How to Be Debt-Free by Retirement

 How to Be Debt-Free by Retirement
Richard BarringtonMarch 13, 2022
Key Takeaways:
  • Debt-free retirement for most people means not carrying debt except a mortgage.
  • Retiring without a mortgage can increase your financial security and comfort.
  • Whether you can or should retire debt-free depends on your resources and lifestyle.

Is a debt-free retirement a good goal? Is it possible to retire debt-free? You may be able to retire debt-free or close to it by following these financial tips. 

What Does Debt-Free Retirement Mean?

On the simplest level, a debt-free retirement means you don’t owe money to anybody by the time you quit working. However, that might not be a realistic goal for many people.

For one thing, just because you retire doesn’t mean you should stop using credit. Credit cards make retail transactions safer and more convenient. And a car loan with a low interest rate can be smarter than paying cash. 

Also, it may not be possible for everyone to pay off all their debt before they retire. If you bought a house with a 30-year mortgage at age 40, you could easily have a few years left on the mortgage when you retire.

So, as a practical matter, consider the goal of a debt-free retirement to mean at least the following:

  • That you are steadily reducing debt rather than continuing to accumulate it

  • That you have a plan and the financial means to pay off your debt in your retirement years

If you can accomplish both those things, you can at least retire free of worry about how you will pay your debts. 

Do I Need to Be Debt-Free to Retire?

You may wonder how you can comfortably retire if you still have debts. The answer comes down to how confident you are in your ability to pay them. 

Frankly, that’s a question you should be asking long before you retire. No matter how young or old you are, you should always ask yourself, “how am I going to repay this?”

In other words, budget before you borrow. Budgeting prevents overspending and should allow you to worry less about your finances. 

The same principles apply when you retire. If you retire with some existing debt, or even if you’re thinking of taking out a new loan, it’s not a big problem as long as you know what your income will be and have a realistic budget to pay down that debt.

What’s more of a problem is retiring without a clear financial plan – and that’s true whether or not you have debt. 

Also, a clear warning sign is if you’re constantly borrowing to support your lifestyle. If you can’t live within your means while still working, how will you do it once you’re living on a retirement income? Not to mention, how will you support your lifestyle and pay off the debt you’re accumulating?

In short, you don’t need to be entirely debt-free to retire comfortably. However, you shouldn’t depend on new debt to meet routine expenses, and you should be able to afford payments on the debt you have. 

Should I Pay Off My Mortgage Before I Retire?

Think of paying off your mortgage by retirement as a luxury but not a necessity.

It’s a luxury because that monthly mortgage bill is probably your largest expense. Get rid of that before you retire, and suddenly your retirement budget goes a lot further towards things you enjoy.

If paying off your mortgage by the time you retire isn’t possible, you can manage the payments by planning correctly. 

Part of financial planning involves estimating how much you’ll have saved by the time you retire and how much you can afford to spend throughout your retirement. The amount you arrive at for annual spending should be the basis of your retirement budget. 

If you can still pay your mortgage and meet your other expenses within your expected retirement budget, you should be okay.

After all, mortgage debt has two advantages over other forms of debt:

  • It has relatively low interest rates. According to mortgage finance company Freddie Mac, as of the end of 2021, 30-year mortgage rates were at 3.11%. This is a much lower interest rate than other forms of borrowing, making a mortgage a relatively cheap form of debt to carry.

  • You may be able to use a mortgage again in retirement. If you have the home equity and income to qualify, cash-out refinancing or a home equity loan can be a low-cost source of credit should you need to borrow again.

So, assuming it fits into your retirement budget, having a mortgage when you retire should be manageable, with one other important caveat.

Most mortgages have fixed interest rates with equal payments throughout the life of the loan. Fixed payments make budgeting easier. 

However, if you have an adjustable-rate mortgage or one with a balloon payment, you may receive a nasty surprise in retirement if your interest rate increases. If that’s the case, it may be wise to refinance to a fixed-rate loan.

Why Is Some Debt Better Than Others?

As noted above, mortgage debt has some characteristics that make it reasonably manageable in retirement. That’s not true of many other forms of debt. 

