Yahoo Finance 7 Steps to Pay off Debt in Retirement
If you've entered retirement with a mortgage, credit card balance or car loan, it may seem tough to tackle the debt on a fixed income. The advantage you have is time: You can use free hours to improve your financial situation. Work up a plan and follow it to wipe out debt. Here are some steps you can take to pay off loans and enjoy the remainder of your retirement days debt-free.
Look over your accounts. If you're not sure how much debt you have, start by adding up all loans, mortgages and credit card bills. Then check the interest rates attached to each balance. "The first thing to remember is that debt isn't always bad in retirement," says Andrew Zimmer, a certified investment management analyst at Overland & Shanahan Wealth Advisors in San Diego. "For example, if you have a 0 percent interest auto loan, don't pay it off to get out of debt, just keep making minimum payments." Another potential good debt is your mortgage, because you might be able to take advantage of the interest deduction on your tax return.
Credit cards usually have the highest interest rates, while other loans might have lower rates. "If the interest rate on your debt is 1 to 3 percent, and your investment portfolio's expected annual rate of return is 4 to 6 percent, then you might consider making payments in order to allow investments to grow," Zimmer says. "If the debt interest rate is comparable to or more than the investment portfolio's expected annual rate of return, then it's likely better to pay off the debt."
[Read: 6 Steps to a Debt-Free Retirement.]
Make sure you have a budget. If you already have a budget in place, look for ways to start putting money toward paying off one of your debts each month. And if you don't have a budget, now is a good time to create one. Start with what you bring in each month. "Once you're in retirement, your budget is fixed," says Tony Drake, CEO of Drake & Associates in Waukesha, Wisconsin. "You know how much is coming in each month in the form of Social Security, pensions and your retirement savings." Then look at expenses for each month. Use a spreadsheet, pen and paper or an app to set up a monthly budget that can be tracked.
Understand your options. Once you have a budget in place, make sure it covers your necessities each month. With the remaining funds, consider one of these two repayment strategies:
-- Avalanche method: This involves making minimum payments on each debt except the one with the highest interest rate. To tackle the debt with the highest interest rate, pay off as much as you can each month. Once that debt is wiped out, focus on the balance with the next highest rate. Continue this strategy until all debt is paid off.
-- Snowball method: For this strategy, you pay the minimum on all balances. With any extra funds, you pay off the smallest balance first. Then you pay off the second-smallest debt. The idea is that you gain momentum along the way, much like a snowball rolling down a hill, and eventually pay off the largest debt.
[See: 9 Easy Ways to Save $500 More Per Year for Retirement.]
Select a plan. To decide which repayment strategy will work best to pay off debt, consider your balances, interest rates and preferred approach. "Unless there is a very large disparity in your interest rates, I recommend using the snowball method," Drake says. "Concentrate on your lowest balance, paying that bill first. Once it's wiped out, move to your second lowest balance, and so on."
Be careful with retirement funds. After you've considered the numbers and set up a repayment plan based on your monthly fixed income, you might look for other sources to draw on to pay off debt. If you have cash in the bank, an investment account and an IRA, any debt repayment should generally be made with cash first. "Liquidation of investment accounts will trigger tax gains and losses," says Blake Christian, a certified public accountant and partner at HCVT in Long Beach, California. Money pulled from traditional retirement accounts will almost always trigger income tax.
[See: How to Pay Less Taxes on Retirement Account Withdrawals.]
Look for extra cash. Instead of drawing more cash from your retirement accounts, think about ways to reduce expenses and put the freed up cash toward debt. "If you just don't have enough money, there's no magic bullet," says Kevin Gallegos, vice president of Phoenix operations with Freedom Debt Relief. "It may mean starting an encore career or taking a part-time job." You might find consulting or part-time opportunities at your former place of employment. Other cash-generating activities to consider: putting items you don't use on eBay, holding a garage sale or selling a second car you no longer use.
Look ahead. If you're able to pay off all debt during the first years of your retirement, you'll be able to spend the remaining decades without lingering loans. In addition to looking forward to more available cash that's not tied up in debt payments, consider using this time to set up new financial habits. "You don't want to climb out of debt only to fall back into the trap again," Drake says. "Treat every purchase like an investment." Become comfortable living within the boundaries of your budget, and write down future goals, such as a trip or new furniture, to purchase when you're debt-free.
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