One of the greatest threats to baby boomers today is not that they don’t save enough, but they owe too much. According to the statistics, many baby boomers are carrying a significant amount of debt into retirement. Recently I read that as many as 61.3% of household’s adults older than 60 have the median total debt around $40,900.
Paying off debt can be a long journey and it depends on how much you have accumulated it over the years. When you retire and start living on the fixed income it will be hard to balance the fun of retirement and worries about finances – and debt is a big reason why.
Primary sources of debt
There are several primary sources of debt we have the tendency to collect during life:
- mortgage debt
- credit card debt
- student loan debt (if you have kids)
Then there is other debt like car loans, home renovation loans, medical expenses, etc.
For most people, the largest liability is their home mortgage.
In fact, nearly 33 percent of total household spending goes toward this one big-ticket item.
On top of the mortgage debt, there is a credit card debt. Many baby boomers carry the highest amount of credit card debt than previous generations. On average people between age, 55 to 64 owe more than $10,000 in credit card debt. And if you have kids you will be already paying for their education.
If you want to enjoy a debt-free retirement, you need to pay off, reduce or get rid of as much of your debt as possible.
Simple ways to pay off debt before retirement:
1. Start with analyzing your personal problems
Do you have bad spending habits? Are you an impulsive shopper?
If the answer is yes, you need to make a plan for how to improve and control it:
- There is a line between the necessities and luxuries. Too often we forget about it. It can be useful to break out your spending into needs and wants.
Your needs are the necessary living expenses like housing, groceries, utilities, transportation, health care.
Your wants are things like nice-to-haves, but not required for everyday survival. Things like travel, hobbies, expensive cars and clothes.
Popular 50/30/20 rule of thumb to follow:
According to this rule, you should budget 50 percent of your household income towards needs, 30 percent toward wants and 20 percent on savings. Paying off the debt should be included in 20 percent.
If you’re serious about reducing your debt, you need mentally say goodbye to some luxuries in your life:
- dining out every weekend
- visits to the spa and manicure/ pedicure salons
- new clothes, shoes, and bags for every season
- luxury vacation.
If you don’t control how much you spend, eventually you’ll add more new credit card debt to the old one.
2. Create a plan of paying off your debt
Creating a plan of how to pay off the debt is as important as sticking to that plan. After all, if you come up with the plan, put it on the paper or your excel spreadsheet, but never follow it through, you’ll be disappointed before you see any results.
If you have various debt, you need to decide which one to pay off first and which one is the last one.
There are two simple strategies to pay off the debt:
The snowball strategy is popular among Dave Ramsey followers.
If you want to use this strategy, start by paying off the debt with the smallest balance, while continuing to make minimum payments on the larger balance debt. The plan is to pay off the first debt as fast as possible by adding all extra money to the principal.
When you finish paying off the first debt, move to the next one. Once the first debt is crossed off the list, use all extra money to pay off the second debt and then go on until all debt is paid off in full.
There is a psychological effect behind the crossing each debt of the list, which helps to motivate you and create momentum.
The debt avalanche strategy.
If you want to use this strategy, start by paying off the debt with the highest interest rate, while continuing to make minimum payments on the lower interest rate debt. Once the debt is paid off, apply all extra money towards the next-highest interest rate debt.
You should choose whichever method makes more sense to you.
If getting a small victory is more appealing to your personality, then go with the snowball method. But it’s good to remember that credit card debt typically comes with a high-interest rate. The longer it takes you to pay it off, the more you will pay in interest.
Unlike mortgage and student loan interest, you can’t deduct credit card interest on your tax return.
My husband Roman and I created a plan before we seriously started paying off our debt.
The deck avalanche strategy works better for us. It helps to save the most money in interest payments. However, depending on the size of the debt, it might take longer to pay off the balance and finally cross the debt off the list.
Currently, we are paying off our daughter’s student loans.
We have three different loans with interest rates of 6.49% the highest, then 6.35% and the last one is 6.01%. We started paying off the highest interest rate loan of 6.49% and were very happy to cross it off the list. After that, we moved all extra money towards the next-highest of 6.35%.
We are planning to pay off the rest of student loans by the end of 2019. (Note: I am happy to report that we finally paid off all student loans. The last check was sent on December 15th, 2019.)
Should you pay off your mortgage?
For many of us, the mortgage debt is the largest in our budgets.
It is my dream to pay off the mortgage before we retire. But I don’t think it is possible. And I am not alone. To be mortgage -free is a dream for many people who are close to retirement.
Roman and I refinanced our house many times. But even with a low- interest rate of 3.5 percent, the mortgage payments take the biggest chunk of our budget.
If you are like me and worry about how to afford mortgage payments in retirement, there are several options to consider:
- Downsizing. Your home is one of the biggest investments. If you’ve been living there for a long time, it went up in price and accumulated a lot of equity. One of the ways to get rid of mortgage payments and home maintenance bills is to sell the house.
You can sell the big house and trade down for a smaller house or a condo. Or you can move to a cheaper area and pay cash for your new house.
- Invest equity. Maybe you don’t want to have a hassle of home ownership in retirement. You want to travel or visit your family and friends. The other option will be to sell the house, invest the cash, and enjoy living on rent and mortgage-free. Investing the cash from the home sale will bring additional income in retirement. Let it grow for 10 years in your investment portfolio, and it might be enough to pay cash for your next house or a condo if you are tired of renting.
Don’t create new debt, while paying off old ones
You have created a strong plan to pay off the debt in the next 12 months. Suddenly your car broke down and or your house furnace blow in the middle of the winter. Emergencies like that could come with the hefty bill.
If you don’t have extra cash available you might be forced to take a new loan or put it on the credit card.
By adding new debt to the old ones, you might feel emotionally defeated and stop trying to pay off all debt.
But if you have saved some money in the emergency fund, it will help you to avoid taking more debt. The best practice is to have saved from 3 to 6 months of monthly expenses in a separate saving account, so you can have access to your emergency money any time you need them.
To save for retirement or pay off a debt?
It’s hard to save for retirement when you’re trying to pay off the debt. There are so many financial decisions to make and it feels like you don’t go ahead on anything.
Please don’t try to reduce your debt by cashing out 401(k) or other retirement accounts. It seems like an easy step to take money out of your retirement savings and reduce your debt. But you’ll regret it later. Retirement savings are for retirement.
If you are under 59 ½, you’ll be charged 10% penalty fee for early withdrawals from 401(k) and traditional IRA accounts. In addition to that, you could be pushed into a higher tax bracket, if you take money from your retirement accounts.
If you are older than 59 ½ and allowed to take money without being penalized, you might be still paying the price of being in a higher tax bracket.
My advice is to continue saving for retirement and create a plan to pay off the debt.
It might take longer, but in the end, you’ll be proud of yourself that you stick to the plan. Your retirement savings will be growing, and your debt will be reduced with every month. In the end it will be a win-win situation.
Discuss the plan with your partner
It’s always a good idea to discuss your plans with the spouse or partner. After all, it will be a team effort to create a plan and to stick to it.
For many of us living in retirement with debt might be a constant source of stress and anxiety. If we don’t plan for reducing it now, we will be facing the challenge of not having enough money to pay for our expenses in retirement.
Paying off the debt on a fixed retirement income can be a big burden. It will be very difficult to get ahead or live comfortably if you have to pay large debt balances.
The best approach to deal with debt is to start with small steps. The earlier you develop a plan to reduce it, the easier it will be to tackle.
In the end, you’ll have a better chance to afford the retirement you’ve always dreamed of.
Please share the ways you deal with your debt. Do you have a plan to reduce it?