Much of the discussion on retirement planning is focused on building the savings required for retirement. An equally important aspect of your finances that can pose a threat to your dream retirement is carrying debt into retirement. Conventional wisdom tells you to work towards a personal balance sheet that is free from liabilities in retirement. But it may not always be possible for everyone to start a debt-free retirement despite best efforts to pay off debt. Long-term mortgages that are preferred for the lower equated monthly instalments (EMIs), a mortgage, educational and personal loans for wedding expenses taken for children, or loans taken for health expenses closer to retirement; are all reasons why there may be debt to service in retirement.

Carrying debt into retirement has repercussions. Mortgage payments that seemed easy to bear may be difficult on a retirement income. Expenses go up with inflation as do mortgage repayments as interest rates are reset, and this will strain the budget. A larger portion of the corpus has to be employed to earn the fixed and guaranteed income required to meet mandatory expenses, including debt repayment obligations. The rate of return on such investments is typically low. You end up underutilizing your corpus and this will impact your financial security through the retirement period. Existing debt obligations may also make it difficult to access debt in an emergency during retirement.

Keep an eye on the retirement date as you deal with debt in your working years. You have more options to do this in your working years. Budget and save, accelerate repayments, refinance to a lower-cost loan, seek a second income or even postpone retirement to get to a debt-free retirement. But despite best efforts you may still be carrying some debt at retirement. You have two options to deal with it at this stage. One, use the retirement corpus to pay off the loan balances. And two, service the debt in retirement.

Using a portion of the retirement corpus to close out the debt will deplete the funds available to you in retirement and that will affect your financial security. Consider this option if your corpus is large enough to not be significantly dented by the use for debt pay-off. Another consideration would be a comparison between the interest you are paying on the debt to what you will earn by investing the corpus. If the cost of debt is very high, then it may make sense to pay off the debt. Delay retirement if possible, or consider a second career in retirement to make good at least some part of the corpus used to close the debt. Moreover, the money that was being used to meet the monthly debt repayment obligations is now free and should be used to shore up the retirement corpus. This requires discipline. Consider the tax implications of cashing out the retirement corpus too. There may be capital gains taxes to be paid, and in some cases even penalties for early withdrawal.

You may decide to carry debt into retirement and service it out of the retirement income. There are some questions you need to ask before you take this path.

The first is obviously to assess the adequacy of cash flows in retirement to meet your expenses as well as the loan repayment obligations. Consider the source of retirement income too. If it is from a pension, then there is a risk of the amount of pension reducing on the death of the primary pensioner, thus making it difficult to service the debt. If you still have to carry debt into retirement, then consider a life insurance on the primary pensioner to the extent of the outstanding debt to protect against the risk of their death.

The rate that you are paying for your loan matters. A fixed, low-cost mortgage makes a loan an easy candidate for servicing in retirement. Not only is the cost of debt lower than what you are earning on your retirement investments, you also don’t face the risk of an increase in EMIs as interest rates go up. Home loans and student loans typically come with tax benefits that reduce the effective rate. In case of home loans, the tax benefit on interest paid may be limited since the component of interest in the EMI will be lower toward the end of the term of the loan. However, the principal repaid may also have tax benefits, such as the section 80C benefits. Given that many of the other eligible expenses and investments under this section may not be available in the retirement phase, repayment of home loans may be a good way to use the tax benefits available.

As always, categorize debt into good and bad debt. Debt taken to buy an appreciating asset such as a mortgage is seen as a good debt because the asset will be building equity or appreciation even as you pay down the debt in retirement. In an extreme situation, the asset can even be sold to pay off the debt. Such debt may be preferred in retirement, compared to a credit card debt that is expensive and does not add any value.

Even where you are confident that your current retirement income can comfortably take care of any loan repayments, a change in circumstances, such as additional expenses on health or inflation pushing up costs or lower than expected returns on investments may make it difficult to service the mortgage. Have an emergency fund for your retirement, that will take care of any liquidity crunch. It should act as a buffer if the income is not able to meet all the expenses. Keep your debt sheet clean. Make due payments on time and avoid adding to debt in retirement. It will keep your credit score good and ease the way for you to access debt in case you need it in an emergency.

Reduce or eliminate debt to retire with confidence. Don’t consider only the financial aspects of the decision to pay off debt or carry it into retirement. Your attitude to debt is also important. Some people find debt very stressful. In such a situation, carrying debt may be the wrong choice even if you can comfortably service it in retirement. It may make your retirement far from the peaceful phase in life that you look forward to.

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