made to make it better. 

Your retirement income plan helps balance your income, cash flow, taxes, and more. To maximize the savings you’ve spent decades accumulating, you don’t want debt to be part of that picture. 

We love helping clients use their money to create the retirement of their dreams. Do you need help organizing a debt repayment strategy? Schedule a call with our team today. We can’t wait to help you build a retirement plan you love.

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