Want to Retire?  Reprioroitize Your Savings

by: J. Patrick Collins, CFP® , EA

As the largest segment of the population begins to approach retirement, planning for financial independence is becoming a major issue for a large percentage of Americans.  Unfortunately, there is flawed information being disseminated on how to prepare for retirement.  Nearly every brokerage firm and bank spews the same mantra, “You have to save more money”.  Logically, it makes sense, but I’d like to point out a more effective alternative. 

My recommendation to the vast majority of those I counsel approaching retirement, is to pay off all of their debt.   Instead of saving more money inside their IRA, 401k or investment account, those approaching retirement should be taking that money and paying off their credit cards, car loan, and mortgage.

In retirement, the most important factor for almost all retirees is cash flow: are you spending more than is coming in?  There are two alternatives on how to solve this dilemma.  First, you can increase your income by saving more money during your pre-retirement years.  Second, you can decrease your expenses in retirement by paying off your debts.  In both examples, you increase your spendable income. 

Let’s look at a real life example of which scenario is more effective:

John and Jane Client, Age 55

Expected Retirement Age: 65

John and Jane have an extra $10,000 per year to save. 

Current Assets: $750,000

Current Liabilities: $150,000

Scenario 1:  Save $10,000 per year, and pay regular debt payments for 10 years

In this scenario, John and Jane would have assets of $1,765,000 at retirement which would produce approximately $88,250 per year in income.  They would still have to pay their debt payments in retirement, which would cost approximately $11,500 per year.  John and Jane would end up having approximately $76,750 to spend after paying their debt payments.

Scenario 2:  Pay $10,000 per year towards debt for 10 years

In this scenario, John and Jane would have assets of $1,620,000 at retirement which would produce $81,000 per year in income and their debts would be paid off.  With no debt to pay John and Jane would have the full $81,000 to spend.

In Scenario 2, by paying off their debt versus saving the extra money, this couple increased their cash flow in retirement by $4,250!

So, why do  you rarely hear this advice from banks and brokerage firms?  There are two main reasons this information is not advertised at the major financial institutions:

• The more money added to investment/savings accounts, the more money they make in fees and commissions.  Recommending more savings increases their revenues.

• These institutions are usually the ones who are lending money for mortgages, credit cards, and other liabilities.  By encouraging their customers to save more and not pay down their debt, they can continue charging interest on the money they have loaned.

Managing your liabilities is just as important as managing your assets.  If you are dreaming of retiring within the next 10 years, don’t listen to the large financial institutions encouraging you to save more in annuities, IRA’s, 401k’s, mutual funds, and investment accounts.  Pay off your debts and increase your cash flow.    

*Example assumes a 6.5% interest rate on liabilities and an 8% rate of return on assets invested.  The example also assumes a withdrawal rate at retirement of 5% on the couples invested assets.

The information in this article is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, and does not purport to be complete and is not intended as the primary basis for financial planning or investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.