As retirement gets closer, many people feel pressure to “clean up” their finances. While debt isn’t always a bad thing, the wrong kind of debt, or even the right debt managed in the wrong way, can limit your flexibility in retirement. The goal isn’t always to pay off everything as fast as possible; it’s to approach debt with strategy, and with an understanding of how each decision impacts your future cash flow. With the right plan, you can strengthen your financial foundation and head into retirement with confidence.
1. Prioritize High-Interest Debt First
Not all debt has the same impact on your financial picture, especially when you’re planning for retirement. High-interest debt like credit cards, lines of credit, or personal loans, can erode wealth quickly compared to lower-interest, collateralized loans like your mortgage.
Why this matters
High-interest balances grow faster than most investment returns. “Since 1957, the S&P 500 has delivered an average annual return of 10.56%”1 With debt, interest always has a negative impact, and high interest rates often refer to anything over 8-10%2 while many credit cards carry an interest rate of over 20%.
While you’re contributing to retirement accounts, double-digit interest rates can easily overshadow your progress. Prioritizing high-interest debt payoff can assist in protecting your future savings and free up cash so you can tackle other goals.
How to approach it
List debts by interest rate, not balance. This helps you focus on the debt that costs the most over time. While everyone’s monthly budget differs, there are a couple of common approaches when it comes to prioritizing paying off high-interest debt quickly
Some will start by putting all additional funds available towards the debt with the high interest rate. This method can help you save the most in terms of interest paid over the life of your loans. While others choose to tackle the debt with the smallest balance first, an option chosen by those needing motivation to stick with their plan.
Keep low-interest debt in perspective. Not all debt needs to disappear before retirement. For example, a low-rate mortgage or auto loan may not be as urgent if it fits comfortably into your future budget. Rushing to pay off this type of debt can lead to depletion of savings, which can lead to stress or actually leave you in a more vulnerable position, financially.
2. Time Larger Payments Wisely to Avoid Penalties or Interest Surprises
Believe it or not, you can be hit with penalties for paying off debt too quickly. While it’s not common, here’s what to look for:
Watch for prepayment penalties
Older mortgages, home equity loans, or private loans may charge a penalty for paying off the balance too early. It’s best to talk to the lender in these scenarios before making a large lump-sum payment. When reviewing the fine print, there are terms to watch for:
- Deferred-interest loans: where missing the promotional deadline can trigger retroactive interest.
- Variable-rate loans: in some cases, interest rates can change. Especially in a time of rising rates, accelerating payments is often worthwhile.
- Promotional balance transfers: where the interest rate jumps after the intro period ends. These offers are enticing to help spread out the cost of a large purchase, but the timeline must be carefully monitored if your goal is to avoid bumping up the total cost of your purchase.
A strategic payoff plan helps you avoid unintended costs and capitalize on the lowest interest periods available.
Consider your broader financial timing
Think of your own checklist of financial priorities; your thought process may align with one of the following examples when it comes to paying off a specific loan, like a mortgage:
- Before retirement, but after major expenses: such as a home upgrade, college costs, or medical needs.
- Before transitioning to a fixed income: when cash flow becomes less flexible.
- After maximizing key retirement contributions: especially if employer matches or catch-up contributions are available.
The goal is to avoid creating a cash squeeze while still making meaningful progress.
3. Can Refinancing or Consolidation Actually Strengthen Your Position?
Sometimes the best way to manage debt isn’t simply paying faster, it’s changing how the debt works. Refinancing and consolidating have the potential to reduce interest costs, simplify payments, and give you breathing room as you prepare for retirement. But these options aren’t something to rush into; make sure you crunch the numbers and understand the true impact on your bottom line.
Everyone’s financial situation differs, and the options in this article should not be construed as advice. Refinancing is selected as an option by some when:
- Current interest rates are a fair amount lower than what you’re paying — an experienced advisor can help you assess whether this is a good route for you, as refinancing does come with transaction costs.
- If you want to lock in a fixed rate before retiring, you may look into this option during times of rising interest rates.
But consolidation isn’t always the solution. If you’re prone to carrying balances or reopening credit lines, it can lead to even more debt. A good advisor helps determine if consolidation is a true benefit or just a temporary reset. Reduced interest can mean thousands of dollars saved; money you can reallocate to retirement savings or other priorities.
Explore home equity with caution
Retirees are often targeted by financial institutions with enticing home equity options, often referred to as a reverse mortgage. While freeing up funds sounds nice and having the ability to pay off high-interest debt may be beneficial, you’ll want to explore the flip side of every offer. Options like HELOCs or home equity loans can provide lower rates, yet they also put your home at risk if payments become difficult, ultimately extending the life of your mortgage and adding to the total interest paid on your home.
Structured Decisions Lead to a Stronger Retirement
Reducing debt before retirement isn’t about doing everything quickly — it’s about doing the right things in the right order. By prioritizing high-interest debt, timing larger payments strategically, and using tools like refinancing or consolidation when thoroughly vetted, you can free up cash flow and potentially assist in reducing financial stress.
A thoughtful debt-management plan puts you in control of your financial future. And when you approach these decisions with strategy and clarity, you give yourself — and your retirement dreams — the strongest possible foundation.
About Foundation Wealth Management
Foundation Wealth Management is a CPA-led organization, that provides financial planning services and tax planning support; services and outcomes vary based on each client’s circumstances. Our team includes qualified professionals, such as CPAs and CFP®s, who are integral to our service offerings. Our team includes 3 Certified Financial Planners: Burt Hutchinson, CPA, CFP®, Paul LaViola, CFP®, and Stephen McDade, CFP®.
As Fee-Only planners, we are compensated directly by clients rather than through commissions from brokerage or insurance products, which we believe helps align our services with client goals.
Sources:
- 1 S&P 500 Average Returns and Historical Performance
- 2 What Is Considered High-Interest Debt?
- 3 Why Are Credit Card Rates So High? – Liberty Street Economics
Disclosure Statement:
This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third-party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way whatsoever. This presentation may not be construed as investment, tax, or legal advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and is subject to change without notice. All investments are subject to risk, including the possible loss of principal.
The client scenarios presented in this blog are entirely fictional and created solely for illustrative purposes. Any similarities to actual persons, entities, or events are purely coincidental and unintentional.
Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website, Past performance is not a guarantee of future results.
