Rethinking borrowing in retirement
Can you really afford loan payments after you're retired?
Dear Maturing Loans,
I'm 62 and am in pretty good shape as far as savings goes, with $500,000 in various 401(k) accounts and an equal amount in home equity. But once I retire, and my only income will be Social Security plus investment interest, will I be able to get a car or other loan? -- Donna
You bring up an interesting question, which leads to a broader discussion.
In retirement, the thinking (and the math) surrounding your income and investments changes. Instead of focusing on borrowing, what you need to focus on is what you'll be able to afford without obtaining a loan first. If you can afford subtracting loan payments from your Social Security and investment income, then you can start looking at taking a loan if it makes financial sense for your situation. However, if your expenses in retirement don't leave you any room for loan payments, you will not be able to afford a purchase with a loan.
First, you need to figure out what sources will provide you with retirement income. Investment interest seems very 'iffy' since we don't know the type of investments you have and the risk associated with them. What you will need to do is set up an income strategy (which is a way to turn your savings into spendable cash distributed on a regular basis) that meets your financial requirements. In other words, build into your retirement income plan any and all expected expenses and then leave enough money for any unexpected emergencies.
Follow these steps:
1. Determine how much income you will need in retirement.
There are several ways to do this. You can use my worksheet or get out your trusty legal pad or financial software.
Here are two ways to determine how much you will need in retirement.
The easy way:
Take how much you are earning today and subtract how much you are saving. The rest is what you are spending.
Earnings - savings = spending (taxes included)
To maintain your current lifestyle, you will need to generate enough income to cover what you are now spending, minus the savings.
The hard way:
Use a worksheet to add up all of your expenses or take out your checkbook and last year's tax forms and add up every expense you have. Expenses include utilities, gas, food, entertainment, property taxes, vehicle maintenance, pet care, prescriptions, car payments, etc.
The next step to take after you have determined your expenses is to identify all your sources of income. Investment interest fluctuates too much to qualify as a bona fide regular source of income.
What we want to look at are guaranteed income sources such as Social Security, pensions, employment and anything else that generates a steady stream of income.
For example, let's say that today you earn $50,000 a year and you are saving $5,000. That means you are spending $45,000, taxes included. Let's say your Social Security and other income sources will add up to $30,000 a year. Then you need to earn $15,000 a year from other investment income sources to maintain your current lifestyle.
Once you figure out what your retirement expenses and income will be, you should be able to figure out if you can afford to make regular, equal installment payments over four or five years for a car or whatever you would like to buy. If those payments will push you over the edge financially, then you obviously will not be able to afford those same payments with a loan.
2. The next step is to find an income strategy that works for you.
This will help you get the income you want from your savings and investments in a way that reduces risk, does not require an unrealistic rate of return (12 percent or more, for example) to work, does not have all kinds of fees and penalties and is a plan with which you feel comfortable. Again, counting on interest income is dependent on the types of investments you have. Interest income can be variable and is not guaranteed. Your best bet is to work with an income strategy that has guaranteed components to it.
Stay away from methods that are variable. Variable means that the income fluctuates with your investments, such as stocks. If you ever need a loan down the road or have an emergency and either need to put these investments up as collateral or want to use them, their value can be down, which will give you less to use (or borrow from).
See you next week with your questions.
Alan Klayman is creator of MyIncomeStrategy.com and CEO of Klayman Financial LLC. Klayman specializes in retirement income planning, business management and planning, estate planning, tax-advantaged investing, trust investment management, professional money management, insurance and annuities, mutual funds, fixed income securities, and institutional and personal retirement plan administration.
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