The Secret to Stretching Your Retirement Income

The more debt you can erase before you retire, the further your retirement income will take you. Here are several ways to cut your debt down to size.

by NEA Member Benefits

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Key takeaways

  • Credit card interest rates continue to trend upwards so carrying a balance can be costly.
  • Reducing debt interest payments is the same as increasing your income.
  • When debt interest rates are higher than investment returns, paying down the debt makes financial sense.
  • If you’re overwhelmed by debt, get help from a reputable credit counselor.

Previous generations tended to head into retirement virtually debt-free. Home mortgages were paid off and credit cards weren’t the go-to source for paying day-to-day living expenses the way they are now. Today, it’s not uncommon for people to enter retirement with substantial debt.

A survey by national mortgage banker American Financing found that 44% of Americans between the ages of 60 and 70 head into retirement with a mortgage on the books. About 17% of these people say they may never pay off their mortgage. Because retirement income from pensions and savings may be lower than working income, and pension payments are fixed, it makes good financial sense to reduce debt as much as possible before retiring.

Less debt means more money in your pocket

You can effectively boost your fixed retirement income by reducing or eliminating the interest payments on mortgages, credit cards, car loans, student loans and other debts. With conservative investment returns hovering in the low single digits, every dollar you pay on a debt with higher interest rates is one less dollar in your pocket.

For many pre-retirees, two of the biggest debt monsters are credit cards and a home mortgage. Here are a few tips to help you cut them down to size.

Eliminate high interest rate credit card balances

Carrying balances on your plastic? That’s probably your most expensive debt from an interest rate perspective. According to creditcards.com, the national average credit card interest rate was 17.07% as of mid-October, 2018. Three years earlier, in October 2015, the rate was 15%. Consumers with less-than-ideal credit scores are likely facing even higher rates—upwards of 25% in many cases.

Many experts suggest paying down your highest interest card balances first. It makes financial sense. But debt guru Dave Ramsey thinks some people can generate more debt payment momentum by paying down the smallest balance first then progressing to the next, in what he calls his snowball plan. The idea is to knock off a few small debts, one at a time, to get quick results and feel better emotionally. Take the route that feels best to you.

Another tactic is to transfer high interest card balances to a card with a low or zero promotional interest rate. Card companies routinely send out promotional offers like this in an effort to sign up new cardholders. Do the math to make sure you can pay off the transferred balance before the promotional period ends or you could find yourself right back on the high interest rate merry-go-round. Avoid using the card for additional purchases while paying off your transferred balance because your payments will first go to the lowest rate balance before being applied to the new purchase balance. This can greatly increase your interest payments over time.

The calculators at Bankrate.com can help you figure out a pay-down plan.

Pay off a home mortgage for more peace of mind

Mortgage interest is still tax deductible under the new Tax Cuts and Jobs Act (TCJA) that went into effect in 2018 (although the interest deductions on home equity loans were eliminated). Because of the deduction, some people feel mortgage debt isn’t so bad. But it’s only deductible if you itemize deductions on your tax return. If your income is lower in retirement, you may not be able to deduct the interest. Besides, 30-year mortgages are weighted towards paying more interest in the first 15-20 years of payments. If you’re 20 years or more into your mortgage payoff, more of your payments will be non-deductible principal rather than deductible interest.

Your mortgage interest rate is likely higher than the rates available in 2018 on certificates of deposit or money market investments. That means using money to accelerate mortgage payments instead of investing it may be a net win. And don’t underestimate the emotional peace of mind that comes from owning your home free and clear. Just don’t pull money out of your retirement savings to pay down your mortgage. You’ll owe taxes on the withdrawal and, if you’re under age 55, a 10% penalty. Plus, that money no longer has the opportunity to grow tax-deferred.

Another option is to sell your home and either buy a smaller home outright or rent. While renting does set you up with a perpetual monthly expense, you eliminate the costs of home maintenance, insurance and property taxes.

Create a pre-retirement debt pay down plan

Maintaining your lifestyle in retirement depends on generating sufficient income from pensions and savings. But nothing chips away at your income like lots of debt.

If you don’t have too much debt, you may be able to clear the decks before you retire. If you’ve got substantial debt and feel like there’s no hope of getting out from under it, be methodical in your approach:

  • Chip away. Much like saving for retirement, making small debt payments is better than nothing at all. It may take you longer but you’ll know you are making progress.
  • Cut expenses. Eliminate some discretionary expenses and use the found money to pay off those credit cards (and then avoid putting new charges on the cards).
  • Retire later. If you need more time to get things under control, consider collecting those paychecks a little longer while you take the steps outlined above.
  • Get help. If you’re still overwhelmed, work with a debt restructuring counselor who can help you develop a schedule for repayment through a debt management plan. You can find a list of reputable credit counselors through the National Foundation for Credit Counseling. Learn more about selecting a credit counselor from the Consumer Financial Protection Bureau.