In addition to decumulating wealth, aging Americans now need to manage and pay off heavy debt burdens in retirement.
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 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 is could be thought of as the minimum one might need to weather a health shock or other costly financial emergency.”
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►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, that usually means, he says:
►Pay off your highest interest debt first, prioritized by non-deductible debt before deductible. 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 and use the money to lighten your financial burden,” says Tresidder.
►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, says St. Clair. “Is it the debt or the debt-service that needs reducing?” he asks. “Recognizing this important difference can help reveal possibilities we might otherwise remain blind to.”
In retirement, this often comes at the expense of taking additional IRA withdrawals. “But if you’re accelerating an IRA distribution to make current debt payments, you may be choosing to pay 25%, 30%, 35% or more in combined state and federal income taxes to accelerate the payoff of something that’s costing you 4%, 5% or 6%,” says St. Clair. “Talk about stepping over dollars to get to dimes.”
►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 month 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, says Tresidder. 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. One resource: https://financialmentor.com/calculator/debt-snowball-calculator.
►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, the owner of Branning Wealth Management.
The HECM is Federal Housing Administration’s reverse mortgage program which enables homeowners 62 or older to withdraw some of the equity in the home. It can be used to pay off a traditional mortgage balance and potentially require not additional monthly principal and interest payments.
►Other options. Consider downsizing, moving to a low tax state, and tapping retirement accounts. Lusardi also recommends avoid late payments which can affect credit scores and also generate higher debt payments in the future.
►If you haven’t retired yet. If you are still working and think you might retire with mortgage and other types of debt, consider upping the amount you save or paying down your debt more aggressively before you retire. “In the past, most households arrived in retirement free and clear of their house payments,” says Geoffrey Sanzenbacher, the associate director of research at the Center for Retirement Research at Boston College. “Today that is less common as more households have some mortgage debt, often from HELOCs or refinancing from the housing boom. This fact means they need to have more saved up in their retirement accounts so they can keep paying that mortgage even once retired.”
Robert Powell contributes regularly to USA TODAY, TheStreet, and The Wall Street Journal. Got questions about money? Email Bob at firstname.lastname@example.org.
Retirement columnist Robert Powell (Photo: USA TODAY, USA TODAY)