Pick A Safe Debt Level In Retirement
BY PAUL KATZEFF
INVESTOR'S BUSINESS DAILY
Posted 11/18/2005
More Americans are carrying mortgages into retirement these days.
That's in stark contrast to an earlier generation, the parents of today's baby boomers. The Great Depression taught that older generation to beware of saddling itself with excess debt.
That may still be a good idea for boomers just entering or approaching retirement.
"I would target zero debt," said Scott Smith, assistant vice president and senior product manager for retirement planning of MFS Investment Management.
But baby boomers have lived in a more affluent age. Their incomes have generally been steady. They've enjoyed a stock market that's usually moved up. Even after declines, the market has bounced back.
"Unlike their parents, most baby boomers haven't been in a prolonged situation where monthly fixed costs have been catastrophic," said Wayne Starr, financial planner and investment adviser for BKD Wealth Advisers in Kansas City, Mo.
Still, how much debt is too much in retirement?
An old rule of thumb was that revolving debt — home loans, car loans and credit cards — should not top 33% of disposable income.
The mortgage on your principal residence alone should not top 25% of your disposable income.
But those caps can deprive you of flexibility in how you use your assets. "I think it's better for people to decide which debts they want to carry into retirement, then decide how much of their retirement income they want to allocate to each one," Starr said.
That latitude is important because home values and mortgage balances can vary widely.
In the New York City borough of Manhattan, the average price of a home is $1.1 million.
For half that amount you can buy the local Taj Mahal in many communities.
Also, some recurring expenses that are essential to you may not matter to other people.
To you, country club dues might be worth every dollar you spend.
To a city-dwelling widower, annual tickets to the ballet might be a prized indulgence.
Starting Steps
Overall, deciding which debt to carry into retirement requires three steps, says John Diehl, who helps design The Hartford's financial planning products.
• Inventory your income and spending.
• Prioritize your spending into two categories — essentials and optional.
• Pick which optional expenditures you can afford in retirement.
Start the inventory of your income and outflow by listing your current major budget items.
A spreadsheet will make it easier to modify your list, categorize spending and prioritize.
Flesh out your list by figuring out what you spend for categories such as housing, food, utilities, health care, education and clothing.
And don't leave out the expensive extras.
Housing includes everything from property taxes to condominium association fees and local assessments for improvements such as sewerage.
On the other hand, some things may cost less after retirement. You probably won't need to buy new business suits as often.
But travel, vacation, hobbies and, before long, health care may start to cost more.
"Until you make a list and itemize the costs, you might be surprised how $100 here and another $100 there add up," Diehl said.
The hard part is deciding which activities you can afford in retirement.
"Can you afford long golfing vacation in Florida during the winter?" Starr said. "Can you afford several trips each year to a spa in the Arizona desert?"
What if you have more than one home or plan to buy another? You may be looking at two mortgages.
"If even one mortgage looks like more than you want to carry into retirement, consider selling the vacation home," Starr said. "Then use the proceeds to pay off the debt on your primary residence."
Live Long And Prosper
As for income, remember that your nest egg may have to support you for a long time.
"If you retire at 60 today, chances are good that you'll live to 90," Starr said. "Your savings, investments and any pension may have to finance as much as one-third of your lifetime."
A bad year in the market can cut your income a lot.
That could force you to trim spending one or more years.
"You may be forced to sell certain assets before you had planned to," Starr said.
One way to minimize the need for pruning your lifestyle is by building a margin of safety into your yearly budget.
"Don't plan on spending every dollar you expect as income," Starr said.
Another coping tactic is to update your budget and priority list periodically.
That'll make it easier to cut back spending if the need arises.
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