So what’s the difference? What makes some kinds of debt better than others?

Here are three characteristics of relatively good kinds of debt:

  1. It finances something that will last longer than the debt. A mortgage may take a long time to pay off, but a home usually lasts longer. Debts offset by assets do not reduce your net worth. But debt without an asset depletes your net worth.

  2. It carries a relatively low interest rate. For some loans, you end up paying more in interest than the amount you initially borrowed, so the interest rate is critical.

  3. It doesn’t have to be repeated frequently. This is important for two reasons. First, if you keep borrowing, it’s a sign you may be accumulating debt rather than paying it down. Second, if you’re dependent on continuing to borrow, it may get more expensive if interest rates rise, or you may get cut off altogether if your credit score drops.

If fixed-rate mortgages are the best example of this kind of relatively good debt, credit card debt is the other end of the spectrum. 

As noted previously, at the end of 2021, 30-year mortgage rates averaged 3.11%. In contrast, the Federal Reserve showed credit cards charging an average rate of 16.44%. Those rates will change over time, but the difference between mortgage rates and credit card rates doesn’t change much. 

Somewhere between the extremes of fixed-rate mortgages and credit card debt are other types of borrowing, including car loans and personal loans. How good or bad these loans are depends on their interest rate, loan term, and the useful life of what you finance. 

What’s More Important? Saving Money or Paying Off Debt?

As you go through your career, you’ll often wonder what to do with any extra money you have. Should you put it towards retirement saving or towards paying down debt?

In that case, ask yourself if you could earn more on your retirement investments than you’re paying on your debt. 

Historically, the average return for large U.S. stocks is about 10% a year. At the end of 2021, the average savings account was earning just 0.06%, and 30-year Treasury bonds yielded 1.9%. 

Now, consider whether those returns could keep up with the interest you’re paying on your debt. If you have a low-interest mortgage, you may be able to earn more by putting extra money into retirement investments rather than paying off the mortgage faster. 

However, even accounting for the tax advantages of retirement savings, it would be difficult for most investments to keep up with credit card interest rates. So, if you have high-interest debt, pay it off before putting extra money towards retirement.

There’s one key exception to this, and that’s if you participate in a 401(k) or similar retirement plan that has employer matching contributions.

With those contributions, your employer kicks in some percentage of the amounts you contribute. According to investment company Vanguard, the most common arrangement is for employers to match 50% of the employee’s contribution, up to 6% of the employee’s pay.

That’s like getting an instant 50% return on your retirement savings. So, if you’re eligible for an employer match, putting enough money into your retirement plan to qualify for the full match available might be better than paying down debt faster - just as long as you’re meeting the minimum required payments on that debt. 

How Should Debt Figure Into My Retirement Planning?

Questions like “should I pay off my mortgage before I retire” and “how much can I afford to live on” shouldn’t be left until late in your working career. Answer them early in your retirement planning process -- which should ideally begin decades before you retire. 

After all, the earlier you get a handle on your debt, the sooner you’ll be able to set realistic retirement goals and start saving towards them.

As noted earlier, you do not necessarily have to get rid of all debt before you retire. Some remaining years on a mortgage or the occasional loan for something like a car or home improvements can be reasonable if you have a realistic repayment plan.

On the other hand, ongoing credit card balances could be a heavy drain on your retirement resources. 

Here are three things to address so that debt won’t be a problem in retirement:

  1. You should not need continued borrowing to support your retirement lifestyle. If you’re borrowing continuously during your career, it will slow your ability to save for retirement and increase the amount of money you’ll need in retirement. 

  2. You must add any debt payments you’ll still have when you retire into your budget. Regular debt payments will squeeze out some of your lifestyle spending. 

  3. Be sure to resolve overspending or debt problems before you retire. If you’re having trouble keeping up with payments or can’t see a realistic path to pay off your debt, you may need to pursue help like credit counseling or debt relief. Doing this before you retire leaves you with more options than waiting until your career is over. 

Ideally, a debt-free retirement would mean having no debt. If this is not possible, you should shoot for a retirement free of debt worries. Having a retirement plan that includes keeping debt under control is one way to make that happen.  

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