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Retiring debt in time for retirement

Especially with new limits on mortgage interest deductions, investors should consider how the costs of debt weigh into their retirement plans. In a Money Talk Video, Dave Sandstrom talks with Joel Dresang about how even low-interest home loans add to fixed expenses when incomes are less flexible. A transcript of their discussion follows.

Joel Dresang: Dave, let’s talk about debt in retirement. I suppose at any point in our life, we don’t want to owe a lot of money, but what are some special considerations for debt in retirement?

Dave Sandstrom: Well, in retirement, Joel, our income is probably a little less flexible. So, when you have debt payments, those are fixed expenses that we would really like to minimize or avoid altogether.

Joel: And I suppose that’s especially true for high-interest debt, like credit cards, but what about mortgages?

Dave: For most Americans, mortgage payments are one of their largest monthly expenses, so freeing up that money in retirement would be a very good idea. But I don’t want you to think that it’s a deal breaker to carry a mortgage into retirement.

As long as you’ve planned for it, you have plenty of current income on a monthly basis to handle it, and you’re understanding of what those expenses are, carrying a little bit of mortgage debt into retirement is not the end of the world.

Joel: And that’s probably something that you should revisit once in a while because interest rates change, tax laws change that affect those mortgage rates.

Dave: Correct, and I would highly recommend working with a tax professional so that you have a real solid understanding of what is that debt really costing me?

Joel: Some people aren’t comfortable having big mortgages in retirement. Are there certain approaches they should take to paying down their mortgage?

Dave: Joel, if you have the means, it would be a great idea to pay it off. However, we have to be very careful about at what cost. So, we have to look at our assets and what’s available to make that payment. What we don’t want to do is run down our cash and our short-term fixed-income positions to a point that we don’t have the appropriate backup for our short-term needs. So, let’s just assume for a minute that we have that in place. Now, look at the remaining assets and see what I can put towards that mortgage payment. Cash is an obvious choice. No tax ramifications. It’s liquid. Pay down the mortgage with that.

I would look secondly at a brokerage account, where you might be able to pick some funds in there or some positions of assets that don’t have large capital gains exposure to limit your taxes.

And the third one is where I’m going to raise a little bit of a red flag, and that is in a tax-deferred account, like an IRA or a 401(k). Be very careful about taking large distributions all in one calendar year to pay off that debt. Sending a large portion of that in for taxes versus allowing that to continue to defer and grow for your retirement needs down the road.

Joel: So ideally, we wouldn’t have debt going into retirement, but if we do, we should prioritize what that debt is and prioritize how we pay it down.

Dave: Absolutely, and I think it’s important to have a plan as it relates to this. Get rid of that real expensive debt first.

Then maybe move on and concentrate on that mortgage. It might be at a lower interest rate but might be a larger piece of that debt. And then look to retire it as quickly and effectively as you can.

It doesn’t have to be all done in one day, it could be doubling down on your principal payments, putting a little extra in at the end of each tax year.

But what’s most important is to try to reduce those fixed expenses so that we have more flexibility with our cash flow in retirement, but it shouldn’t just be done at any cost.

Dave Sandstrom is vice president and an advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Jason Scuglik and Pete May

Learn more
Debt in retirement, a Money Talk article
You need a budget, by Tom Pappenfus
Knowing the number, by Brian Kilb
Having the confidence to retire, a Money Talk Video by Art Rothschild
Retirement investing: Where to begin, a Money Talk Video by Kyle Tetting

(initially posted August 21, 2018)

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