Retirement

Retiring with Debt: What’s OK?

By Chris Duderstadt

May 11, 2023

Retiring with Debt: What’s OK?

Key Points – Retiring with Debt: What’s OK?

  • Considerations for Retirement and Debt
  • The Difference Between Good Debt and Bad Debt
  • Psychological Debt versus Financial Debt
  • Looking at the Current and Future Tax Brackets as You Think About Debt in Retirement
  • 10 Minutes to Read | 23 Minutes to Watch

Are You Retiring with Debt?

Debt can be a complicated topic—both financially and emotionally. Should you pay it all off prior to retirement or is there some debt that’s OK to take into retirement? Is there debt that you shouldn’t even think about retiring with? Dean Barber and Bud Kasper examine retiring with debt on America’s Wealth Management Show.

Incurring Debt in Retirement

There’s a psychological thing about retiring with debt. From a psychological perspective, being debt-free is a freeing type of feeling. That may be a good thing and it does feel good, but there also may be reasons that you want to be retiring with debt. If you are retiring with debt, you need to make sure that you understand what kind of debt it is and that you can dismiss it in a short amount of time.

“Dean and I have met with hundreds of people about whether they should pay their house off or things like that. I don’t think there’s anything more liberating than making the last payment on your house. Or maybe you get a bonus and you put it into to reduce that amount of debt because you’re chipping away that’s been a constant in your life for all these years. It’s yours. It’s a great feeling to know that money is coming back into your pocket for potential spending.” – Bud Kasper

It’s All About Cash Flow in Retirement

When you go into retirement, cash flow is critical. What’s the net spendable amount that you can have to do live the life you want to live with confidence and freedom?

Let’s say that someone is 55 and they’re getting serious about planning for retirement. Maybe they want to retire at 60 and they’ve done a good job of saving and have some tax diversification. However, they still owe $300,000 on their house because they just refinanced their house during the pandemic and got a 30-year note at 3%. Should they rush to pay that off before retiring in five years?

Dean wasn’t looking at retiring in five years at the onset of the pandemic, but he still found himself in a similar situation. Fifteen years ago, Dean bought the Modern Wealth Management business park (then Barber Financial Group) in Lenexa, Kansas. He was close to having it paid off when the pandemic hit but realized it didn’t make any sense to rush to pay it off at that point.

“I did a cash-out refinance because he could get a new 15-year note for 3.5% on the commercial property. I took as much cash out of the property as I possibly could knowing that over the next 15 years that I’m going to earn more than 3.5% on that loan. At the same time, it won’t affect my cash flow, profitably of the property, or anything like that. Suddenly, I’ll have the property paid for at the end of 15 years and that money I pulled out is going to be worth a lot more. I’m not taking that money out to spend it. I’m arbitrating. So, in that aspect, I think debt is fine.” – Dean Barber

Retiring with Debt Responsibly

People who work in real estate are notorious for using debt to leverage returns. In that case, it increases risk and potential reward. But in Dean’s scenario, if he were to take that money and use it for an extravagant vacation or a new vehicle or house, that would be irresponsible.

Here’s another example. Today, you can get a one-month treasury at 5.5%. Dean borrowed money at 3.5%. He wants to know how much he can borrow at a low interest rate as long as he knows he can get a better interest rate. Dean understands that he made an aggressive move by doing that, but the point is that that’s an example of good debt.

When you look at where we’re at today, obviously no one is refinancing mortgages today because 30-year mortgages are above 6%. If someone refinanced in the last five to seven years and is going into retirement, it probably doesn’t make sense to rush and pay off that debt. If your debt is at a low enough rate, there’s no sense in hurrying.

“You need to think outside the box of the traditional debt-is-bad-and-you-need-to-pay-it-off-now mindset and assuming that you shouldn’t buy anything unless you can pay cash for it. Even today, you can get some reasonable interest rate specials on vehicles. You might get something that’s 1.9%, 2.9%. If you’re going to buy a vehicle, are you paying cash for the vehicle or is it OK in retirement to take out one of those loans that’s at a lower interest rate?” – Dean Barber

Understanding How Much of Your IRAs Is Yours

Another thing to look at is if someone plans on taking money out of their IRA to pay off a mortgage, car, etc., you need to understand what the real numbers are. Remember that you have a partner in your IRA, and it’s Uncle Sam. As soon as you take the money out of the IRA, Uncle Sam is going to get his piece of it.

