It’s no secret that money can become a challenge when you enter retirement. Many people, understandably, focus mainly on the income side of things – how to save enough before retirement and then generate enough income to pay the bills while in retirement.

This is important, but equally (or perhaps more) important is keeping expenses down as you enter your later years, which can help you to save and give more and also make whatever savings and income you do have go further.

Eliminating debt is always a good idea

Some Christians believe that scripture prohibits all types of debt. Others would say that it allows for debt, but implies that it must be paid off as soon as possible.

Actually, scripture teaches that being in a position to lend money to others is a blessing, whereas being the borrower is to be under a curse (see Deuteronomy 28:44-45). So, at minimum, I think the Bible teaches that debt is not normative, and if we do borrow, we should pay it back as soon as possible.

Debt-free living is good at any stage of life, but I think it is more important as we transition out of our working-for-income years. Once we stop bringing in a regular paycheck, it can be a lot harder to pay off the debt we have accumulated.

Less debt can give you some financial “margin”

One of the best ways to reduce expenses in retirement is to get rid of debt to help ensure that the money you do have coming in is enough to cover your living expenses and also, hopefully, other things that truly enrich your life and the lives of others.

In other words, it can give you some degree of financial margin, depending on your actual living expenses. This is part of wise retirement stewardship.

So, if you are still working, now is the time to pay off debt, while you are bringing home a paycheck. In fact, that’s actually a good idea regardless of which stage of life you’re in.

If you are younger, pay off debt to free up money to help you save and give more. If you are older, do it for the same reasons and also to better position yourself for retirement as it may be tougher when you are retired and you certainly don’t want to use your tax-advantaged retirement savings to pay it off if you don’t have to.

Remember, if you liquidate retirement savings to pay off debt, you may also have to pay taxes on that money, which is almost like a debt penalty and effectively adds to the total cost of the debt. Plus, you are giving up some of your retirement income-producing assets.

Debt has become a problem for more and more retirees

This is a bigger problem than you may think. In 2010, seven percent of all bankruptcy filers were over the age of 65. That’s up from just two percent a decade ago. For the 55-and-up age bracket, that number balloons to 22 percent of all bankruptcy filings nationwide. Granted, not all those bankruptcies were due to high debt, but it is a major contributor.

A study published in 2013 by the AARP provides us with these surprising insights on credit card debt among older people:

1. Older Americans now have higher overall credit card debt than younger people.
2. Thirty-four percent of Americans age 50+ use credit cards to pay for basic living expenses because they do not have enough money in their checking or savings accounts.
3. Eighteen percent of people age 50 to 64 reported that they drew on retirement funds to pay off credit card debt.
4. Older Americans are more likely to take on credit card debt in an effort to assist other family members.
5. Sixteen percent of Americans age 50+ used their home equity to pay down credit card debt in the past year.

To be fair, this report does seem to suggest that credit card debt among older Americans is primarily a reflection of the difficult economic times of the last decade, not necessarily a lack of personal financial responsibility. Many people in the study indicated that job loss, healthcare expenses, and helping family members were the main causes of their credit card debt, not over-indulgence.

Let’s do some math

Some simple math can show us why this is so important.

First of all, let’s say that you have credit card debt of $5,000 and are paying 12% interest, which is $600 per year (not allowing for any compounding – i.e., paying interest on interest, which could be the case). If you pay off that debt, you will save 12%, which is essentially the same as earning a 12% return on the same amount of money – guaranteed! Considering that savings accounts are basically earning nothing or next to nothing nowadays, that sounds pretty good, right?

Now let’s look at this from broader perspective. Let’s say you have the $5,000 credit card debt ($100 per mo. payment – est.), a car payment of $300 per month, and a monthly mortgage payment of $900 (P&I only). To meet those obligations on a monthly basis in retirement will require approx. $1,300. That equates to $15,600 per year! For many, that could be an entire annual Social Security check. Or, viewed another way: To generate annual income of $15,600, you would need to have $390,000 invested and earning 4% per year for income of $15,600 just to make those payments (more if you have to pay taxes on that retirement income)!

Of course another way to create that kind of income is part-time work, which is a GREAT idea in retirement. But wouldn’t it be great to be able to use that income for saving, or travel, or giving instead of for making debt payments? Of course! So, for the vast majority of those of us getting ready for “retirement”, getting out of debt – at least all non-mortgage installment debt – can be very helpful.

