How Much Debt Is OK in Retirement?


Many people share the same retirement vision: kids grown and removed from the budget, a fat investment portfolio, the mortgage and other debts all paid off.

But it doesn’t always work that way, especially when it comes to debt. Some people pick up a second home or recreational vehicle as they near retirement, and credit card bills are always hard to control. How much debt can you sensibly bear after retirement begins?

Christine Fahlund, vice president of investment services at T. Rowe Price (Stock Quote: TROW), the mutual fund company, starts with a couple of rules. Writing in the firm’s Financial Planning Insights newsletter, she says people should plan a lifestyle in retirement that costs about 75% of what they earned at the end of their working years.

That should be enough to maintain a comparable lifestyle, considering savings on commuting costs and other work-related expenses. Also, a sizable portion of the pre-retiree’s income should be saved, perhaps 10%, 15% or 20%, so the pre-retiree already lives on less than 100% of annual income.

Fahlund says the typical retiree should plan on spending about one third of income on non-discretionary expenses like groceries, utilities and taxes.

She argues that it’s generally wise to keep debt to a minimum in retirement. Because debt is a fixed cost that cannot be avoided, it can become a big problem if the retiree’s income dips after an event like a stock market pullback. Also, it’s hard to estimate other expenses over a retirement that could last 30 years or longer. Medical expenses, for example, could be bigger than forecast.

Many homeowners, says Fahlund, feel it is OK to carry a mortgage into retirement because of the tax deduction on mortgage interest. But that benefit may not be as big as the homeowner assumes, especially if the mortgage is 15 or 20 years old. That’s because mortgage interest charges are frontloaded, meaning they are much larger in the early years of the loan than the later ones, when the remaining debt is smaller.

In the first year of a 30-year fixed-rate mortgage of $300,000, charging 5%, interest payments would come to nearly $15,000. A homeowner in the 25% tax bracket would save $3,750 in federal income tax. But in the 20th year, the interest cost would be about $7,300, producing a tax saving of just $1,825 at the 25% rate. The tax benefit would be even smaller if the homeowner’s income was reduced in retirement, producing a lower tax rate.

Put simply: it doesn’t make sense to take on a dollar of debt just to save 25 cents in taxes.

Fahlund recommends a debt-reduction strategy in the years before retirement. That starts with an attack on credit card debt, which typically carries higher interest rates than a mortgage, and which offers no tax deduction on interest charges. The Accelerated Debt Payoff Calculator can help you devise a strategy.

Next, she suggests making extra principal payments on the mortgage to eliminate the debt before retirement begins. Use the Mortgage Payoff Calculator to see how quickly you could clear your debt.

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