Good debt, bad debt:

How to manage debt in retirement

A common view of retirees is that of people who live in their own  (fully paid-off) homes, with no debt and the ability to do whatever they want, whenever they please.

Those who have already retired may find this amusing, annoying or simply wrong.

That’s because financial concerns don’t stop at preservation age and debt is very much an issue for many in retirement. The propensity of older Australians to take more debt into retirement has more than doubled over the past few decades, according to the Australian Bureau of Statistics (ABS). Today we consider the role of debt in retirement and how it might be managed for better income outcomes.

The first point when discussing debt is to distinguish between good and bad debt. And yes, there is a massive difference.

Good debt refers to money borrowed to invest in an asset which will gain in value over the longer term. Ultimately you will have earned more than the cost of the interest and repayment of the debt.

Bad debt actually costs you money. And this can snowball out of control. For instance, you may have bought too many discretionary items (travel, clothing, household furniture) with your credit card, are unable to cover the full repayment at the end of the month, and so are charged interest which is likely to be nearly 20% (The Reserve Bank of Australia measures the current average standard credit card rate at 19.94%).

If you can’t cover the full repayment in the first month, by the time this interest is applied, you may be less able to cover it in the second month, and so are paying interest on interest – for no net capital gain.

What type of debt are you carrying?

Most of us have at least a small amount of debt. The first step is to analyse the type of debt you have, whether it is ‘good’ or ‘bad’ and how it affects your household budget. This knowledge is very powerful – it will give you a clear view of your status quo – as well as lead to possible next steps if some aspect of your debt is negatively affecting your retirement income.

Here are a few of the most common form of loans and ways to view and review their impact upon your financial peace of mind:

• Home mortgage
• Investment loans
• Personal loans
• Credit card debt
• Payday Loans
• Buy Now, Pay Later (BNPL) loans

No one but you can decide if any of the above constitute ‘good’ or ‘bad’ debt.

If you apply the prism of good or bad debt to each category you are holding, you can quickly see if that loan/debt is costing or earning you money. Your next step is to tackle the debt that is costing you. This normally involves trade-offs. Retirees are in a unique situation compared to younger Australians as they can now access lump sums which can be used to pay down debt, often mortgages. But is this a smart use of your funds?

Using super to pay down your mortgage

Most of us love the idea of retiring debt. But if we are taking money from a place where it is earning more and using it to reduce debt that is (relatively speaking) costing us less, we may be moving it for emotional, not rational, reasons. These sums can be tricky, and when we factor in Centrelink entitlement requirements, they just get trickier. As the home is an exempt asset, and funds in super are normally subject to deeming, moving money from super to pay down the mortgage can increase Age Pension payments. But if you are saving, say, 4% on your home loan, at the expense of earning, say, 7.5%, in your super fund, have you used your money wisely?

There is no easy answer here. But withdrawing super to pay down your mortgage as soon as you reach preservation age because it makes you feel better is an emotional action, not necessarily a moneysaving one. It is really important that such a decision is taken with all the facts at your disposal (i.e. the rules on superannuation, Centrelink entitlements, taxation implications and conservative money market projections). This is usually best done in consultation with a qualified financial professional.

Is there any debt that should be paid off quickly?

Generally speaking, yes, credit card and ‘payday’ loans which cost you money through the exorbitant interest rates charged, should be paid off as soon as possible. Some people are simply not in a situation to do this. But there is support if this is your greatest debt issue. Financial counselling services are excellent and free to anyone in need. Negotiating manageable loan repayments directly with your bank or credit provider is also possible.

In summary , managing debt is difficult so try not to add guilt to your load. The difficulty is not just because most of us don’t like debt. It’s more because we need to make value judgments about the trade-off involved in taking funds from one asset in order to reduce another – and whether this makes financial sense. Making such decisions is challenging because there is a lot at stake and you need to know you have covered a range of rules relating to retirement income and entitlements when you do so. If you feel that there might be a better way to manage your debt, why not book a consultation with one of our advisers who can help you run the sums and observe the rules to deliver an improved scenario? In the end, it all comes down to trade-offs and ensuring you make decisions which maximise your income and lead to greater peace of mind.

Talk to an Adviser

This article is provided by Retirement Essentials Representative Number: 001260855.  We are an authorised representative of SuperEd Pty Ltd ABN 88 118 480 907 AFSL #468859.  This information is not intended as financial product advice, legal advice or taxation advice. It does not take into account your personal situation, goals or needs and you should assess your own financial situation, consider if the information is suitable for you and ensure you read the relevant Product Disclosure Statement (PDS) if you choose to make any changes to your financial situation. It is always advisable to consult a financial adviser before making financial decisions.