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Why You Should Eliminate Debt Before You Retire

Conventional wisdom – and a good rule of thumb – suggests you should not have any debt when you retire.

However, a recent Globe and Mail article reports that people are more comfortable with carrying debt into their retirement years than past generations and that more than half of all retired Canadians are carrying some debt.

A survey by Equifax shows consumer debt rose by 6.5 percent among people 65 years of age and older.

Related: Things to consider when you turn 60

Apparently, being debt free in retirement isn’t always the ultimate goal.

Sufficient cash flow

According to the Globe, retirees believe their cash flow is sufficient to service mortgage and other debt.

One commenter remarked that he spent his discretionary working income on trips and enjoying life while he could.  Instead of paying off his mortgage he put money into his pension and retirement accounts and now has a good nest egg to live off.

He makes a good point that if you wait until retirement to enjoy the good life, health may become an issue and not allow certain activities such as travel, and insurance is expensive.

Using mortgages as a financial tool

For many there is an emotional component behind the desire to live in a home that is owned free and clear.  For others, whose homes can be 50 percent or more of their assets, refinancing mortgages and taking out Home Equity Secured Lines of Credit makes financial sense and can fund a wide range of expenses.  Lines of credit have seen the biggest growth increase.

One financial planner with Investors Group suggests that a client with sufficient investments to pay cash for a property may choose to use a mortgage instead of cashing in their portfolio, which could trigger increased income tax payments or other fees.

Related: Are you expecting an inheritance?

People are borrowing to fix, renovate, or make their homes “aging-in-place” friendly.

Some people are passing funds on to children so they can buy their own places.

Unexpected expenses due to health are huge financial issues for some.

Financing your lifestyle

Alarmingly, many people are using credit to finance their lifestyle by using it for income replacement.  Those who have used borrowed money to live well in the past are now carrying those same habits into retirement.

Related: Does a reverse mortgage make sense for seniors?

Lines of credit, especially, are so easy to dip into.

Low interest rates

People are taking advantage of low interest rates that make mortgage and loan payments more affordable.  But, even if you can currently afford it, there’s no way of knowing if the payments will stay the same.

We tend to assume that the stock market will rise forever, and interest rates will remain low, but make no mistake about it, it will come to an end.  It’s a question of when – not if.

The danger with rising interests rates is, the more you owe, the higher your payment.  A $75,000 line of credit that requires interest only payments will cost you $188 a month at the current 3 percent.  At 4 percent the payment increases to $250 and at 6 percent it goes up to $375.

If your income is not sufficient you may have to withdraw more from your RRSPs to cover the increased debt payments, resulting in a higher taxable income and the potential for OAS to be clawed back.

Related: What’s all this retirement planning for, anyway?

Or you may be forced to go back to work.  Not a happy prospect when you are in your 70’s and moving a little slower than previous years.

Another danger is, if payments increase, creditors may call in loans or trim the size of allowable credit.

Conclusion

Freedom in retirement used to mean growing old without having to work or owe money to the bank.  Retirement means adapting to living on a fixed income.  One survey suggests that managing day-to-day expenses is the number one financial priority.

However, unpaid mortgages are becoming the norm for many seniors with some retirees adding even more mortgage debt.

People who are expecting to live longer and healthier lives are more optimistic about being able to pay back their debts compared to previous generations.

Although retirees have less debt than those still working, they are more likely to be carrying debt over a longer period of time than anticipated, costing more in interest payments and affecting cash flow, discretionary income, and future living standards.

Related: RRIFs (Good God Y’All!) What Are They Good For?

Carrying debt in retirement can be a dangerous move that can imperil your financial future and drain your retirement savings too soon.

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12 Comments

  1. Miriam on April 9, 2014 at 6:57 am

    I knew the general advice was to come into retirement debt free including the mortgage. I didn’t manage that for several reasons. As an entrepreneur I often lived well when income was high and didn’t cut back soon enough when income was low resulting in debt. When my husband passed away 4 years ago I knew that to survive on my retirement income meant I had to make some changes. I converted my large victorian house into three apartments and rent two of them out. The income more than pays for the mortgage – it covers the utilities, insurance and tax too. It wasn’t easy and I did most of the construction work myself (with the help of my daughter) but now I feel secure knowing that I have the ability to survive on my fixed income. I’ve developed a contingency fund to handle times when the units may be vacant but that hasn’t happened yet.

