Debt Relief Experts
Carrying debt into retirement is risky financially. It is difficult to balance debt repayment with living expenses when on a fixed income. As your retirement income decreases, living expenses stay the same or even increase, leaving less room in your budget for debt payments. This is why five percent of consumer insolvencies in Canada are filed by retirees struggling with debt.
Here are some recommendations for managing debt and retirement.
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How Much Debt Should You Have When You Retire?
Ideally, you should enter retirement debt-free. This provides the most financial freedom and peace of mind. However, this isn’t always realistic for many Canadians.
Some debts may be more acceptable in retirement, such as a manageable mortgage, reverse mortgage, or home equity line of credit, which you might use for money management.
Having said that, here are five types of debt you should never carry into retirement:
- Credit card debt
- Tax debt
- Payday loans
- Student loan debt
- High-ratio mortgage debt
These revolving or consumer credit options rarely help build investment savings or equity, can charge high interest rates, and drain retirement budgets. As such, they should be paid down before you stop working.
No matter how much debt you carry into retirement, you must be able to service loan payments on your expected retirement income. Debt servicing means having enough regular income to make all required debt payments while still covering your living expenses. As a rule of thumb, no more than 36% of your pre-tax income should be used to manage debt payments, including your home, credit cards, car loan, and line of credit. As your income drops after you retire, the amount of money you have available to service debts also drops.
Consider how debt might impact your quality of life in retirement. Excessive debt can force you to compromise on essential expenses or enjoyable activities. Also, factor in potential risks like health issues or market downturns that could affect your ability to manage debt.
Credit Score Considerations in Retirement
While maintaining a good credit score is important, you may not need as much credit in retirement, so focus on your overall financial picture rather than just your credit score. Continue to make timely payments on any existing debts. This will ensure a good credit score in case you need to borrow money for unexpected expenses or want to refinance existing debt.
Credit Card Debt and Retirement
Credit cards can be useful for retirees, offering ease of payment, fraud protection, and the ability to track expenses. However, it’s important to approach credit card use with caution, particularly when living on a fixed income. Carrying credit card debt into retirement is a bad idea, as high interest rates on unpaid balances can quickly erode retirement savings.
Consider keeping one or two credit cards active with low balances to maintain your credit history. Keep credit card use to essential purchases and limit the number of open accounts to reduce the risk of overspending. Charge only as much as you can pay in full each month so credit card debt does not become a burden.
Additionally, cognitive decline can affect financial decision-making. Older retirees should consider setting up safeguards, such as automatic payments, account monitoring, or even assigning a trusted family member or financial advisor to help oversee accounts.
Payday Loans and Retirement Income
Payday lenders will loan against stable retirement and pension income. However, you should avoid using payday loans in retirement due to their extremely high interest rates and short repayment periods. The fees and costs associated with payday loans are far higher than traditional credit options, making them a poor choice for covering unexpected expenses.
Co-signing and Helping Adult Children
One worrisome trend is seniors taking on debt in retirement to help their adult children financially. Be aware that co-signing a loan makes you equally responsible for the debt. If your child can’t make payments, the lender will look to you for full repayment, potentially jeopardizing your retirement finances.
Be clear about what financial help you can offer without impacting your own personal finances. You can’t help your children in the long run if you’re struggling financially in retirement.
Should You Pay Down Debt or Save for Retirement?
Deciding whether to focus on paying down debt or saving for retirement depends on your time horizon. The closer you are to retirement, the more critical it becomes to eliminate debt.
High-interest debt should always be prioritized over savings, as paying this down first will save you the most money. However, for lower-interest debt, potential investment returns might outweigh interest savings, especially if retirement is still several years away.
Finding money for both debt repayment and savings requires a careful review of your finances. Create a budget that tracks your spending to identify areas where you can cut back. Focus expense reduction on discretionary spending like dining out, entertainment and services you no longer use. Apply for all government benefits like CPP, OAS, and GIS to maximize your income.
Once you’ve paid off high-interest debts like credit cards, avoid accumulating new debt by cancelling extra cards and reducing credit limits. Keep one or two cards with lower limits for emergencies and regular expenses.
Should I Use My RRSP to Pay Off Debt?
Using your RRSP to pay down debt is generally a poor financial decision. Not only will you permanently lose your retirement savings, but RRSP withdrawals are fully taxable as income and subject to immediate tax withholding at source.
It is important to know that registered retirement funds (RRSPs and RIFs) are protected from creditors in a bankruptcy or consumer proposal, except for contributions made within the last year. Always consult a Licensed Insolvency Trustee before draining your RRSP to pay down debt.
Can Creditors Garnish My Pension?
If you’re missing monthly payments and worried about creditor actions, you should know that most retirement income in Canada is protected from creditors. Government pensions like CPP, OAS and GIS cannot be garnished except for government debt. Private pension income is also typically protected from creditors. However, once pension money is deposited into your bank account, it may lose this protection unless you keep it in a separate account used only for pension deposits.
Worried about debt affecting your retirement?
The Financial Preparedness Plan
Having savings goals is still important even after you’ve left the workforce. While certain expenses, like commuting or work-related costs, may decrease, new or unexpected expenses, such as healthcare needs, home repairs, or long-term care, can arise. Inflation also erodes purchasing power over time, meaning the cost of living may rise faster than anticipated. Being prepared to live off a fixed income means having money set aside for each of these purposes:
- Emergency Savings: This protects you from costs like home and car repairs.
- Retirement Savings: How much you will need depends on your lifestyle expectations and how young you retire. If you carry debt into retirement, you will need more money to keep up with debt payments.
- Personal Saving: Consider this your discretionary account and comfort cushion. It’s money you use to replace your car, take a vacation, pay medical bills, etc.
Debt Relief for Seniors
If your debt load is unmanageable on your retirement income, consider these debt relief options for seniors:
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Explore debt consolidation: Combining multiple high-interest debts into a single, lower-interest loan can make repayment more manageable and potentially save you money on interest.
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Leverage home equity responsibly: If you own your home, a reverse mortgage or home equity line of credit might provide funds for debt repayment. Be aware, however, that reverse mortgages often have high fees and interest rates, while home equity lines of credit could put your home at risk if you can’t make the payments.
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Consider a consumer proposal: This legal debt settlement process allows you to repay a portion of your unsecured debts over time with no interest. It can stop collection calls and preserve any retirement savings you may have.
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Seek credit counselling: A non-profit credit counselling agency may be able to help you create a debt management plan, potentially securing lower interest rates or fee waivers from your creditors.
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It is rare for a senior to need to file bankruptcy since pension income cannot be garnished.
If you’re approaching retirement with unmanageable debt, don’t wait until your financial situation worsens. Taking action now gives you more options and a better chance at a secure retirement. Contact Hoyes Michalos today for a free consultation with a Licensed Insolvency Trustee to review your situation and explore solutions that can help protect your retirement savings.
