Do you need to pay down all your debts before you retire? Here’s what you need to weigh up

Being debt-free could come at a cost

The idea of a debt-free retirement definitely sounds nice. If debt is something that keeps you up at night, getting rid of those monthly payments could benefit your mental health and help you have an even more relaxing retirement.

But do remember that there’s an opportunity cost to paying off debt.

You should ask yourself whether you’re losing more money to interest than you could gain by investing it. If so, prioritizing your debt makes sense. But if your debt isn’t costing you that much, you may want to invest the money or maintain a larger savings cushion.

If you’re burdened by expensive debt, most experts advise prioritizing paying that down. The average credit card interest rate is currently around 27%, per Forbes Advisor. Even if you’re an exceptional investor, it’s hard to beat that return in a stock portfolio given the market’s historical average yearly return, which has been closer to 10%. So it absolutely pays to rid yourself of credit card debt as soon as you can.

Similarly, the average new auto loan interest rate as of March 2024 is 9.7%, per Kelley Blue Book. Can you beat that with a stock portfolio? Maybe, but possibly not. So shedding an auto loan ahead of retirement could also pay off – especially since at that point, you may be looking to shift toward conservative investments that average a much lower annual return than the stock market.

On the other hand, paying off a mortgage before retirement isn’t necessarily wise. If you locked in a low-cost mortgage when rates fell during the pandemic, you may be paying around 3% on your home loan. Why pump money into that loan and tie up more cash in your home when you may be making more than 3% in a basic high-yield savings account? And even a conservative investment portfolio should give you more than 3% a year on average.

Also, don’t forget that paying a mortgage in retirement gives you a tax break on the interest portion. If you don’t have retirement savings in a Roth account, your IRA or 401(k) withdrawals will be subject to taxes, and the same may hold true for your Social Security benefits. Paying a mortgage could offset those taxes.

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How to whittle down debt ahead of retirement

Paying off all debts before retirement may not be necessary or even a good use of your money. Paying off costly debts absolutely makes sense, though.

If you’re hoping to be reasonably debt-free by the time your career ends, order your debts by priority so you know which to tackle first. If you owe money on credit cards, a car, and a house, that’s generally the order to stick to, since you’re probably going from highest interest rate to lowest.

Of course, paying off debt will require you to come up with the money. To that end, try:

• Trimming non-essential expenses
• Monetizing your home by renting out a room or finished basement
• Renting out your car via a peer-to-peer service like Turo
• Joining the gig economy

One source you generally don’t want to tap for debt payoff purposes is your retirement savings. You need that money to cover your living expenses once your career ends. And if you’re not yet 59 ½, there can be costly penalties for an early IRA or 401(k) withdrawal.

Remember, though, if paying off all of your debt ahead of retirement isn’t possible, do the best you can, and worry less about a lingering mortgage. As of 2022, 38% of homeowners aged 65 to 74 had a mortgage, according to Federal Reserve data cited by Urban Institute, while 30% of those 75 and older had one as well. If you’re still paying off your home in retirement, you won’t be alone.