“Anyone that goes into retirement with an IRA or 401(k) is retiring with debt. You owe a part of what’s in that IRA or 401(k) to the government. If you don’t believe me, try to take that money out and spend every dollar of it. You can’t do it because part of it belongs to the government.” – Dean Barber

Taxes on Retirement Income

We when start thinking of retiring with debt, we think of taxes as a debt. Taxes on IRAs are a debt. We need to start planning early—well before retirement—of how to pay off that debt. How are you going to pay as little tax as possible on that IRA—not in a given year, but over your lifetime?

“That’s why people should be using Roth IRAs. You should be focused on getting money in on an after-tax basis that will never be taxed again. We’ve been very diligent about that. Our team of CPAs and CFP® Professionals are constantly looking at how to limit the tax liability in the future by doing something constructive with it today.” – Bud Kasper

There are several benefits to Roth IRAs, but most people won’t go into retirement solely with Roth IRAs. Even if you were contributing to the Roth portion of your 401(k), all the matching contributions have been done to the traditional side. And even if you were trying to save all the money you were going to need for retirement into the traditional side, you’re not going to have enough money. You’re going to have some traditional assets that have the tax embedded in there that Dean considers to be a debt.

Once the financial plan gets built, we bring in our team of CPAs look at the plan from a tax perspective. We know that a portion of the IRA is going to go to Uncle Sam, but how do you pay as little tax as possible to get that money into a situation where you can spend it in retirement?

Considering Roth Conversions

We’ve been doing more Roth conversions than ever and anticipate that trend to continue the next couple of years. The main reason for that is that tax rates are going up on January 1, 2026 when the Tax Cuts and Jobs Act sunsets. So, we’re calculating how much conversion we can do for each person in a given year.

“I love the way we do it. It’s purely from a financial planning perspective when we look at the tax liability if we were to convert X-amount of money. We’re always looking at what the tax liability would be in specific situations. What we’re really finding is that people are willing to do the Roth conversions, but you need after-tax money to pay for them.” – Bud Kasper

If you don’t have that other bucket of money to pay the tax, then it doesn’t make any sense in some cases. But there are some exceptions, as Dean and Bud were reminded at the Ed Slott Elite IRA Advisory GroupSM workshop that they attended a couple of weeks ago in Baltimore.

“Our good friend, Marty James, did a presentation on when it would makes sense to convert it. It was all about health care and bridging that gap to qualify for the subsidies on the ACA. There are going to be sometimes when it does make sense to pay the tax out of the conversion itself. And there when it doesn’t make any sense at all. It’s a case-by-case basis. To make sure you’re getting the right answer, you need the plan done first. Then, the CPA comes into work with the CFP® Professional and the client to figure out how to reduce taxes over a lifetime.” – Dean Barber

Factoring in Required Minimum Distributions

Let’s run through another example while looking at the 2023 tax brackets. The 12% bracket runs from $22,001 to $89,450. The 22% bracket runs from $89,451 to $190,750. Then, the 24% bracket runs from $190,751 to $364,200.

Imagine someone early in retirement in their early 60s. They have most of their money in 401(k) and IRA assets, which is typical. The first thing we need to do is determine what tax brackets will look like when RMDs start at age 73. Or it could be age 75 depending on the year you were born. Keep in mind that the tax rates are reverting to the rates of 2017 when the Tax Cuts and Jobs Act sunsets.

Methodical Roth Conversions

If you’re in the middle of that 22% bracket, should you convert some of that traditional to a Roth all the way to the top of the 22% bracket? Or does it look like you’re going to be in the 32% once you hit your RMD age? Those projections are part of the plan, so maybe you need to convert to the top of the 24% bracket.