    • Money Saving on April 9, 2014 at 11:09 am

      Wow – that sounds like an awesome strategy to keep you going basically forever. Great idea!

      • Boomer on April 10, 2014 at 4:34 pm

        Well said! Diversifying your income sources is a good plan, not to mention you’re making good use of what for most people would be their largest asset by making it a money maker.

  2. Mike Collins on April 9, 2014 at 7:19 am

    A few years ago my father-in-law reached retirement age and immediately filed the paperwork to retire from his job at the post office. A few months into his retirement he regretted not staying on for an extra year or so to pay down his credit card debt. He ended up getting a part-time job as a crossing guard to supplement his retirement income. Luckily he didn’t mind the job and it kept him active, and I’m glad he was able to enjoy some retirement time before he passed away.

    • Boomer on April 10, 2014 at 4:37 pm

      @Mike Collins: This is similar to what a friend of mine did. She purchased a new car using her line of credit then took part time job as a retail sales associate to make the payments. She always said she didn’t mind when she was called in t work extra hours because it meant her loan would be paid off quicker.

  3. Alan on April 9, 2014 at 9:38 am

    There may be good reasons for carrying mortgage debt into retirement, but I can’t think of a good reason to carry credit card debt after you retire. There are many cautionary tales that suggest this is a bad strategy. A woman once told me that the only way she could get through the month was to use a number of credit cards. That always ends badly. I knew a guy who retired from teaching at age 55 and his only assets were an old beater of a car, and his collection of hockey cards. Too close to the line for my taste!

    • Boomer on April 10, 2014 at 4:43 pm

      @Alan: I personally would not want to use my retirement income to pay debts. That said though, if I had a major expense I would be more likely to use my line of credit than cash in some of my investments and I’d have a plan to pay it off quickly. But that’s me.

      Some people receiving govm’t and company pensions may be receiving a similar income to when they were working and I can see that they would be more comfortable carrying a mortgage.

      I don’t like the idea of using credit to fund living expenses, though. I read that bankruptcies have increased quite a bit for older people. I wonder if that is why.

  4. My Own Advisor on April 10, 2014 at 6:22 pm

    Amen Marie.

    My wife and I are working, sometimes our asses off it seems, to ensure we don’t have any debt in retirement. We hope retirement is 15 years away 🙂

    Servicing debt in retirement limits cash flow, and freedom. I don’t want that reality.

    Mark

  5. John @ FirstStepFinance on April 11, 2014 at 12:38 am

    Great post! I think everybody should delete debt before retirement if possible. otherwise it will be a great problem in future. Thanks for sharing this well information.

  6. I think retiring debt-free will be a lot more achievable for boomers with defined benefit pensions who purchased their homes before real estate prices skyrocketed. For Millennials, I’m not sure how achievable this is. My best advice is to purchase a home you can afford – a bigger home means thousands of extra interest and higher carrying costs, such as property taxes.

    • Boomer on April 12, 2014 at 9:29 am

      @Sean Cooper: I don’t really agree with you Sean. In fact I think the opposite is more true – if you receive a DB pension you will be more likely to retire with debt. The biggest culprit is the HELOCs that were readily available when real estate skyrocketed.

      I won’t get any company pension and I will retire debt free.

      You’re spot on with your advice to buy a house you can afford.

  7. Don on April 12, 2014 at 9:31 pm

    My parents are in their 70’s and still carrying a HELOC of $100K. I’ve had no end to discussions about paying it down, but it’s like talking to the wall. Thankfully, my father has a defined pension and they still earn close to six figures.

    That being said, my father’s pension will be cut in half when he passes, and my mother’s family is long-lived, my mother’s grandmother lived until 92, and her mother lived to 96; so it’s not exactly clear how things will work out. At least we (the children) don’t have any financial issues.

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