By Christine Fahlund on November 10, 2009
While managing debt is a primary consideration during your working years, it takes on added importance when you transition from earned income to retirement income.
Generally speaking, you should plan to have approximately 75% of your preretirement salary to maintain the lifestyle you had while working. In addition, your nondiscretionary monthly payments (e.g., taxes, utilities, groceries) should equal approximately one-third of your monthly income. Given these parameters, you're now ready to take a closer look at your own potential future cash outlays in retirement.
Of all the debt you may be incurring now—including car and credit card payments—usually the most important is your mortgage. While not all retirees are faced with these monthly payments, many carry those payments into retirement, a time when cash flow will likely decrease. One way to avoid this is to accelerate the payments on your mortgage by adding extra dollars to your principal.
While some mortgage holders may not want to lose their home mortgage income tax deduction, it is important to remember that mortgages are "front-end loaded" so that most of the interest paid is in the earlier years of the loan. By the time you reach retirement, your final payments include very little interest, so you have only a very limited opportunity to benefit from an income tax deduction.
For homeowners who are considering transitioning into retirement with a mortgage, there are a variety of strategies you may want to think about:
- Increase the size of your mortgage payments.
- Sell your current home and reinvest that equity in a less costly house.
- Move to a more, affordable area.
As we age, there are additional expenses to consider, namely health-related costs. If you have been thinking about retiring before age 65, you might want to think twice, since you will not be eligible for Medicare coverage until you reach that age. So unless your spouse is still employed, or you find a part-time job with benefits, the costs of health insurance premiums may be significant. It is also a wise move to explore how much Medigap insurance will cost, and purchase long-term care insurance coverage while you are still in your 50s or early 60s since those premiums tend to rise dramatically the older you are when you apply for coverage. These types of insurance coverage can help to guard against potentially debilitating medical bills in retirement, which could throw you into debt that could be very difficult to repay on a limited income.
For many retirees, one approach to financing retirement, that has garnered attention over the past few years, is a reverse mortgage. While some retirees may view the strategy as beneficial, T. Rowe Price suggests that it should be used cautiously, if at all. In addition an advisor with reverse mortgage experience, one who will not, nor will his employer benefit from the transaction, should be consulted before finalizing any contracts.
Credit card debt is another factor you'll want to carefully monitor. While such cards offer the convenience of cash-free transactions, be sure to pay them off in full each month to avoid future financial pitfalls. Read the fine print in your agreements with the credit card companies, and watch out for any increases in the interest rates you are being charged. Although we all intend to pay our cards off each month, sometimes that just isn't possible, so know in advance how the interest rates on each card could affect you in such situations.
In a nutshell, since you could spend as much as one-third of your life in retirement, it makes good financial sense to do your homework in advance. Plan for any costs to cover adequate insurance protection during retirement—and pay down as much debt as possible before you retire to ensure that you can afford to stay on solid financial footing once you are ready to finally take the plunge.
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