by Gary Foreman

If you’ll be living on a limited income in retirement, a steep monthly debt payment could make retirement pretty uncomfortable. A CFP advises on what you need to know about carrying debt into retirement.

To help us examine how debts can ruin retirement, we contacted Tim Hamilton. Mr. Hamilton is a Certified Financial Planner® with the FinancialFamilies planning firm in Pickerington, Ohio. He’s written on fee-only financial planners and how debts affect family finances.

Q: How important is it for people to be debt-free when they retire? Does it really make much of a difference?

Mr. Hamilton: I have found that sometimes people are motivated to become debt-free and I am generally happy to encourage that ambition in healthy moderation. If interest rates are low and debt payments manageable, and debt repayment is unlikely to become a burden to heirs, borrowing remains a reasonable option when called upon throughout life. Often, the need to borrow is less common in retirement. However, when a need arises, borrowing in retirement can be an acceptable option.

Q: One of the biggest sources of debt for baby boomers nearing retirement is the student loans they co-signed for their children. Is there anything that families can do to avoid the problem? And, for parents who have already assumed the debt, is there a way out?

Mr. Hamilton: Most parents care deeply about the trajectory they set for their children. FinancialFamilies was founded on this very notion. Beginning a family dialogue in the early teenage years is critical to managing expectations for both children and parents. A financial plan that is sensitive to the realities of college funding, in light of mom and dad’s ability to support their own standard of living throughout their lifetimes, can help parents better assess the range of options as college nears.

Better understanding generally leads to better conversations between parent and child. These early conversations are critical in avoiding excessive college debt obligations. There are many ways to reduce the cost of college. Being alert to those opportunities with a strong sense of the family’s financial situation supports college success and a solid trajectory for both child and parents.

If student loans are required, complete a FAFSA to secure federal student loans. They do not require a co-signer.

For co-signed loans, the lender provided a clear indication of the primary borrower’s ability to repay when they required the co-signer. Lenders are experts at assessing a borrower’s ability to repay. Therefore, co-signers of any sort should fully anticipate paying back the loan themselves when they co-sign the loan. For parents, it is possible to request to be removed as a co-signer on student loans. The student must demonstrate an ability to repay the loan, so be sure to help the borrower establish that wherewithal.

Q: Some financial planners talk in terms of “good debt” and “bad debt.” Does that concept hold any validity for retirees?

Mr. Hamilton: Sure, I suppose it would. If bad debt means debt with high interest rates or too much at stake, like your home or the value of an insurance policy, then bad debt would hold as a concern for retirees. From a financial standpoint, the last thing most couples want is to be in a situation where debt is required in retirement. There is only so much income a retiree can generate.

Allowing debt payments to exceed that income-generating ability is a recipe for an unpleasant experience. Planning early and often is the key to managing money and producing a healthy and lasting standard of living.

Q: For someone who has debts when they retire, does it make sense to use a lump-sum distribution from their IRA or 401k to pay off their debts?

Mr. Hamilton: This depends on a number of considerations. Taxable income consequences can result from retirement plan withdraws. Relieving the interest expense for carrying the debt must be weighed against an offsetting tax expense for withdrawing from the retirement plans as well as an opportunity cost for no longer investing the dollars that have been withdrawn.

Further, young retirees should carefully consider retirement plan withdrawal penalties. The required age to avoid early withdrawal penalties depends on the plan type, ranging anywhere from age 50 to 59 1/2. How does the retiree feel about carrying the debt? Some retirees find debt much more stressful than others. Peace of mind has value! How much is the debt impacting the standard of living and current cash flow situation? If debt payments were reduced, would their current standard of living markedly improve?

Q: Reverse mortgages have become very popular among retirees looking for some extra income. Should they consider what they owe on that mortgage as debt? Or does it sidestep the problems of debt?

Mr. Hamilton: Yes, a reverse mortgage is a debt. In a way, it does seem to sidestep the cash flow pressures of typical debt. A reverse mortgage can be designed to grow over time, as the retiree receives payments. Those payments reduce the equity in the home in the form of debt but also provide positive cash flow to the retiree.

This is the reverse of a mortgage, if you will, which would provide all the debt up-front and require the borrower to make the payments to the lender. Those typical debt payments can be a burden to a standard of living, as they draw upon available cash.

Expert Interview: Can a Reverse Mortgage Safely Boost Retirement Income?

Q: What do you advise people who are within ten years of retirement and still repaying car loans, student loans, and credit card balances?

Mr. Hamilton: It is reasonable to make debt payments in retirement, though supporting excessive debt is a danger, especially when given limited income opportunities. We want to make sure any debt carried into retirement is manageable with a clearly defined resource earmarked for the payments.

A careful review of any recently created debts should also be thoroughly pursued. If ongoing expenses lead to recent debt, those expenses must be well understood. They cannot be permitted to foster endless additional debt and a potential debt crisis in retirement.

• The Importance of Managing Debt As You Near Retirement
• Declaring Bankruptcy In Retirement: What You Should Know
• What Happens to My Debts When I Die?
• How Credit Card Needs Change After Age 50
• Will I Inherit My Spouse’s Debts?
• Debt Consolidation: Is It a Good Deal?

Reviewed October 2023

About the Author

Gary Foreman is the former owner and editor of the After50Finances.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com.