Debt isn’t necessarily the enemy of a comfortable retirement

Can you look forward to a retirement that’s not shot through with financial anxiety if you’re still carrying debt? Absolutely, say experts, but it depends what kind of debt we’re talking about.

Good debt vs. bad debt

Wilmot George, vice president of tax, retirement and estate planning at CI Global Asset Management in Toronto, says it’s important to draw a line between what’s considered good debt and bad debt.

Bad debt, he says, involves the cost of financing purchases of depreciating assets, like a car or boat. Good debt, on the other hand, lets people buy assets with the potential to generate income, like shares in a dividend-paying mutual fund or a rental property.

In addition to providing an additional income stream, these good debts offer tax advantages that can help reduce their overall cost. “What many people don’t realize about debt that’s used to purchase assets that have the potential to earn income is that the tax rules allow us to deduct the interest costs on that debt,” George says.

Bad debt doesn’t give you those benefits. And, because it’s often tied to things you need, like a car, it can be hard to avoid.

Planning around debt in retirement

George says there’s no secret recipe that says, “X amount of debt can be paid off in Y amount of time using strategy Z.” When you’re getting close to retirement, your financial plan needs to factor in your debts so you can budget around them accordingly.

But if you don’t think carefully about how debt will impact your overall financial picture, there can be pitfalls.

If your plan is to sell off chunks of your investment portfolio to pay bills, George says you must be aware of the effect that profits generated by those sales could have on any income-sensitive benefits you’ll be receiving after you retire — like Social Security.

If any asset sales push your income into a higher tax bracket in 2022, for example, the government will have reason to claw back a portion of your Social Security money at tax time next year.

When you take on debt to buy assets with income potential, it’s important to get confirmation from a financial planner that the interest you’ll be paying will be tax deductible. If it isn’t, you could be in for an ugly surprise when the refund you’re counting on fails to materialize.

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Reasons to avoid debt in retirement

Even with a solid financial plan in place, unexpected costs — car repairs, a new roof for your house — can strain your retirement budget.

Just think about today’s runaway inflation and its impact on your purchasing power.

While Social Security payments do get adjusted for inflation, the tax implications haven’t changed since the Reagan administration. The threshold at which you can begin to owe taxes on that money — $25,000 for individuals — is not adjusted for inflation.

That’s why the Congressional Budget Office​​ predicts the total income taxes paid on those larger Social Security checks will jump this year by 37%.

Legislation to address the problem was sponsored by Rep. John Larson last year, but Americans may not see changes for quite a while.

To maintain financial flexibility and establish peace of mind, George says paying off debt prior to retirement should be the goal.