Not Enough Retirement Savings? Try Paying Off Debt

What happens if you aren’t able to build up a large retirement investment stash — are you doomed to live on the streets in retirement? Probably not. Millions of people will be in the dilemma of having not enough retirement savings, and if you’re late in the game, you’ll have to look at alternatives.

While retirement investing may be the single best way to prepare for retirement, there are other strategies that can at least help to offset the impact of inadequate savings.

One of the most effective is to pay off debt.

The elderly are drowning in debt

Debt has become a chronic problem across the board, but it’s also affecting retirees. A Yahoo Finance/Wall Street Journal article, Debt Hobbles Older Americans reports that debt has become quite common among current retirees and near retirees:

“Most people used to pay off their debts before retiring. But as wages have barely kept up with rising prices over the past 35 years Americans have pushed debt higher, living beyond their means. Now, people are postponing retirement, cutting living standards or both. All kinds of debt held by this age group have risen, but the big problem is mortgages. Thirty-nine percent of households with heads aged 60 through 64 had primary mortgages in 2010 and 20% had secondary mortgages, including home-equity lines, according to research group Strategic Business Insights’ MacroMonitor. That was up from just 22% and 12%, respectively, in 1994.”

Not Enough Retirement Savings? Try Paying Off Debt
Not Enough Retirement Savings? Try Paying Off Debt

That represents a near doubling of the number of people in their 60s carrying both first and second mortgages in just a little over 15 years. The article goes on to report that the situation has only gotten worse as the housing slump has wiped out equity faster than people can pay down their mortgages. And apart from mortgages, people are also moving into retirement with higher levels of auto and credit card debt than ever.

Why the change from previous generations?

The Debtor Mindset

Millions of people have come to view debt as benign and the idea that it ever needs to be fully paid off has largely gone away. There’s a common belief among people preparing for retirement that the primary focus needs to be on building up retirement investments, and that they’ll “get right” about debt as they get closer to retirement. That probably won’t happen.

The flaw in that thinking is that after a lifetime of using credit, you won’t be able to stop and suddenly begin living without it. It’s a certainty that a lot of current retirees — who are now carrying substantial debt into retirement — thought the same way when they were younger. Somehow, we’ll magically stop using credit, and it will just kind of…go away in time for retirement!

Why the rising asset/rising debt parallel won’t work for retirement

In the best of all worlds, we save for retirement at the same time we pay down and pay off our debts, ultimately learning to live without them. But life has an uncanny way of derailing the best of intentions. It’s not at all hard for a person to both increase retirement investments and increase debt at the same time. After many years, you’re looking at two very large piles of money that may even cancel one another out.

Save for retirement we must, but eliminating debt can be equally important. If we think about the basic purpose of debt — to enable us to buy now what we can’t really afford — what it does is put us on a path toward lifestyle inflation that isn’t consistent with the goal of retirement.

It’s not just a matter of debt per se, but rather the lifestyle it affords that we settle into. Our standards go up with the cost of our possessions and activities, which not only will make retirement more expensive, but it will also reduce our ability to prepare for it between now and then.

More bang for the buck

Let’s get down to the numbers – how can paying off debt be more effective than saving for retirement? It’s purely a matter of math.

Let’s say you’ll be carrying a $100,000 mortgage balance into retirement, and the payment on it is $1,000 per month — we’re assuming that you’ll be halfway through a $200,000 loan, which is why the payment is high based on today’s rates. Now at $1,000 per month ($12,000 per year), you’d have to earn 12% on an investment portfolio of equivalent size just to stay even with the payment; do you think you can do that every year until the loan is paid?

It’s very doubtful. You’d have to be 100% invested in the stock market which has the potential to fall, setting you back even farther. Over a 10-15 year period, you’ll be more likely to see returns in the 7-8% range (or even zero if the past 15 years is any indication!), which means your cash flow would improve quite a bit more if you concentrated on having your mortgage paid by retirement instead of an additional $100,000 in savings.

The same is true of car loans—paying off the loan will have a more positive affect on your cash flow than an investment equal in size to the loan balance. And credit card debt…it goes without saying.

The critical takeaway is that the payoff of debt lowers your expenses more dramatically than the income from an investment of equal size will provide. By being debt free, you’ll need less income, and that can help offset a shortfall of retirement investment savings.

Once debt is gone, everything else is easier

Here’s an inescapable fact: there is an asymmetric relationship between debt and investments. Debt payments are fixed, investment income is not. Once we realize that, the course of action changes. If all you do to prepare for retirement is to get completely out of debt, you’ve probably done the single best thing you can. I’m not saying that you shouldn’t save for retirement, but what I am saying is that if time is growing short and investments will be insufficient, paying off your debts will be the single best strategy.

The unexpected bonus is that once your debts are paid, not only will your living expenses be lower (maybe MUCH lower) but you’ll also free up money for saving and investing. The sooner you can do this before retirement, the more you’ll save.

The key is to pay your debts off once and for all, not only to reduce expenses and have more cash for investing, but to establish a debt free position as a lifestyle as far in advance of retirement as possible. Once you learn to live without debt, everything else will be easier.

Right now there are a lot of people struggling with building retirement savings in the face of unstable employment. Do you think paying off debt and learning to live without it could be a viable Plan B?

( Photo from Flickr by PinkMoose )

4 Responses to Not Enough Retirement Savings? Try Paying Off Debt

  1. Great advice. We have eliminated debt except for our mortgate which has about 2 more years to pay off. Getting out from under those payments is wonderful. We plan to be done with debt prior to kids’ college expenses and to stay ahead of debt during college time by putting the now unallocated funds toward College (allowing our kids to start their careers debt free). We have always contributed to our 401K with employer match of course, but aside from that, our main strategy has been to attack the debt.

  2. Hi Darryl – You’ve hit on/highlighted a second advantage of getting out of debt. By getting out, you’re keeping your kids from getting in in the first place. That’s a double win, and an excellent lesson!

  3. So many times I read an article about whether s person should suspend retirement savings in favor of paying off debt, and I think my head is going to explode. I would never ever ever stop saving for retirement. At least save enough to get the employer match if one is offered. However long it takes to pay off debt, those years are lost in compounding earnings in the retirement account if contributions are stopped. Instead, continue saving for retirement and find a way to pay off debt also, whether it be through the snowball plan like Dave Ramsey recommends, or finding side jobs to bring in extra income used specifically for debt repayment. I would have never been able to retire at age 53 if I had suspended retirement savings.

  4. Hi Kathy – I’m in complete agreement with you. But the article is aimed at those who are approaching retirement age and don’t have sufficient savings. It’s an alternative strategy for people who don’t have the benefit of compound investment returns over decades. So at that point, it might be better off to get out of debt than to save more money.

    For example, if you can save $10,000 this year, it will only return 10% in stocks (optimistically) or $1,000 in investment income. But if you also owe $10,000 in credit card debt, with a minimum monthly payment of $250 ($3,000 per year) you’ll get more bang for the buck by paying off the debt than by saving and investing the money. I hope that makes sense.

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