The Eternal Struggle: Getting Out of Debt vs Retirement Planning
Conventional investment wisdom suggests that saving for retirement is the most pressing thing in a retirement planning client’s priority list. But this doesn’t account for the fact that people who are ensconced in debt are already in financial hot water, and once they reach their boiling point, they will turn to their retirement accounts to make ends meet if there are no longer any other options.
It’s important to stress to clients that debt on its own doesn’t have to be a negative thing. However, to keep debt from causing clients to stray from their retirement planning objectives, it’s important to make sure clients understand the distinction between ‘good debt’ and ‘bad debt’ as well as a clear outline of how much debt they can comfortably maintain during retirement. Here are some things to look at when evaluating a client’s particular situation in order to ensure successful retirement planning:
Put Debt in Perspective
Any debt where the cost is low and comes with potential tax advantages can be put to work in the client’s favor. For example—mortgages or HELOCs allow clients to borrow towards owning an (in theory) appreciating asset. Home loans may also possibly be tax deductible. This puts the debt incurred under the ‘good debt’ classification. Another form of ‘good debt,’ possibly, are student loans. In theory, the education they finance enhances a client’s earning potential and expands the possible career opportunities that are available to them. Most student loans are low-interest and can also be tax deductible.
Credit card debt, however, is most often high cost and isn’t tax-deductible. It is the same for car loans, but with the added fact that the loan is taken against a depreciating asset. These things can be considered ‘bad debt.’
This seems like such an obvious task, yet financial planners may be surprised at how few clients take the time to complete this task. This should be the first step in determining the path clients should take as they begin preparations for retirement. Sit down with clients and prioritize their debts based on the current interest rates on the accounts.
Create an action plan. Taking care of the most expensive credit/debt first will reduce the amount of money going towards interest-only payments as well as expediting how quickly clients can pay off all debt. Taking the time to increase payments on the most expensive debt a retirement planning client has, while they continue to make minimum payments on the rest, they can work their way down the list until it is all paid off.
Create a Retirement Timeline
Successful retirement planning requires clients to take the time to look at the big picture. First, have clients do a rough estimate of their total expected expenses while retired. Then draw up a visual representing the sources of retirement income: Social Security, capital gains from investments, pensions, 401(k) distributions, etc. This will give clients an idea of what they’re looking at and whether they have to save more money currently or work longer.
These steps, dealt with head-on by clients and advisors, will ensure that the eternal battle of debt repayment versus retirement planning can be won, with clients and advisors both reaping the benefits of successful long-term planning.