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Before retiring, it’s important to eliminate or reduce debt as much as you can. When you’re no longer receiving a working paycheck your income will be more limited, and any money paid to service debt is money not available for you to live on. It’s also money you can’t put in your retirement accounts to grow over time. Carrying substantial debt into retirement increases the risk that you won’t be able to sustain a comfortable lifestyle in retirement. Here are some ways to handle debt before retirement.
1. Pay off the highest interest rate debts first. These are typically consumer debts like credit card and personal loans. Eliminating the highest cost debts first reduces your interest payments.
2. Minimize your interest payments. In the current low-interest-rate environment, there are opportunities to refinance and transfer debts between institutions and accounts to lower your interest rate. You can transfer credit card balances to a lower rate card. You can refinance your mortgage or home equity loan to a lower rate. A lower rate of even a couple of points can save you thousands of dollars over the term of the loan. Of course, refinancing is only feasible if you …
3. Maintain your credit rating. A good credit rating makes it much easier to get favorable rates and terms when you transfer or refinance debts. There are free services such as Credit Karma which enable you to monitor your credit score. Credit Karma also has tools that enable you to figure how long it will take to pay off a loan.
4. Keep an emergency fund. A cash fund of six month’s living expenses is recommended by many financial advisors. This will enable you to handle contingencies that come up like unexpected home or car repair bills or medical expenses without having to incur additional debt or dip into your retirement savings.
5. Put the money you save to good use. After you reduce or eliminate debt, start paying yourself instead of the bank. Put the money you used to send to make debt payments into a retirement account. If your employer offers a 401(k), especially with matching funds, take advantage of that (almost half of employees don’t contribute to a 401(k)).
6. Take on additional income. If you need more time to retire your debts, consider working a year or two longer, taking on a second job, or working parttime in retirement. The extra income can help with paying down debts.
Many retirees and near-retirees are burdened with debt. According to the Social Security Administration, 80% of households approaching retirement in 2010 held some debt. Most of that was housing debt of over $120,000. Many households also had consumer debt of over $18,000. Additionally, many have education debt: according to an analysis of government data by the LIMRA Secure Retirement Institute, in 2013 retirees had average education debt of $2,300 and pre-retirees age 55-64 had average education debt of almost $8,000.
Well-known financial advisor Dave Ramsey says it’s “imperative” that debt be eliminated before retirement.
If you have debt and retirement is looming, there’s no reason to panic. Just create a smart plan to eliminate debt as quickly as possible. The less debt you carry into retirement, the more likely you are to have a comfortable lifestyle.