Will we have a debt in retirement problem?

The second blog article I wrote way back in July 2013 (we are now on blog 472) was the 6 biggest mistakes retirees make. The number 1 mistake that a retiree can make is carrying debt into retirement. Ten years later and my view hasn’t changed, I still think it is the biggest mistake a retiree can make.

When the Baby Boomer generation bought their homes, it was very difficult to get a mortgage. Banks were strict on how much they would lend, interest rates were double digits and mortgage terms were relatively short at 20 or 25 years. During the Celtic Tiger, the rules went out the window. Deposits weren’t needed, the capital amount lent were much higher and the terms were extended so people could afford the monthly repayments. It is now rare to see a 25 year mortgage, with most of them being 30 years plus. Some of these mortgages extend out to the borrower being 70 years of age when their mortgage is paid off.

A lot of these borrowers took out these long term mortgages to get on the housing ladder. As their earnings increased, the also increased their repayments to pay off their mortgage way ahead of the original term. But many won’t, either through never being able to afford to overpay their mortgage or just preferring to spend money on stuff now and not even thinking about the outstanding mortgage they will have when they retire.

Impact on retirement planning

This will have a massive impact on the ability to provide an adequate income in retirement so you can do all the things that you want to do.

If you have a big enough tax free lump sum, you can use this to pay down the remainder of your mortgage. The tax free lump sum is traditionally used for those bigger once off purchases like changing the car, getting work done on the house or even helping out the kids financially. A lot of people also use it as part of their retirement income, the additional money they can use if there is any shortfall from the amount they are receiving from their ARF/ annuity. Using your tax free lump sum to clear debt is the right thing to do but you will not longer have the money for these once offs…unless you want to take more money out of your ARF, which is a taxable event.

Or you may decide to just continue with the monthly repayments. Pensions aren’t designed to completely replicate the same earnings that you had when you were working, so you will receive less than you earned. This continued debt will now take a larger proportion of your disposable income.

For example, if you were a 66 year old with an income of €100,000 a year, you will receive €67,892 net a year. A mortgage of €2,000 a month would take 35% of your net income. If you retired on the maximum pension of €66,000, you will now receive €50,050. Your mortgage will now take up 48% of your net income. If you were a public servant and receive 50% of final salary, you now receive €41,090 net. Your mortgage repayments now take up 58% of your net income!

What can be done?

For those who have mortgages that will not be paid off until after their planned retirement age, you need to work out the cost of having it paid off at the same time as retirement. Even if you can’t afford to pay the full amount, you need to increase your repayments. If you are on a fixed rate, you are allowed to overpay 10% of the capital amount, so there is room to overpay. You need to get the amount outstanding down to a level that it can be paid off by the tax free lump sum. Carrying a large amount of debt into retirement will have a big impact on your ability to enjoy retirement. You would be better off continuing to work. At least you will have more income to service your debt.

Steven Barrett

20 November 2023