It’s the patriotic thing to retire with big debts.
The more money you owe, the more you’ll have to withdraw from your registered retirement accounts over the years to cover debt payments and other living costs. The more you withdraw, the higher your taxable income. The higher your taxable income, the more potential there is for some of your Old Age Security benefits to be clawed back.
The federal government was worried enough about rising OAS costs to have scheduled benefit cuts for future years in the last budget. Now, we have a growing cohort of indebted retirees doing their part to sustain OAS by handing some back. How patriotic of them.
Not that many of today’s indebted retirees have a clue about what it really means to have smashed the cliché of the frugal senior. They’re comfortable carrying debt because low interest rates make it ever so affordable.
“Some people in retirement will look at the monthly payment and say, yeah, I can afford that,” said Clay Gillespie, a financial adviser and managing director at Rogers Group Financial in Vancouver. “In a low-rate scenario, I don’t disagree with them. The problem is, there’s no way of knowing if that payment will stay the same.”
Here, Mr. Gillespie offers the standard warning about today’s high debt levels for all age groups. When interest rates rise, comfortable debt burdens can become unbearable. Experience tells us a lot of people are ignoring this argument, which is understandable because persistent global economic weakness leaves little chance for a rise in rates any time soon.
So let’s try another warning for seniors, one suggested by Mr. Gillespie: “If you have huge amounts of debt going into retirement, you may get your OAS clawed back. You may lose other government benefits that are means-tested.”
The OAS clawback makes some retirees irate. They see themselves as having paid for OAS benefits through a lifetime’s worth of work and taxes, and they want the full package. They misunderstand that OAS is designed as an income top-up for people who need it. That’s why the clawback starts kicking at taxable income of $69,562, which is a comfortable threshold in today’s world.
Numbers-wise, the rising interest rate risk is actually a more compelling argument against retiring with a mortgage, a credit card balance or a line of credit that never gets paid down. With a $75,000 balance on a home-equity line of credit, you’re looking at minimum monthly interest-only payments of $185, assuming a rate of 3 per cent. A rise of one percentage point in rates and you’re at $246; a rise of two points puts you at $300.
Mr. Gillespie sees a lot of people come into his office with five years to go until retirement, and about 25 per cent of them have debts. Usually, it’s a home-equity line of credit used to finance their lifestyle. The advice he provides from there starts with this sensible maxim: “A good rule of thumb is to have no debt in retirement.”
If clients have assets in a tax-free savings account, he suggests they use them to pay down their debts. Also, he urges people with an unregistered investment portfolio to sell enough of the holdings to pay off their debts. If the clients are dead set on keeping the investments, he suggests a strategy where they sell some holdings, pay off their debt and then re-borrow to buy back the securities after a 30-day period has elapsed. (This keeps the taxman from getting interested in the transaction.)
“If they still ... want the debt at least we can make it tax-deductible,” Mr. Gillespie said. Interest on loans for investment purposes is tax-deductible, unlike regular loans.
Another way to attack debt before retirement is to use money that would otherwise go into registered retirement savings plans. If your income when you retire will be lower than it is while working, a smarter use of your money from a tax point of view is to contribute to an RRSP.
But from a common sense vantage point, paying down debt is a bigger priority because of the risk of soaring costs as interest rates rise. Mr. Gillespie suggests using a five-year debt repayment plan, fuelled by what would have been your RRSP contributions.
The kind of debts Mr. Gillespie sees among people approaching retirement suggest they’ve been borrowing to finance their lifestyle. If they’re hooked on spending, won’t they fall back into debt again?
Mr. Gillespie is doubtful. “You find that when people get close to retirement, they’re scared of their debt. They don’t realize until it’s gone how much of a stress it was on their life.”