Should you make it a priority to retire your debts before you retire? As with other aspects of your financial planning, the answer depends on your personal goals and situation. A debt-free retirement is a goal for many Americans if for no other reason than the peace of mind it can bring. Among retirees surveyed in 2017, 70% of those without any debt said they are confident they can live the lifestyle they want, whereas only 51% of retirees with debt said the same.¹ If having to make debt payments creates financial and emotional stress, then you’ll want to make an effort to eliminate — or at least significantly reduce — your debts before you retire.
Absent a large influx of cash, you may not be in the position to pay off your debts all at once. When deciding which debts you want to pay off first, you should consider which of your debts are “good” and which are “bad”. Generally, good debt is considered to be any debt that will increase your net worth or future value such as a mortgage or student loans. Bad debt is incurred when you purchase things on credit that that quickly lose their value and do not generate long-term income, without the ability to immediately pay for such expenses. Bad debt is also debt that carries a high-interest rate, like credit card debt. Once you’ve determined your good debts and your bad debts, next you should consider how much it costs you to carry each debt and take steps to address your bad debt first.
One option is to pay off credit cards and consumer loans with high-interest rates as soon as possible. Although the money allocated to paying off these debts won’t be available to invest elsewhere, you’re essentially saving money equal to the interest you’d otherwise pay.
Paying Off Your Mortgage
Although your home mortgage can be considered “good debt”, it may be your largest debt and the one you would most like to pay off before you retire. But before you pay it off, check to see if there’s a penalty for prepayment and review the loan amortization schedule to get an idea of how much interest you’d save by accelerating your payments.
With a traditional mortgage, the amount of each monthly payment that goes toward principal increases – and the portion representing interest decreases – as you get further into the loan term. So paying off the loan a few years early may not save as much interest as you’d expect. Sometimes, keeping a mortgage and allocating additional cash flow to other investment opportunities can be a good strategy. Your financial advisor can help you work through the analysis.
Finding the Money
Reducing your debt while saving for retirement may seem daunting, but don’t give up on the idea without examining all your options. Are there ways you can simplify your lifestyle? Could you downsize to a smaller home? Drive a less expensive vehicle? Spend less on college for your children? Steps taken now, before you retire, can go a long way toward freeing up the cash you need to pay off debt, increase your savings and improve your overall financial picture in the years ahead.
Be sure to check out the Accelerated Debt Payoff calculator to help you determine how soon you can pay off your debts based on your personal situation.
¹ LIMRA Secure Retirement Institute, July 2017.