I want to take a quick minute to address an occurrence that has actually happened more often over the past few weeks. I have some clients that are approaching retirement. They are getting ready to flip that switch where they no longer have that paycheck they have been so accustomed to their entire life, to now they're paycheck is going to become their retirement account. Their IRAs will now be depositing directly into their bank accounts and that's going to be their paycheck, so that is what they have to live off of. The mistake that I am seeing a lot of them want to do is they want to pay off all their debt. They think they still need the exact same amount they were getting as they were working, so they want to keep drawing the same amount of paycheck.
How Important is Paying Off Debt?
The one thing I have to go over with them again is this: Okay, I agree, paying off debt is a very good thing. I want people to do it, but not from the stand point of having to pay extra tax by doing so. What I mean is these clients are wanting to take distributions from their IRAs or pensions and pay the appropriate 20, in some cases we're talking 25%, taxes to pay off the debt. If the debt is a car note, which often time it is to where their note interest rate is anywhere from 4-6%, I just don't see the point of paying 25% income tax to pay off a note that is only having to yield you 6% interest.
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One thing I would just have you consider is when you do retire and you want to pay off these debts, make sure you do it in a tax-efficient manner meaning that maybe it's not this year. Maybe you retired half way through the year to where you still have six months worth of wages you have to claim, and now if you're going to take distributions from your IRA that is also going to be treated as ordinary income. On top of that you're going to take distributions from your pension or your 401K. All the sudden now, where we could have been in that 10-15% bracket, we are in the 25% just because you want to pay off debt. To me it's just not worth it. I admire the fact that you want to get rid of the debt, but at what cost. If it is actually going to cost you more to pay off that debt, does it really make sense?
How Much Do You Really Need?
The other thing is, are you really thinking that you need the exact same amount per month to live off of? If you have done an awesome job to where you have several millions saved and that can yield you that same income that you are used to without hurting your principle, that's fine. A consultation I had with a client, they wanted to start drawing the exact same amount they were earning from their paychecks. Basically, my thought was why start on the higher side. Why don't we start off smaller, a more conservative number, and let's gage it over a 90-day period to where after 90 days, did you have enough? Were you able to make your budget, still pay off all your household living expenses, and also have enough left over to do the things you want to do? Eat out, travel, etc., do all those things?
Those are the two things that just came up here recently, and I just wanted to address it. If you are approaching retirement: 1) Don't get so in a craze of paying off debt, especially if it's going to cost you more on taxes and 2) Really start thinking or just being prepared to live off less. Don't think that you're going to need to draw the same amount income wise just to sustain your standard of living. Those are just some quick retirement tips and things to consider if retirement is approaching you.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.