Spending your prime behind a desk or in the workshop has an advantage: it’s a good way to pay off your debts.
But if debt follows you into retirement, the lack of full-time income may mean that meeting those monthly payments may require dipping into your savings or investments. And that can drain the resources meant to sustain you through your golden years.
Can you expect a retirement free from financial anxiety if you still have debt? Absolutely, say the experts, but it depends on what kind of debt we’re talking about.
Good debt versus bad debt
Wilmot George, vice president of tax, retirement and estate planning at CI Global Asset Management in Toronto, says it’s important to draw a line between what is considered good debt and bad debt.
Bad debt, he says, involves the cost of financing purchases of depreciating assets, such as a car or boat. Good debt, on the other hand, allows people to buy assets that can generate income, such as shares in a dividend-paying mutual fund or rental property.
In addition to providing an additional source of income, these good debts offer tax advantages that can help reduce their overall cost. “What a lot of people don’t realize about debt being used to buy assets that can generate income is that the tax rules allow us to deduct the interest expense on that debt,” George says.
A bad debt does not give you these benefits. And, since it’s often tied to things you need, like a car, it can be hard to avoid.
Planning around retirement debt
George says there is no secret recipe that says, “X amount of debt can be paid off in Y time using strategy Z.” As you approach retirement, your financial plan should take into account your debts so you can budget accordingly.
But if you don’t think carefully about the impact of debt on your overall financial picture, there can be pitfalls.
If your plan is to sell chunks of your investment portfolio to pay bills, George says you need to be aware of the effect the profits generated from those sales might have on the income-related benefits you’ll receive after your retirement – like Social Security.
If asset sales push your income into a higher tax bracket in 2022, for example, the government will have reason to claw back some of your Social Security money at tax time next year.
When you take on debt to buy assets with income potential, it’s important to get confirmation from a financial planner that the interest you pay will be tax deductible. If not, you could be in for a nasty surprise when the refund you’re counting on doesn’t materialize.
Reasons to avoid debt in retirement
Even with a solid financial plan in place, unexpected expenses — car repairs, a new roof for your home — can strain your retirement budget.
Consider today’s runaway inflation and its impact on your purchasing power.
Although Social Security payments are adjusted for inflation, the tax implications have not changed since the Reagan administration. The threshold at which you can start owing taxes on that money – $25,000 for individuals – is not adjusted for inflation.
That’s why the Congressional Budget Office predicts that the total income taxes paid on these larger Social Security checks will increase this year by 37%.
Legislation to address the problem was sponsored by Representative John Larson last year, but Americans may not see any changes for quite a while.
To maintain financial flexibility and establish peace of mind, George says paying off debt before retirement should be the goal.
“I think that’s always the most cautious approach. That’s definitely my approach,” says George. “As much as possible, you really don’t want to have any debt hanging over you when you retire.”
An exception could be your mortgage. While George says it’s ideal to zero out a mortgage before retirement, paying off your home during retirement isn’t an objectively bad decision — as long as it’s within your budget.
“A mortgage is a debt that many people think of as reasonable debt,” George says. “You accumulate assets that you can use throughout your life [and pass on when you die]. It is one of the expenses that add to the quality of life.
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— With files by Samantha Emann
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.