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Paying off debt before you retire

Should you use retirement money to pay off your mortgage? Your kids' college expenses?

Tips for handling different types of debt

It seems obvious: The higher your debt payments are when you retire, the less you'll have to spend on other things.

But how much should you spend on paying down debt versus stashing away extra money for retirement?

Your mortgage

When interest rates are low, you may be better off putting potential "extra" mortgage payments into a retirement account that holds stock or bond investments. That gives your money a chance to grow, which could benefit you more in the long run.

Taking money out of a 401(k) or an IRA to pay off your mortgage is almost always a bad idea if you haven't reached age 59½. You'll owe penalties and income taxes on your withdrawal, which will likely offset any benefit of an early payoff.

If you're age 59½ or older, letting the money stay in your account and continue to grow can still be a better option if your rate of return is higher than the interest rate you're paying on your mortgage.

And remember that taking a large withdrawal to pay off your mortgage could catapult you into a higher tax bracket.

College loans

Despite drawing close to retirement, people age 60 and over now comprise the fastest-growing segment when it comes to taking out loans for education. On average, they carry almost $20,000 in college debt either for themselves or for their children.

Good idea? Probably not. Student loans generally can't be discharged even in bankruptcy, and up to 15% of your Social Security payments could be garnished if you fall behind on student debt.

And remember that unlike mortgage interest, interest on student debt may not be tax-deductible.

The best strategy is to take out loans only if they're scheduled to be paid off before you retire. But if that's not possible, what should you do? As with a mortgage, think carefully before withdrawing money to pay off debt in a lump sum, especially if you're under age 59½.

On the other hand, using some of your income to make extra student loan payments before you retire can be a good move—if you're paying a higher interest rate than what you expect your retirement investments to return.

Other debt

Other types of debt—personal loans, credit cards, and auto loans, for example—tend to have higher interest rates and lack any potential tax benefits.

These kinds of debt should "retire" before you do, because they can eat into your savings and reduce your standard of living.

For example, if your monthly retirement budget includes a $400 car payment and $600 credit card payment, you'll obviously be able to spend $1,000 a month less than someone without those bills for, let's say, the first 5 years of retirement.

If you instead keep working another two years and put an extra $25,000 toward your debt, you could retire without having to worry about making these payments—saving yourself about $11,000 in interest and gaining a spending cushion of $12,000 every year.

Paying off debt now equals more flexibility later

A bar chart showing that if you pay off debt before you retire, you'll pay less in interest and have more to spend than if you retire immediately.

This hypothetical illustration assumes an auto loan balance of $22,000 and an interest rate of 4%, a credit card balance of $22,000 and an interest rate of 21%, and that you make additional debt payments of $12,500 per year.

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Paying off debt now equals more flexibility later

This chart shows that if you pay off debt before you retire, you can have more to spend during retirement and pay less in interest. For example, if you retire immediately and continue to make $12,000 a year in debt payments, you might have $28,000 a year to spend in retirement, and you could pay $60,000 in interest by the time you pay off the debt. On the other hand, if you wait two years to retire and make extra debt payments of $12,500 a year during those years, you might have $40,000 a year to spend in retirement, and you could pay only $49,000 in interest by the time you pay off the debt.