Should You Carry Debt into Retirement?
The experts agree! They all say "maybe"
Today we’re going to tackle the question of whether you should carry any debt into retirement. I hate the word “should,” especially in this context. There really isn’t a “should.” There is a risk/return tradeoff and it’s up to you how you play it. Let’s dig in. Oh, and, as always, I’m not a financial advisor. I have no certifications. I have a business undergrad degree with a finance emphasis and I spent my career in corporate finance. That’s all very different than this stuff. Talk with your advisor.
Types of debt
There are lots of types of debt and we could break it out many ways, but for this article I’m going to talk about three types. The first type is the type that has an interest rate higher than the returns on your investment portfolio (like your 401(k) or brokerage account, or money market if that’s where you have your money). This is most debt. Credit cards, other revolving credit and even car loans probably fall into this bucket. The second type of debt is debt that has an interest rate that is less than your portfolio. You probably only have one loan that fits that bill, but it’s probably your largest debt and that is your mortgage. Now, if you only have money in a money market, your mortgage may not even fall in this bucket. The third type of debt is debt that has a progressive or variable rate. You may have a mortgage, equity loan or even a credit card, with this type of rate. Sometimes the interest may be less than you are earning on your portfolio and sometimes it may be more, all within the life of the loan.
The basic premise
The basic premise of most of the articles on this subject is that if you are earning more on the money in your portfolio than you are spending in interest on your loan, keep the money in your portfolio rather than paying off your loan. Makes sense, right? If my million is going to make me 10% this year, but my million dollar mortgage is only going to cost me 3%, I’d rather invest that million and make $100K than use it to pay off my mortgage and save $30K. (There may be a tax advantage to the mortgage, too, which would make my savings even less.) On the other hand, if you are paying 20% on a credit card and you’re only making 10% on your portfolio, pay off the credit card because it’s costing you more than you are making on that money with your investments.
So, let’s tackle the last one first - when the interest you are paying is more than you are earning on your investments. It’s going to be a lot easier to make your money last in retirement if you pay off your high interest debt before you sign up for a fixed income. So, you “should” pay off those credit cards and other high leverage items.
Get out of debt free!
As interest rates rise, this paying off your variable rate and high interest rate debt is getting more urgent, but there are fewer vehicles to do this. If you’re in trouble, though, the first line of defense is to call your creditors. They want SOME money, even if they have to sacrifice a larger upside. You may be able to negotiate a lower interest rate or lump sum.
If you just want to speed up the payment of your debt, try to find a zero interest credit card. The offers are definitely out there, but there are fewer and fewer of them as rates rise. Jump on what you find and try to qualify. Pay very close attention to when the zero interest period expires and what the rate is after that period. Only transfer what you know you can pay off in the zero interest period if the interest rate after that period is higher than the rate you currently have. Then, set about paying it off. Pay the amount that you would pay for both principal and interest on your current card (or more). All of it goes to principal, so you should really accelerate the pay down rate. Keep doing this until you have your revolving debt paid off.
There are a TON of articles, systems, strategies, coaches and advice out there on paying down “bad” debt. This is just the tip of the iceberg. It’s important, so here are a few references to get you started.
Carrying a mortgage (or other loan with low interest) into retirement
A mortgage is a different animal. It’s probably your biggest budget item, but, as we said, it probably isn’t costing you as much as you are making on the money you would use to pay it off. There is also some possibility that it is giving you a tax advantage to write off that interest, though that’s not always the case. With the tax laws that went into effect in 2017, and the probably lower principal (and commensurate interest) you are paying off as you get older, fewer people are able to take advantage of that interest write off. So, let’s look at the pros and cons of taking a mortgage into retirement.
Benefits: On balance, you’ll make more than you spend, if the market comes back from its current retreat (which it likely will, eventually). Also, you may get some tax advantages with mortgage interest. In fact, this article from Schwab even suggests taking out an equity line of credit before you retire to get even more tax advantages. The ROI (return on investment) for keeping your mortgage, then, is usually positive.
Drawbacks: First, consider where the money is coming from. If you are going to take it from a tax advantaged account (like a 401 (k)) consider the tax consequences. If it pushes you into a higher bracket, do the calculations to see if you come out ahead. Secondly, consider market returns. Right now, the market is likely not giving you higher returns than your mortgage. Will that last for the duration of your mortgage? Probably the most important thing to consider is your behavior. If you have the money, will you invest it, or spend it? If you spend it, you are not getting the higher returns so pay off your mortgage and at least get that return. This investopedia article has a fantastic discussion of pros and cons of carrying a mortgage into retirement. It takes a more careful look at the cons than most. Finally, there is the emotional piece to consider…
The emotional part: You’re very likely going to have a fixed income in retirement. If you are living off your investments, once those are gone, that’s it, other than social security - which is largely fixed with a small COLA. Seeing those assets depleted can be stressful. Sometimes, it just “feels” better to have a smaller budget in retirement. This Marketwatch article talks about the stress of holding debt in retirement. It’s real.
I argued with myself for, literally, years on this one. I didn’t carry debt except for my mortgage. The financial part of me knew that holding the mortgage after I retired was the smart move. The emotional part of me really liked the $2,500 reduction to my budget I’d get by paying it off. At the end of the day, I only had a small portion of my loan left and I wasn’t getting much of a tax deduction. (Today, I would be getting zero deduction because of the increased standard deduction.) For various reasons, I got a one-time payout from my employer when I retired and, about a month after I retired, I paid off my mortgage with that money. I figured it was a pretty small margin of financial downside and a huge emotional benefit from not spending as much each month. As you can see, I’m still having the argument with myself. :-) But I’m glad I paid it off. I see the budget every month and it doesn’t cause me anxiety. That’s worth the small financial penalty to me.
So, what do you do?
There is no “one size fits all” for debt in retirement. Having said that, carrying a huge amount of debt into retirement, or carrying a lot of high interest or variable interest debt can really tank things. If you’re using most of your fixed income to pay off debt, there isn’t much left for that vacation or presents for the grandkids - or even a latte from Starbucks. Be kind to yourself and get your spending and budget aligned with your income, meaning don’t gather debt, before you retire. If you already have debt, other than a mortgage, think about ways to redirect your budget to get rid of it. If you only have a mortgage to carry into retirement, though, your risk/reward tradeoff is all yours. If you’re going purely on calculated ROI, most of the time you “should” carry that debt into retirement, but I hate it when people should on me. I won’t do that to you.