Mortgage debt is the bigger problem

Mortgage debt can be a more difficult thing for retirees to deal with. In another study by the Social Security Administration, in 2013, almost half of households nearing or in retirement had mortgage debt. If you are one of them, you may be okay if your retirement income is sufficient to cover your mortgage expense in addition to everything else. If not, you may want to consider these alternatives:

1. You could downsize to a smaller residence, thereby reducing mortgage amount and payments
2. You could sell your home and rent at a lower monthly cost (perhaps a condo or apartment)
3. You could refinance your current mortgage for a longer term, reducing monthly payments

What you want to avoid is a forced sale of a primary residence due to inability to pay the mortgage in retirement (or, in the worst case, loss via foreclosure); or, limited ability to use any housing equity for funding retirement expenses in the future.

But the very best thing you can do is to pay-off your mortgage before you enter retirement. (This applies to rental property as well, but there are other factors involved there, particularly your confidence level about being able to consistently cover all the expenses associated with owning the property.)

Surprisingly, I have heard that some financial planners/advisors recommend that you not pay off your mortgage and invest the money instead (while meanwhile keeping the mortgage interest tax deduction). I think this would make sense if those deductions somehow equal the sum of your annual mortgage payments, which of course isn’t possible. I will discuss this at length in a future article, but I want to briefly discuss the matter of mortgage interest tax deductions.

The mortgage interest tax deduction myth

When you are young, you have essentially two choices in terms of housing: rent or buy. If you decide to buy, the mortgage interest tax deduction helps make ownership more affordable – the government planned it that way. But the older you are, and the further along you are toward paying off your mortgage, the less interest you’re paying. And less interest means less of a tax deduction (you can’t deduct payments toward principal). And the smaller the deduction, the smaller the tax savings.

Consider this example: A 30-year fixed rate mortgage for 200,000 at 4.5% carries a monthly payment of 1,013 ($12,156 per year). Because of the way fixed-rate mortgages are amortized, in year one, the tax savings based on the income tax deduction for the total interest paid for someone in the 25% marginal tax rate bracket would be $8,933. That is sizeable – equivalent to 8 months of mortgage payments.

However, as the years go by, you are paying less and less interest and will therefore enjoy a shrinking tax savings. For example, in year fifteen, the savings would be $5,656. By year twenty, it would fall to only $1,067. Plus, if you end up in retirement with a smaller marginal tax rate (say 15% instead of 25%), your tax savings would only be $878 at year fifteen and $640 at year twenty. Meanwhile, you’re still paying P&I payments of $12,156 per year but the actual tax benefit to you becomes very, very small. (By that time you are increasing your equity with each payment, but it still has a significant impact on your monthly cash flow.)

What to do next

Here’s a simple plan to help you become debt free before you enter retirement:

Step One : Make a decision not to take on any additional debt. This probably goes without saying, but lets face it, its hard to bail water out of a boat with a hole in the bottom.

Step Two: Make a personal/family goal to be completely debt-free before you retire. And be realistic – this may take some time, but you probably have several years before retirement, which could be plenty of time to get this done.

Step Three: Eliminate credit card debt. If you have debt, the first thing you really need to do is get rid of any credit card debt. This is something that can take some serious time, depending on the size of your debts. So you should look to put together a plan several years before retirement to make sure it is possible. Use the debt snowball approach – you may find that you can get it done sooner than you think. You may have to make some sacrifices, but it will be worth it in the long run. Dave Ramsey explains the debt snowball as follows:

Pay minimum payments on all of the debts except the smallest one then attack that debt with a vengeance. We’re talking gazelle intense, sell-out, get-this-thing-out-of-my-life-forever energy. Once it’s gone, take the money you were putting toward that debt, plus any extra money you find, and attack the next debt on the list. Once it’s gone, take that combined payment and go to the next debt. Knock them out one by one.

Step Four: Eliminate installment (non-credit card) debt. Once you’ve dealt with credit card debt, go to work on any non-mortgage installment debt, such as car loans, furniture loans, etc. Continue to use the debt snowball

Step Five: Payoff your mortgage. Once you’ve paid off all other debt, it’s time to turn your attention to your mortgage. The easiest way to pay it off early is to make additional payments to principal. If you have more than 20 years remaining and are 10 years or less away from retirement, consider refinancing to a 10 or 15 year mortgage IF you can easily afford the higher payments. Then make additional payments to principal, if you can. Of course, downsizing to a smaller mortgage is another way to go. Get a 10 or 15 year mortgage on the smaller house.

If you take these steps toward reducing or eliminating debt before you enter retirement, you will significantly improve your overall cash flow position and perhaps have something left over to bless others.