More and more boomers may be retiring with debt, but you can retire completely debt-free, as long as you're prepared to make the necessary sacrifices. "Naturally, starting with someone who's 19 is easier than trying to correct a situation when somebody is 59," notes Rock Lefebvre of CGA-Canada. But avoiding debt in retirement is something you have start working on now. Here's how.
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1. Prepare for the worst
A red flag for people in their prime earning years is a drop in savings levels, for example below the standard goal of 10% of gross income per year, says Alfred Feth, a fee-only financial planner based in Waterloo, Ont. In itself, that doesn’t mean you’ll retire in debt, but it sets up that scenario when combined with an unexpected setback such as illness, divorce or business failure. Many people need to redefine what they understand by living within their means. That status should include contingency plans, such as holding the equivalent of three to six months’ income in cash in case of a layoff.
Also see: The best places to retire for international luxury
2. Get a budget
Another risk factor is having no financial plan or annual budget. Feth says he’s getting more and more calls from middle-aged clients wallowing in debt, and they almost never have a documented strategy or monitoring process for their finances. “I believe it should be written down,” he says. On the budget, identify the basic expenses that must be covered every month (shelter, food, transportation), and reduce or eliminate the more discretionary ones. Tracking your cash flow changes over time will help you make it balance.
Also see: How much do you need to retire well?
3. Prioritize your debt
If you find yourself overwhelmed with debt, regardless of your life stage, you have to line your debts up, ranking them a number of ways: from smallest to largest amount, lowest to highest interest, and into categories of deductible and non-deductible debt. While some advisers push for tackling the highest-interest debt first, Feth advises starting with the smallest bill. Paying that off not only frees up ongoing interest charges to apply to other debts, it gives you a feeling of accomplishment that will help motivate you to keep at it.
Also see: Retirement saving: Your early years
4. Become tax-efficient
When grappling with debt, you also have to consider the impact of taxes. The cost of servicing debt incurred to finance a business or a rental property can be deducted from your taxable income, and therefore should be a lower priority for paying down, especially if you are in a high tax bracket. Barb Garbens, a financial adviser at B.L. Garbens Associates in Toronto, will sometimes advise clients to sell off assets to pay down their debts, then borrow to buy the assets back so that the interest they pay is tax-deductible. Then it falls into the category of “good” debt.
Also see: Retirement saving: Pre-retirement case study
5. Decide what's important to you
Unfortunately, most debt is of the “bad” debt kind, and it often requires more than plans and budgets to deal with it. Are you really willing to do what it takes? The answer can involve some soul searching. “There’s a philosophical part of this,” Feth says. “We have to ask ourselves: What is it that’s really important to us? What is the big-screen TV going to do for me?” In that light, taking action now may seem less daunting.