Previous generations used to steer well clear of debt in retirement. Nowadays, this has become a more viable option, thanks to the benefits of employer matched contributions.
The number of retirees who bring debt into their retirement is on the increase. There are several factors that are behind this, starting with the historically low interest rates that we’ve seen lately. In concert with this, home prices going up as much as they have serves to provide us with more means to borrow, and employer-matched retirement plans provide a big enough incentive to make a lot more sense of borrowing to fund our retirements.
Together with all this, today’s retirees and those approaching retirement have relaxed their attitudes toward retiring with debt and using debt to further their retirement plans, as opposed to the more stalwart views towards this that previous generations had, where this was simply seen as wrong as a matter of principle.
We might think at first glance that seeing your income cut the way retirement tends to do it would not be a time to hold debt, and after a lifetime of accumulation, we should really be doing what we can to rid ourselves of this prior to retiring. We may even want to prolong our working years if we haven’t been able to get a handle on this enough because when we are relying on pensions and our savings to make up the difference. This is going to make stretching out these savings more difficult, and provide less of a cushion to fall back on should unexpected expenses arise, as they often do.
While this rather cursory view does have something to tell us, we can’t just look at disadvantages, which this view does quite well, without looking at the merits of such an idea. The cons are easier to see though as they are more obvious, and the pros of carrying debt in retirement aren’t so obvious and require us to think about this more.
When we speak of carrying debt in retirement, we first need to distinguish between types of debt as well as amounts of it. Secured debt and unsecured debt are two very different creatures, especially where retirement considerations are concerned. Whether we own our own home and how much equity we have in it to work with it is going to matter as well, and using home equity for this is far preferable and even serves as the dividing line in the overwhelming majority of cases.
Of course, some people end up in debt at this stage of their lives simply because they mismanage their funds, and even the lowest income people need to be as wise as they can about this.
Home Equity Can Really Be Leveraged Well with This
Whether we own our own home or not will matter a lot here, at least the part that has us using debt strategically and intentionally holding a certain amount when we could have at least reduced it. This does not necessarily mean that those who do not own should just exclude the possibility of this without looking at whether this could benefit us or not.
Without home equity to fall back on, it’s not normally such a great idea to take out unsecured loans at higher rates and shorter amortizations to invest, and this is all about if and when we should borrow to invest or defer money that could have been used to pay down debt and invest that.
Borrowing by taking out unsecured loans may even have their place in some circumstances, if the payments extend into retirement. However, we might think that this is no time to be adding significantly to a situation where we usually have some sort of shortfall, where ends don’t meet anymore and this will be further apart if we add a loan payment that we don’t need to this.
Once we reach retirement, we can always draw down on our retirement savings in order to service this loan though, so it’s not that we don’t have the capacity, it’s more a matter of whether we can make sense of this. The rates will be higher, but they can’t really be too high, so we will need a very good credit rating and access to low rates as far as unsecured loans go to want to play this game well.
The numbers can still come out in our favor, provided that we don’t make mistakes with it such as buying into a bear market. Whether we should do this or not will actually depend on how far we can extend the loan into retirement, and believe it or not, the more the better.
If we are just taking out a loan to contribute to our retirement savings and pay it back while we’re still working, we could just contribute the payments and just avoid the interest. If, instead, we only have one year left to go at work and we can get a $10,000 contribution match, we end up with $20,000 in our retirement account and only owe $10,000. This is exactly why this is a lot more viable a plan than it may appear.
We Also Need to Make Sure We’re Choosing the Right Investments
We want to take particular care to avoid investing this borrowed money in a bear market, whether you own your own home or not, and especially if you do not. This doesn’t mean that the bears run us off from this strategy necessarily, it just means that we need to look to avoid too much market risk here. We usually can choose our asset mix though so this means that we need to not be in stocks when they are falling and can choose bonds or savings instead when appropriate.
Stocks go through bear markets quite often, and even bonds can as well, and it’s better to lean on the side of safety here if there is much doubt. For instance, if you were looking to do this now, you’d need to either avoid stocks or be at the ready to switch to something else if the bear market that people have been talking about for a while materializes.
If we pay interest to invest and also see the investments lose money too, that’s not what we should be after, although this plan really isn’t so much about nominal return on investment, it’s about taking money that is on the table for us and putting it in our pockets.
This is all really about taking better advantage of employer contributions to our retirement plan. It’s much less about looking for returns, and in fact if not for your employer matching these borrowed contributions, the whole idea wouldn’t hold much water at all. Market returns average higher than secured lending rates at least, but when we factor in the additional risk, it doesn’t really make much sense to add this risk at this point in our lives.
If we do have home equity to use for this though, this makes it both easier and more sensible to use as a strategy. Let’s say we add $10,000 to our 401(k) by adding it to our home equity line of credit, which is the weapon of choice for this. We only need to make the interest payments on this, which is pretty minimal, and we’re only looking at less than $40 a month at today’s rates.
Meanwhile, our investment of $20,000 can easily cover this cost as far as how much it grows. We’ve got twice as much money invested, so we only need half as much of a return to break even, around 2% a year. We could even get this back in the end by investing in treasury bonds, even at today’s very low yields.
When we break even on the costs, we are then left with doubling our money over a relatively short period of time. Any additional profit earned on the returns of this invested money is pure gravy.
We don’t want to get too greedy here as this late in the game is not the time to fiddle around too much with risk, even though a lot of people do. Bonds are actually a pretty appropriate asset class at this stage, even though so many advisors tell us to maintain a big exposure to stocks. Depending on the market, this may be a good idea or it may be a terrible one.
This is not something that a blanket approach is very appropriate for, fixed allocation percentages that is. This requires no real thinking or effort, but this is a time where we do need to think and do need to make the effort commensurate with the importance of managing our retirement properly.
While unsecured borrowing for retirement is more on the fringe and is something that people rarely even do, and really is only appropriate for one last trip to the employer contribution bank which we would miss out on doing otherwise, secured borrowing for retirement can make a lot of sense for a lot of people in a lot of situations.
We don’t want to be too aggressive here, where we may be pushing the limits too much with this borrowing and end up not being able to handle unexpected needs properly. If used wisely though, borrowing for retirement can allow us to further our retirement objectives and live a more comfortable life in our final decades.