The Importance of Paying Off Debt Before Retirement
Retirement is meant to be a time of relaxation and enjoyment after years of hard work. However, entering this next chapter while still carrying debt can cast dark clouds over what should be sunny days. Paying off debt before retirement is critical for maintaining financial security and peace of mind.
Debt threatens the ideal retirement in several key ways:
Reduced Financial Burden
Debt payments, whether for credit cards, mortgages, medical bills, or loans, drain retirement income. A report by the Employee Benefit Research Institute found that 40% of retired households had outstanding debt payments, with a median balance of $31,300 [1]. For context, median household income for Americans age 65 and older was $44,209 in 2020 [2]. With median debt balances taking up over 70% of annual income for many retirees, it’s easy to see how burdensome these payments can become on a fixed budget.
Eliminating debts ahead of retirement can lift this heavy financial burden and free up income for travel, hobbies, and time with family. Every extra dollar not going toward a credit card bill or installment loan payment gives more latitude in retirement spending. Being able to reallocate even a couple hundred dollars monthly from debt service to discretionary purposes greatly improves cash flow.
Fixed Income
Once retired, income often becomes limited to Social Security payments, pensions, and retirement account withdrawals. The Social Security Administration notes that 1 in 4 married couples and 2 in 3 unmarried retirees receive over half their income from Social Security [3]. For 30% of elderly Social Security beneficiaries, it comprises at least 90% of their income [4]. With such dependence on fixed sources, retirees need ample net income to cover both living costs and debt payments. Paying off debts while still earning a paycheck provides that flexibility.
Trying to meet regular debt payments on a fixed Social Security check or 401(k) withdrawal poses difficulties. Not only does the retiree need to budget very carefully, but they have little margin for error in case of emergency expenses. Unanticipated car repairs or medical bills can force painful cuts to retirement lifestyles. Having the reliability of fixed income without inflexible debt commitments makes retirement spending less stressful.
Peace of Mind
Ongoing debt stresses mental health and may lead to anxiety, depression, and sleep troubles [5]. Leaving the workforce while still facing piles of bills can exacerbate money worries. Becoming debt-free clears the slate and allows for relaxation, knowing all retirement income can go toward new adventures.
Research shows that financial stress significantly increases the likelihood of poor health, especially high blood pressure and cardiovascular disease [6]. The annual Retirement Confidence Survey has found debt to be a top concern among those nearing retirement [7]. With Americans living longer than ever, ensuring a debt-free transition into retirement could literally be a lifesaving measure.
Long-Term Savings
Interest payments on debt, especially high-interest credit cards, accumulate substantially over time, eating away at potential savings. The Consumer Financial Protection Bureau reported Americans age 60+ paid over $20 billion in credit card interest and fees in 2020 [8]. Much of seniors’ debt comes from unpaid credit card balances carried over from younger years [9].
Paying off debt early allows redirecting those interest payments to grow retirement savings and ensure long-term security. Consider a credit card with $10,000 balance at 17% APR. That cardholder would pay $1,700 yearly in interest charges alone. Investing that $1,700 annually in a retirement account earning a 6% return for 20 years before retirement results in an extra $52,000+ in savings.
The benefits of eliminating high credit card interest prior to retiring provides huge savings that enable a more robust nest egg and financial freedom in later years. Decades of compounded returns have much more impact than trying to save aggressively in only the final few working years.
Legacy for Loved Ones
Leaving an inheritance or solid financial foundation for family is important for many retirees. However, debts die with the original debtor, so any unpaid balances fall to heirs. A T. Rowe Price survey found 37% of parents have not factored potential leftover debt into their estate plans [10]. Paying debts ahead of time is crucial to pass on assets rather than liabilities.
Beyond direct debt transfers, lingering old debt also reduces what seniors can leave behind for their survivors and beneficiaries. Retirees still servicing years-old medical bills, personal loans, and credit card balances cannot maximize tax-advantaged estate planning vehicles, such as trusts and annuities. The dollars still going toward interest and principal payments on outdated debts represent lost potential to provide financial security to loved ones.
Strategies for Debt-Free Retirement
Becoming debt-free by retirement will look different for each individual. It depends on the amount and types of current debts and how many earnable working years remain until retirement. However, certain strategies apply universally:
- Prioritize high-interest debts for accelerated payoff
- Adopt an aggressive debt repayment budget, diverting all extra income to eliminating debts
- Lower monthly payments through debt consolidation loans or balance transfers
- Consider part-time work after early retirement solely to generate “debt payment income”
- Discuss debts honestly with family if assistance is needed with repayment
The key is having a plan early for getting the debt monkey off your back well before retirement. Even starting 5-10 years out from retiring can make an enormous difference compared to waiting until the last few months on the job.
Retirement is meant to be the prime of life, with relaxation, travel, and time for people and passions. Entering debt-free provides the peace of mind and financial security to make retirement truly golden. Shedding the debt burden before leaving the workforce allows savings to grow and income to be allocated toward the things that matter most. With sound preparation, you can break free from debt and step into a fulfilling new life stage.
Sources:
[1] https://www.ebri.org/retirement/retirement-security-project/levels-of-debt
[2] https://www.census.gov/library/publications/2021/demo/p60-273.html
[3] https://www.ssa.gov/policy/docs/ssb/v75n3/v75n3p1.html
[5] https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3216540/
[6] https://www.apa.org/news/press/releases/stress/2010/financial-stress
[7] https://www.ebri.org/docs/default-source/rcs/2021-rcs/2021-rcs-short-report.pdf?sfvrsn=2d453f2f_4
[9] https://www.cnbc.com/select/average-retirement-credit-card-debt/
[10] https://finance.yahoo.com/news/one-third-parents-havent-factored-120406288.html
