Addressing Debt to Protect Your Retirement Plans
When the Fed raises the federal funds target rate, variable rate debt such as adjustable mortgages and credit card borrowing can become toxic and especially damaging in retirement.1
Household Debt is On The Rise.
US household debt surged by to a record $16.90 trillion in the fourth quarter of 2022, the sharpest increase in two decades. This increase reflects the perfect storm of rising mortgage and credit card balances due to rising inflation and interest rates. Mortgage debt rose to $11.92 trillion at the end of 2022 as the Federal Reserve pushed the average rate on a 30-year fixed mortgage briefly above 7%, a level not seen since 2001.2
Credit card balances increased by $61 billion, of concern due in part the variable nature of the rates, which can rise with the federal funds rate.2 If card balances are carried over rather than paid in full each month, each month’s interest gets tacked onto the carried balance, which then also starts accruing interest.1
December 2022 Household Debt Levels:3
Total Debt 16.90 Trillion Student Loans 1.60 Trillion Mortgages 11.92 Trillion Credit Cards 0.99 Trillion Car Loans 1.55 Trillion
While debt can be necessary to own a home, grow a business, or build professional skills, the reality of most retirees is that of an income that will remain fairly level over time, and any debt retained from pre-retirement can eat away at a budget. More retirees than ever are turning to part time employment or side hustles to ease into retirement or maintain a standard of living, but today’s rising cost of living through inflation as well as increasing medical costs as a natural circumstance of age can eat away at savings. Many will turn to credit cards in a pinch.
Debt Among Older Americans Is On The Rise.
Only 38 percent of households headed by someone aged 65 and older held any debt in 1989, but this same age cohort in 2016 showed 61 percent of households carried debt, according to the Federal Reserve. Average debt levels for these households nearly tripled in 2016 dollars, from $29,918 in 1989 to $86,797 in 2016. 4
Over 40% of Baby Boomers had credit card debt as they neared retirement, according to a July 2019 survey from real estate company Clever. Debt in retirement means a reduction in monthly cash flow, and the increasing credit card rates can take increasingly larger bites out of a fixed income. Unfortunately, 31% of Baby Boomers also did not have an emergency fund in place, which can lead them to rely on credit cards to an even greater degree.5
Paying Down Debt In Retirement.
Paying down debt in retirement can be extremely challenging, especially during inflationary times and under the restrictions of a fixed income. However, variable interest rate debt such as credit cards and adjustable rate mortgages will grow with the prime rate, so keeping these types of monthly payments in check or reducing them can protect a monthly budget.
One important principle in paying down debt is to not add anymore to the outstanding balance. A counterintuitive approach to this principle is establishing an emergency fund which can be tapped instead of credit cards to cover an unexpected expense. Cutting out unnecessary recurring costs and a little bit of belt tightening in order to live well within your means can reduce the payback period for credit cards and ensure a substantial emergency fund is maintained. Sometimes a brief period of pain is worthwhile to quickly eliminate the future burden of that credit card payment.
Sometimes, more agressive strategies are necessary to reduce retirement debt. Debt consolidation, bankruptcy, or cashing out life insurance policies might be a higher level of impact than credit card balance transfers to mitigate high interest debt. Adjustable rate mortgages can increase dramatically over time, and large mortage payments of any kind can strain a fixed budget. Downsizing, especially in an environment of rising real estate values, can resolve a lot of economic strain in retirement.4 Adding an extra income stream, by way of a part time job, can ease the financial pressure. The 2022 State of Retirement Finances survey from real estate company Clever shows that 7% of retirees are engaged in a part time job, and a large portion of these folks, 73 percent, continue to work to cover basic expenses or for extra income.6
Some retirees may question the point of trying to get out of debt compared to making minimum payments and letting those debts die with them. Typically, an estate must repay debts, including medical bills, before heirs can receive an inheritance - each state in the US will set the statute of limitations for collecting debts from an estate. Surviving co-signers or joint account holders will be held responsible for paying off any loans that remain. If family is concerned they will be left with nothing when their loved one’s creditors are all paid off, a life insurance policy may be helpful in this instance.
Citations.
1 - nasdaq.com/articles/almost-half-of-americans-have-credit-card-debt-survey-finds
2 - tradingeconomics.com/united-states/debt-balance-total
3 - tradingeconomics.com/united-states/debt-balance-auto-loans
4 - forbes.com/advisor/retirement/how-to-pay-debt-in-retirement/
5 - listwithclever.com/research/baby-boomer-retirement-savings-by-generation/
6 - listwithclever.com/research/retirement-finances-2022/
