Managing Debt in Retirement Takes Some Planning

File Photo: Paying debt usually gets more difficult on a fixed income. Mortgage debt, especially, can be a huge burden in retirement. (Photo by Tax Credits/Flickr, CC BY 2.0)

Owing money in retirement isn’t ideal — but most people do.

Seventy per cent of U.S. households headed by people ages 65 to 74 had at least some debt in 2016, according to the Federal Reserve’s latest Survey of Consumer Finances. So did half of those 75 and older.

Paying debt usually gets more difficult on a fixed income. Mortgage debt, especially, can be a huge burden in retirement. Retirees may have to withdraw larger amounts from their retirement funds to cover payments on debt, which can trigger higher tax bills and increase the chances they’ll run short of money.

People have the most options to deal with debt if they create a plan before they retire, financial planners say. Refinancing a mortgage, for example, is usually less of a hassle while people are still employed. It’s also typically easier to generate the extra income that may be needed to pay off debt.

“It is much easier to keep working for another year or two than to try and come back into the workforce when they are older and the employer needs have changed,” says Linda Farinola, a certified financial planner in Princeton, N.J.

Here are three loans to consider before you stop working:

REFINANCE (OR RECAST) YOUR MORTGAGE

Certified financial planner Rebecca L. Kennedy of Denver would prefer that clients pay off their mortgages before they retire. But paying off a mortgage may not be feasible or advisable, especially if it would mean taking a lot of money from a 401(k), IRA or other account.

“Often the majority of the assets are pretax so it would require a much larger withdrawal to net the after-tax amount needed,” Kennedy says.

People also could consider downsizing to eliminate or reduce mortgage debt, Farinola says.

For retirees determined to stay put, refinancing or “recasting” the loan can lower payments, says Serina Shyu, a certified financial planner in Atlanta. While refinancing requires taking out a new loan, with substantial fees, recasting means keeping the same loan, but using a lump sum to pay down the balance and lower the payments. Recasting is offered by some but not all lenders and may not be good idea if the lump sum would come from retirement accounts.

Another option, if the mortgage balance is less than half of the home’s market value, is using a reverse mortgage to pay it off. Reverse mortgages allow people 62 and older to tap their home equity without having to pay the money back until they move out, sell the house or die.

“For many, that is a very viable way to increase cash flow,” says Chris Chen, a certified financial planner in Waltham, Massachusetts.

CONSOLIDATE YOUR DEBT

Credit card debt indicates people may be living above their means. That’s not something that tends to get better when incomes drop in retirement, Farinola says.

“I find that if people cannot pay off debt when they are working, they certainly cannot when they retire and the cycle just continues,” she says.

People with good credit scores, and sufficient discipline, can use zero-per cent balance transfer offers to consolidate and pay off their credit card debt. Those who need more time to pay off debt might consider a personal loan with a fixed interest rate and fixed payments. If it would take over five years to pay off the debt, however, their debt load may be unmanageable. In that case, they should talk to a credit counsellor and a bankruptcy attorney to better understand their options.

OPEN A HOME EQUITY LINE OF CREDIT

A home equity line of credit is like a credit card that allows you to borrow against the value of your home. If that sounds dangerous — good. It should.

HELOCs shouldn’t be used for frivolous spending, but they can be a good backup to an emergency fund. HELOCs also can fund home repairs or long-term care.

A HELOC probably isn’t a good option for people who aren’t disciplined about their spending. HELOCs have another big pitfall: Payments on any borrowed money can spike after an initial interest-only “draw period” ends, usually after 10 years.

Another product, a reverse mortgage HELOC, costs more to set up, but payments are optional. Some financial planners recommend reverse mortgage HELOCs as a potential source of cash in market downturns. The retiree can draw on the HELOC rather than selling stocks in a bad market, and pay the money back — or not — in good markets.

“The key advantage is ability to choose if and when to make payments, and ability to access a growing line of credit,” says Tom C.B. Davison, a certified financial planner in Columbus, Ohio.