We recently wrote an article about unanticipated factors in your retirement equation.  We discussed the “how much you have when you retire” minus “how much you will need in retirement” balance to determine if you will be in good shape for retirement.  That previous article focused on Medicare costs fitting into that equation, but this week we want to talk about a different figure that can impact your retirement plans: Debt.

According to data from the Federal Reserve Bank of New York, older Americans are seeing much more red in their personal ledgers than they did in the past, with the amount of their debt growing for those both entering and already in retirement. In fact, the average 65-year-old borrower has 47 percent more mortgage debt and 29 percent more automobile debt than the average 65-year-old had in 2003.
Although those two categories of debt are significant for older Americans, for the first time in history, we are also seeing senior citizens with student debt, debt absorbed by them from their children, who cannot afford to pay it.

Essentially, there has been a reallocation of debt in our society from our younger to our older generations. However, even with seniors taking on more debt, they are still considered much more capable of managing and paying down that debt than our younger folks. If this changes, and there is evidence that large numbers of people entering retirement carry debt they cannot manage, this could cause some unease, but this does not seem to be a current concern. In fact, the older households that are carrying this debt have overall higher credit scores and more assets than we have seen in years past.

When we speak with investors, we help them understand that during the accumulation phase of our financial life cycle (building up “what we have”), we are preparing for our distribution phase (using “what we will need”). In our distribution phase, our income is usually derived from just a few sources: Social Security, pensions, and our investments. Uncle Sam often limits and, in some years, does not give any cost-of-living adjustment for Social Security; furthermore, if you don't work for the government, then you probably don't have a pension, and if you have an outdated investment strategy, then you may be losing half your assets every five to seven years. So, when we are in the distribution phase of our financial life cycle, we need to keep our monthly expenses down as low as possible. This means limiting debt as well. It does not take a mathematician to understand that shrinking income and growing debt do not paint a pretty picture. And unlike younger people with debt, older folks have less time to play with debt balances.

But our younger generation is not off the hook. The average 30-year-old borrower has nearly three times as much student debt as the average 30-year-old borrower had in 2003. Nevertheless, the overall debt levels for our younger generations are lower due to a decrease in home, credit card, and auto debt. In fact, according to US News & World Report, home ownership for Americans 35 and younger is at the lowest level since the government started calculating home ownership by age in 1982.

Young or old, whether we are in the accumulation or the distribution phase of our financial life cycle, we must manage debt. So, for those of you worried about your debt levels, let me give you a few quick reminders on how to reduce or eliminate that debt.

First, it is important to know how much debt you have and to understand that debt. Separate each account by balance, interest rate, minimum payment and the number of payments you have left. Once you have done this, determine how much you can put toward paying off your debt each month. The goal for this amount should be more than the combined minimum payments on all of your accounts. (This may require some strict budgeting throughout the month.)

Next, find the debt with the highest interest rate. After paying the minimum amount on each balance, pay all of the extra toward paying down that debt with the highest interest rate. This will help you nip the problem in the bud and keep your debt balance from rising. Your last goal is to pay off any secured debt that has just a few payments remaining.

Once you have dug yourself out of debt, don't fall back in. Oftentimes, becoming debt-free leads to the same habits and behaviors that caused the debt to grow in the first place. If lowering debt is a real goal for you, you need to commit to it. Don't let yourself backslide, especially if you are entering that second half of  your retirement equation, because then you are starting over with even less time in front of you.