6 debt-reduction tips before retirement
By Dawn Papandrea
March 24, 2015
Ah, the retirement years. You've worked hard and have often fantasized about all of the traveling you'll do, hobbies you'll take up and new opportunities you'll explore. Unfortunately, retirement doesn't come cheap.
That's why you want to be in the best financial position possible when you decide to stop working for good. Part of that is being as close to debt-free as possible.
“You're getting to a point where your ability to generate additional income without having to go back to work is limited,” says Jim McCarthy, CFP and founder of Directional Wealth Management. That's why identifying and eradicating your debt obligations will save you lots of financial headaches when you'd rather be golfing.
Paying off your obligations should be carefully planned out so you can get rid of the debts that are costing you the most. “First and foremost are credit cards,” says Dan White, retirement income certified professional and principal of Dan White & Associates. He explains they likely have the highest interest rates of all your debts. After that, you can concentrate on any consumer debt, such as auto and household loans or even student loans. Lastly, try tackling tax-deductible, low-interest debt, such as mortgages or home equity loans.
If you have several card accounts to pay off, you should consider using one of two popular pay-off strategies, says McCarthy. The first method is to rank the accounts according to their interest rates — from highest to lowest. You would then pay the minimum on everything except the highest interest rate account, so you can put the most money toward that one until it's paid off, he explains. Once that's done, you move to the next one on your list and repeat.
The other method is similar, but you rank the accounts by lowest to highest balance. This time, you make just minimum payments on everything except the lowest bill until you pay it off. This method works for those who need extra motivation to forge ahead, says McCarthy, since there is satisfaction in crossing accounts off the list more quickly.
Now that you know all about prioritizing your debt, here are six options for aggressively attacking it before you retire:
1. Start with savings. If you have money sitting in a money market account earning almost nothing and have debt, take it and pay off a credit card, says White. “It doesn't make any sense to keep it in the bank or in taxable accounts. Take some of the risk off the table and reduce your debt,” he says.
The exception to that is if you're using your savings as an emergency fund, since you don't want to leave yourself with nothing, says Stephanie Sherman, a certified financial planner with Prudential in New Jersey. “It is important to maintain an adequate emergency fund, even as retirement approaches, to cover unforeseen expenses. As such, it is not recommended that an individual use their cash savings to reduce debt unless it won't impact their emergency fund,” she says.
“Take a long hard look. Do you really need 800 cable channels? Do you need to go out to dinner once a week?”
–Dan White, Dan White & Associates
2. Trim your budget. “Everybody carries a lot of fat in their budget,” says White. “Take a long hard look. Do you really need 800 cable channels? Do you need to go out to dinner once a week?” By cutting your bills and being more frugal, you can use the additional funds to put toward your debt payoff plan.
Sherman takes that idea a step further by recommending that people try living off of their anticipated retirement income several years prior to retirement. “For example, if your monthly retirement income is anticipated to be $4,000 and your pre-retirement income is $6,500, practice living off of the $4,000, making the necessary changes in order to do so,” she says. Not only can you use the “extra” income to reduce your debt, but you'll have a smoother transition into your retirement budget.
3. Analyze your assets. Selling non-retirement assets, such as stocks, is a viable strategy, says McCarthy. “I wouldn't advocate selling shares of IBM to pay off a home mortgage since you're probably earning more on the stock than you're paying in interest. But to pay off a 12 percent credit card? I'd do that in a heartbeat,” he says.
Remember, this goes for non-retirement assets only. “The last thing you should invade is a retirement account,” says White. Using money that's earmarked for retirement will leave you less financially secure, plus you could be hit with a tax penalty for drawing funds too soon.
4. Sell some of your junk. Many years living in one residence makes for a lot of stuff. Consider a garage sale or selling items online to reduce your clutter, and bring in extra cash in the process, says McCarthy. Another way to give your income a boost is to think about how you might be able to monetize your hobbies. “If one is a knitter or an artist, it can make a lot of sense,” he says.
5. Consider consolidation. If you have a lot of equity in your home, taking out a home equity line of credit to pay off your “bad” debt could be a wise move, says White. “Interest rates are so low, plus the interest on the home loan is tax deductible,” he says. While that's a viable strategy, McCarthy points out that you're really just transferring — not getting rid of — your debt, and it still needs to be paid. Also: “You have to be super vigilant not to run those credit cards back up,” he says.
6. Deliberate downsizing. While leaving a home you love can be an emotional decision, it's something worth thinking about if it will ease your financial burden. “Downsizing could certainly be a consideration if the cost of home ownership, property taxes and maintenance is high. Plus, it's expensive to heat and cool large homes,” says McCarthy. Moving into a lower cost residence or community might allow you to pay off your bills, or even profit from the sale of your home, while also taking the home care responsibilities off of your aging shoulders.
By combining some of these debt reduction strategies, you can set yourself up to be a financially stress-free retiree.