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The Debt Bet
"Debts are like children--begot with pleasure, but brought forth in pain." --Moliere


Managing or eliminating debt is crucial to stable finances as one moves toward or in retirement. However, according to the Survey of Consumer Finances—a cross-sectional survey of U.S. families conducted by the Federal Reserve Board—the percentage of families over 65 with debt has increased from 42% in 1992 to 60% in 2016.

“This is a disturbing trend,” says Franklin Parker, Chartered Financial Analyst® and Chief Investment Officer for Bright Wealth Management. “It can eliminate the financial buffer needed to weather potential unplanned expenses down the road.” Expenses like home improvements, medical costs, and, in some cases, meals.

Ohio State University’s Donald Haurin, Cäzilla Loibl and Stephanie Moulton released a paper on the relationship between debt and financial stress for older Americans. They defined a hierarchy of debt and its effect on stress levels. Unsurprisingly, credit card debt is the most stressful. This unsecured type of debt is usually highest cost, especially after the initial “0%“ teaser rates.

Bright Wealth Management’s own research shows that the difference between the average interest rate on credit cards and US Treasuries as at a 25-year high. This means income from savings accounts or bond related investments have a lower return while individual borrowing costs are rising.


ValuePenguin, who recently explored data from the US Census Bureau and the Federal Reserve to take a closer look at credit card debt, found that more than 40% of all US households carry credit card debt, with the average American household carrying a balance of $5,700. For only indebted households, which excludes people who pay their balances in full every month, the average debt is $9,333. Combining these two facts, indebted households can be paying an average of $135/mo in interest.

It is also insidiously easy to increase this debt, which gets many into financial trouble. One cultural cause is an inability to delay gratification. Easy access to credit card loans and low minimum payments means I can purchase that car, furniture, game, trip, clothes - literally anything I want - NOW rather than save up and purchase later.

Don’t get me wrong: I like credit cards when used properly. For example, everything I buy with my Harley Davidson Visa creates a future discount for any HD company purchases. I don’t care that it has a sky high interest rate of 21%. I always pay the balance every month. Does this mean that Visa loses money on me? Nope. They’re getting 2-5% on every transaction from merchants. As far as I’m concerned we both win. So far I’ve received over $200 in discounts on my HD stuff and the local dealer is always happy to see me every time I stop by.

Sometimes debt isn’t from buying stuff. Things happen and expenses pop up outside one’s budget.

I once helped a couple who had taken another financial planner’s advice and eliminated their mortgage. However, they were so aggressive with their payments that they emptied out their savings (I admit, once you begin paying off debts it’s fun to see those loan balances fall like a lead balloon). But then disaster struck! He needed back surgery. Even with Medicare covering most of the cost, they were left with over $20k in medical expenses. They decided to charge them to multiple “zero balance” credit cards. However, their cash flow was insufficient to make much more than the minimum monthly payments, so the credit card debt began growing dramatically when the “free” interest period expired.

There was no way they could pay off this debt under current circumstances. They were in a vicious cycle that was causing a lot of stress. They were deciding whether to pay credit card debt or buy food! They recounted their story to me in tears.

My solution was simple: refinance the house and pay off their high interest card debt. Then begin a regular savings program to build up their “emergency fund” with at least three months of expenses so they won’t ever have to use credit cards for unanticipated expenses.

Their relief was palpable! All they needed was permission from a financial advisor—with the calculations to back up the approach—to increase one debt (mortgage) to trim down the other (credit cards).

Data from the Consumer Bankruptcy Project points out that nearly two-thirds of older Americans who filed for bankruptcy claim medical expenses were a catalyst. While I hated adding years to the debt payoff, the difference in interest rates, income tax deductibility, and decrease in expenses actually gave this client financial breathing room and reduced their stress considerably. Six months later, they reported zero credit card balances, hitting their savings account balance target, and a plan to slowly increase their mortgage payment to eliminate that debt once again. And NO BANKRUPTCY!

Some near-retirees consider using their 401k or other qualified savings to eliminate debt before retiring. This can create some other issues that negate the benefit of eliminating that debt, however. Being too aggressive could launch you into a higher tax bracket. You’ll save money on interest but wind up paying more in taxes. If under the age of 59 ½ you’ll also incur the “early withdrawal” penalty of 10% from the IRS. PLUS, that distribution is now “off the table” for future income.

So what are our best options for eliminating debt before or during retirement?

  1. Get on a budget NOW. This is key to avoid repeating debt behavior. Work with a professional financial advisor to help set reasonable financial goals.
  2. Work an additional year to pay off credit card debt. If you’re already retired, get a part time job (it can actually be fun since you don’t need a career now). Apply all of the income to the credit card(s).
  3. “Snowball” the debt. If you’ve got more than one credit card or combination of credit card, auto loan and mortgage debt, prioritize payments by smallest to largest balances. As each card/loan is repaid, add that prior payment to the next payment. By the time you reach the last payment you’re paying far above the minimum and actually eliminate all the debt faster.

  4. Refinancing debt is a last resort. There are several companies that will help you consolidate debt, but we recommend non-profit firms. There could even be a state sponsored organization that you can tap into.

 

“Before borrowing money from a friend, decide which you need most.” – Addison Hallock

Using friends or family to finish off debt can impact that relationship. I learned this the hard way when I helped a friend with his mortgage down payment. He wound up losing his job and foreclosed on the house. He went into bankruptcy and was so ashamed that he could not pay me back that he literally disappeared. I think he’s out east somewhere. This is a person I actually considered one of my best friends who has “gone dark” from me (his choice not mine).

If you are desperate and family or friends want to help, it’s best to consider their assistance as a gift. When you’re back on your feet you can gift it back. Loans between friends and family are simply too risky (at least, if you want to stay friends).

Bright Wealth Management advisors always consider managing debt as a crucial aspect of a sound financial plan. It’s just as important as managing income, generating savings, proper investing and tax efficiency, especially in or near retirement. You don’t have to work through this on your own. Get professional help from a good financial advisor.
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The information herein contains forward looking statements and projections representing the current assumptions and beliefs based on information available to Bright Wealth Management, LLC at time of publishing. This information included is believed to be reasonable, reliable and accurate, (however no representation is made with respect to the accuracy and completeness of such data) and is the most recent information available (unless otherwise noted). However, all the information herein, and such beliefs, statements and assumptions are subject to change without notice. All statements made involve risk, uncertainties and are assumptions. Investors may not put undue reliance on any of these statements. There is no guarantee that the market will move in any direction, as there is no way to predict with certainty future market behavior. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make an informed investment decision based on individual objectives and suitability.



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