When clients need to use debt in retirement

Most financial advisors would agree that going into retirement without debt is ideal. But in some scenarios, as outlined below, clients may need to use debt during their golden years, so it’s important to consider this possibility when creating financial plans and supporting clients through retirement.

Failing to include existing debt or to prepare cost-effective debt options in retirement could endanger an otherwise well-crafted plan. Also, advisors who work within the silo of assets and insurance alone could miss valuable opportunities for clients and leave them open to risks.

Covering expenses during short-term periods

Your client may need a larger lump-sum withdrawal from their retirement accounts to cover an upcoming major expense but may want to effectively split the withdrawal over two tax years. A line of credit to temporarily borrow funds would allow them to make the second withdrawal in the following year. Of course, for this strategy to work, the cost of borrowing has to be far less than the tax consequence.

Buying a new car

Most retired clients who drive — especially younger retirees — will have to purchase at least one or more cars during retirement. Too often, this cost isn’t projected in the retirement plan as either a monthly payment or planned lump-sum withdrawal. Once again, the cost of borrowing versus the tax consequence of a withdrawal should be weighed.

Making other major purchases

Unlike car purchases, which might be more predictable as part of a retirement plan, some major expenses could come out of left field. Whether there is an unexpected opportunity, like buying a cottage, or a major house repair, having access to lower debt options can help clients balance the total costs between interest and taxes so they can maximize their resources.

Downsizing

Bridge financing has become prevalent in the last few years. Clients who planned to downsize but find their dream home before they’ve sold their existing home will often need temporary bridge financing. While these bridge financing products often have higher interest rates than a typical mortgage, their short-term nature tends to limit the cost and therefore the risk. The client still must qualify for this type of financing, and ensuring your clients know how to keep their credit healthy in their golden years can help. Understanding how much of your client’s retirement income can be used to qualify for a loan is also important.

Refinancing diversified debt

Like many Canadians, some clients will carry debt from their working years into retirement. In Q1 2024, households with a primary income earner between 55 and 64 carried more than $315 billion in mortgage debt in aggregate, according to Statistics Canada. This represented a substantial increase over the same quarter of 2020.

The potential for debt in retirement is another reason debt should be part of regular planning from the get-go. It’s especially important to work debt into the plan when clients have various debts with balances. Diversification can be a helpful strategy for investing, but diversifying debt can make the debt harder and more expensive to manage.

Help clients find debt strategies so that the debt balance can be paid off as early as possible in retirement. To do this, organize their debts so they can maximize principal repayments. Don’t focus on only rates; paying down the balance is the best protection from fluctuating interest rates.

Don’t wait to deal with debt options until after your client retires

Even if clients have plenty of assets, getting a loan or line of credit isn’t necessarily easy. Borrowing in retirement isn’t as straightforward as it is during working years. Borrowing based on net worth, as opposed to income, is complicated and probably not something to leave as your client’s only option.

As for borrowing based on income, some types of retirement income may be only partially counted for lending purposes, and some income may not count at all. For example, many lending institutions might want to see years of proof that a client has made sustainable withdrawals from their investments to provide regular income — proof that a new retiree wouldn’t have. Those who make irregular withdrawals face the same issue. Many clients will benefit from securing a re-advanceable credit facility before they retire so they have easier and potentially less costly options if and when they need to use debt in retirement.

Debt is a financial power tool, and no matter what your current process is, it’s time to make sure debt management strategies are part of your regular planning repertoire.