“We just went through a scenario where we knew that converting to the top of the 24% bracket would trigger the additional Medicare IRMAA surtax. That allows us to get everything converted by the time the Tax Cuts and Jobs Act sunsets. It made a huge difference in the overall success of the plan and in the amount of lifetime taxes that would have been paid if the conversions hadn’t been done. We didn’t do it blindly. The plan is done. The CPA spent a lot of time working with the CFP® Professional and the client to talk through all those options.” – Dean Barber

Ask yourself the question, “If you’re going to pay this tax now, how long will it take to get the return that I paid in taxes in the time I did the conversion?” There are a lot of factors that go into that in terms of where the money is invested. But at least you know that you’ve taken the taxes on that money out of the equation by doing the conversion at that time.

We can still do Roth conversions after tax rates go up in 2026. We’re just saying that time between now and then is an opportunity to convert at a lower rate. We could go on and on about Roth conversions. The point is that taxes in your retirement accounts are essentially debt.

What Could Retiring with Debt Look Like for You?

This really highlights what financial planning—and more specifically, retirement planning—is all about. One of the things we’ll do during the retirement planning process is assess the amount of debt that someone has and what kind of debt it is. As Dean mentioned, there might be some situations in which you’re OK with retiring with some debt.

That’s one of the items that we review in our Retirement Plan Checklist, which is designed to gauge your retirement readiness. Download your copy today to get a better idea of where you stand in the retirement planning process.

Retiring with Debt

Download: Retirement Plan Checklist

Good Debt vs. Bad Debt

According to Clever Real Estate, 71% of people are retiring with non-mortgage debt. That’s OK to an extent. When our CFP® Professionals are building your plan, they need to figure out how that debt impacts the probability of success of your retirement. Is there something that needs to be done to mitigate that debt before you retire?

“You need to have a financial plan to see if the debt makes sense or not. I believe that there’s good debt and bad debt. Bad debt is credit card debt. It’s bad when someone allows their credit card to charge them interest and they’re not just using it to get points, cash back, or whatever, and they’re not paying it off at the end of every month. That’s the worst thing that someone can do is to rack of credit card debt going into retirement.” – Dean Barber

Due to the rapid increases in prices with inflation not being under complete control, credit card debt can cripple you. Inflation is getting under control a little bit, though. Federal Reserve Chairman Jerome Powell threw the lasso and at least has it around inflation’s neck, but he hasn’t reeled it in.

“Interest rates on credit card debt are going to be in the 20-plus percent range. It’s just insane to have any credit card debt.” – Dean Barber

How Much Do You Need to Live?

Again, the big question that you need to figure out the question to is, how much do you need to live? What is that debt costing you? What would it cost you to take funds from another asset that you have to pay off that debt? It’s not as simple as answering a yes-or-no question. It requires a well-thought-out financial plan when you’re looking at retiring with debt.

“If you’re not borrowing money that you don’t have, that’s a different story. If you have money that you can pay debt off any day, that changes the scope of the debt. It’s when people borrowing money to buy something that they couldn’t pay in cash for is when debt gets questionable.” – Dean Barber

Working with a CFP® Professional to Assess Retiring with Debt

There’s good debt and bad debt. There’s the psychological aspect of retiring with debt and the financial aspect of retiring with debt. Don’t get those confused. You can make sure you have it all right by working with a CFP® Professional that’s working with a good CPA because there are tax consequences to most debt.

If you have any questions about retiring with debt, you can schedule a meeting with one of our CFP® Professionals by clicking here. We can meet with you for a 20-minute “ask anything” session or a complimentary consultation. That meeting can be in person, over the phone, or virtual—whatever it’s easiest for you.

And if you don’t feel like you’re quite ready to meet with a CFP® Professional, we have another way that you can get started on building your financial plan. We encourage you to spend some time using our industry-leading financial planning tool. You can begin building your plan at no cost or obligation—and from the comfort of your own home—by clicking the “Start Planning” button below.

Retiring with Debt

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A financial plan is where it all starts with answering the questions about retiring with debt. As always, if you have any questions about building your plan or about retiring with debt, please don’t hesitate to reach out.

Retiring with Debt: What’s OK? | Watch Guide

Introduction: 00:00
Thoughts on Retiring with Debt: 01:55
Dean’s Example on “Good Debt”: 04:15
Financial Planning and Debt: 9:13
IRAs Have Debt??: 11:49
Good Debt & Bad Debt: 19:32
Conclusion: 21:30

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The views expressed represent the opinion of Modern Wealth Management, LLC, an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management, LLC does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.