How (and why) to retire debt free

It’s almost impossible to open a newspaper these days without reading about your retirement “number.”  That is, the amount of money you need to set aside to fund your retirement years.  While important, the “number” is only one way to skin the proverbial cat.  What if I told you that you could slash 20-40 percent off the amount you need to save without reducing your standard of living in retirement?  Would you be interested?

While it may sound too good to be true, that is exactly what you can do by entering retirement debt free.  To see why, let’s look at an example.  Imagine two couples, the Drakes and the Palmers.  They’ve been friends for years and live next door to each other in a small community in Oregon.  The couples, both in their mid-sixties, plan on retiring next year, so they sit down with their respective advisers and calculate how much they’ll need.

The Drakes outline their retirement budget and determine that, in addition to Social Security, they will need $5,000 per month or $60,000 per year.  Approximately $1,300 of that is for their mortgage and $400 is for a car payment.  Assuming a withdrawal rate of 4 percent, the Drake’s adviser tells them they will need a nest egg of $1.5 million to generate the income they need ($60,000 ÷ .04).

The Palmers expect their retirement expenses to be nearly identical to their friends the Drakes with one big exception: they have no debt.  Ten years ago they set a goal to enter retirement debt free.  They paid extra on their mortgage each month and resisted the urge to buy expensive new cars.  As a result, rather than $5,000 per month they only need $3,300.  Assuming a withdrawal rate of 4 percent, their adviser tells them that their “number” is $990,000.

So even though they are planning nearly identical retirements, the Palmers can generate the cash flow they need with nearly half a million less than the Drakes, simply because they have no debt.

Cash flow during retirement

During retirement, your portfolio takes over the job that the payroll department handled during your working years, namely to send you a paycheck every month.  As we saw in the example above, debt makes that task much more challenging.  It cuts into your cash flow and increases the risk that you will outlive your money.

Even so, more people are following in the footsteps of the Drakes than ever before.  According to the Joint Center for Housing Studies at Harvard University, more than 60 percent of people aged 55-64 have mortgage and home-equity debt.  Funding retirement is difficult enough without handicapping yourself with liabilities.  Here are three steps you can take to make sure your debt retires when you do.

1) Commit

Paying off your house and other debts takes time and requires a serious commitment.  It might even mean putting your retirement dreams on hold.  Getting into debt is easy, but getting out of debt means adjusting your lifestyle and choosing to live below your means so that you can allocate the excess to your creditors.  If married, discuss the plan with your spouse so that you can hold each other accountable and work together towards a common goal.

2) Develop a plan

Once you’re committed to the idea of retiring debt free, it’s time to develop a plan.  Make a list of all your debts, including credit cards, car loans, mortgage debt, and school or business loans.  Next look at your budget and see how much you can allocate towards deleveraging each month.  Some say you should start by paying off the loans with the highest interest rates.  Others say you should start with your smallest loans and pay those off first so you can build momentum by seeing quick progress.  Choose whichever you think would work best for you.  As you pay things off, use the money you were allocating toward that loan and apply it to the next loan on your list.

When you get to large loans like your house, contact your lender and ask for a payoff amortization schedule so you can track your progress.  Don’t be tempted by the thought of holding on to your mortgage interest deduction.  Congress is considering eliminating this tax break in order to close the budget gap, but even if they don’t, it may not provide you much benefit in retirement.  You’ll likely be in a lower tax bracket and mortgage interest is front loaded, so the deduction shrinks over time.

These arguments aside, it’s questionable whether paying interest to get a tax deduction is a benefit in the first place.  Let’s say you pay $20,000 in mortgage interest in a given year and you’re in the 25 percent tax bracket.  Deducting $20,000 from your income would save you $5,000 in taxes.  Only in America does it make sense to spend $20,000 in order to save $5,000.  How much better would it be to pay your mortgage off, send Uncle Sam the extra $5,000 in taxes, and pocket the remaining $15,000?

3) Outline your retirement budget

Once you’ve cleaned up your balance sheet and are ready to move into retirement, develop a detailed retirement budget that matches your income with your expenses.  This will help you keep a reign on your spending so you can stay debt free.

As you can see, debt is inherently limiting at a time when most hope for greater independence and opportunity.  Eliminate it and you will gain the freedom, flexibility, and peace of mind that so many see as the hallmarks of a great retirement.

Note: I first published this article at

7 Responses to “How (and why) to retire debt free”

  1. Dan September 27, 2013 at 9:06 am #

    Your example above assumes that the first person would be paying their mortgage and car payment throughout the whole of their retirement years. However, both debts would be paid off at some point, at which point the retirement savings would be putting off additional money that is not needed, ie. it would be more savings than was needed at the time of retirement.

    Of course you could argue that they may keep getting new mortgages on new houses and/or keep replacing current cars with new cars, thereby always having those payments. But then they would be choosing to live a “better” (read more expensive) retirement lifestyle than your more frugal couple.

    Don’t get me wrong, I agree that it is wise to enter retirement debt free, it just isn’t as clear cut as your scenario.


    • Joe Hearn September 30, 2013 at 10:09 am #

      Hi Dan. I agree. The reason I used the assumptions I did in the article is that many people who use debt use it as an ongoing part of their planning. Ideally, the house gets paid off, but in reality, a lot of baby boomers (believe me, I’ve seen it) have used the low interest rates as an opportunity to refinance their mortgages (often taking money out) and/or buy a second home. If you’re in your 60s and you have a 20 or 30 year mortgage, I think it makes sense to have a nest egg that can support those payments. If you’re in your 60s and you have a 5 to 10 year mortgage, then, as you indicated, you can set aside only what is needed to retire the debt. Thanks for you thoughts.



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