How Does Debt Impact Retirement?
As we cruise along in life, getting older, perhaps building up debt (and hopefully some retirement savings), how will that debt impact our retirement? And when I say “debt”, that means anything where we’re making payments. And you’ll see why I mean ALL debt in the paragraphs below, because debt payments have a serious impact on the lifestyle that we hope to enjoy during retirement. There is no concept of good debt or bad debt in retirement. Just debt.
Why is that? Isn’t it normal to have a car loan? Does a relatively small amount of credit card debt really make a difference? What about my mortgage? Surely, I don’t have to pay off my mortgage to retire, right? Well, nobody has to do anything, of course, but debt becomes very expensive when we have to live off of our savings and social security.
When we retire, we get our social security, which hopefully everyone knows will not cover our retirement costs. An enormously small number of people still get a decent pension. If you get a healthy pension, congratulations! But, in most cases, a pension still won’t cover our retirement costs. A few people also have real estate that they can rent out for passive income, and there’s other various things, like continuing to work, that people do to cover retirement costs. But for most people, retirement savings are needed to cover some or most of our expenses. Without retirement savings, in most cases, lifestyle is going to be drastically impacted.
To start, everyone should create a retirement budget to estimate expenses during retirement. What do you want to be doing when you’re not working 40 hours a week any longer? Do you want to travel? Have lunch with your friends and family? Visit interesting places & be entertained? Purchase a nice retirement home? Go golfing and/or pursue other hobbies? Visit & enjoy your children and grandchildren? You might notice that all of these things cost money. So, if you want to retire with the lifestyle you hope for, you have to make sure you have saved up enough, beyond covering your basic monthly bills, to make that lifestyle actually happen. Many people unfortunately don’t have any idea how much they need to retire & enjoy life.
Let’s say that you complete a retirement budget, and the lifestyle that you want to live adds up to $7500/month. This is just an example because everyone’s going to have a different number. But, if you have debt included in that number, let’s say a $500 car payment and a $2000 mortgage payment, you really only have $5000 left to pay your bills & enjoy life. What could you do with that $2500 that might be more enjoyable? You can see already that you’ll have $2500/month less that you could spend on your lifestyle.
But let’s go a step further with the math. There’s a rule in retirement called the “4% rule”. Anyone familiar with the 4% rule is going to have an opinion on it, and I’m not here to defend it. I’m just going to use it as an example. The 4% rule says that we should withdrawal 4% each year from our retirement savings. If we do that, without going into the logic behind it, we can then feel comfortable that we won’t run out of money. The percentage might be off, but whether we should withdraw 3%, 4%, 5% or whatever, using 4% is a good illustrator. So, if we have $2500 of debt payments each month, that’s $30,000 we’re spending each year on debt payments. So, if we are withdrawing 4% each year from retirement savings, then the math says that we should divide the amount we need by 4% to determine the amount, roughly speaking, that we need to save & cover the costs.
So, to cover $30,000 a year of debt, we take $30,000 and divide by 4%. $30,000 / .04 = $750,000. So, just to service just our debt payments, we need to save $750,000 in our retirement account! Or, to put it another way, if we pay off our debt, then we need to save $750,000 less to cover our retirement. Or we would be able to use that $750,000 for our enjoyment, instead of using it to pay for our debt. Let that sink in for a minute! Obviously, this is a ballpark estimate, and we need to factor in other income streams like social security, pensions, jobs and passive income. But it just shows how incredibly expensive debt becomes in retirement. Debt robs us of our income throughout our lives, but during retirement it’s a real killer!
Therefore, part of any retirement strategy should be a debt elimination strategy. Going into retirement without any debt, including a mortgage, gives us much more flexibility in our budgets to enjoy our golden years. And the best time to get started on that is right now! So, if you’d like to take a hard look at your financial situation and develop a plan to eliminate your debt, you can click here to schedule a Complementary Consultation. We’ll get to know each other, discuss your situation, and decide if financial coaching is a fit.
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