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Even in retirement, not all debt is bad, author says

 
Published March 28, 2015

WASHINGTON — Traditional retirement advice typically calls for paying off a mortgage and reducing debt as much as possible before moving on to what's sure to be a smaller paycheck.

Tom Anderson, author of The Value of Debt in Retirement, says that's a big mistake.

Anderson says people should think more like corporations by balancing debt with the cash on hand. While some debt should be paid off as soon as possible, he says, not all debt is bad.

Anderson, a wealth manager in Chicago, recently spoke with the Washington Post. Here is an edited version of that conversation:

Tell us about your strategy.

All I'm doing is taking corporate finance ideas and applying them to the individual. I spent a long time studying finance and optimal debt structures. If you take on too much debt, your company is going to go bankrupt.

People can have too much debt or be very debt-averse. Few have an optimal debt ratio. There is no middle ground.

All I do is take corporate debt ratios and make them more conservative and apply that same framework to the individual balance sheet.

For an individual, what would be an example of that optimal balance?

When you're getting close to retirement or in retirement, I like a range of 15 to 35 percent. Most people are way above or way below that. So if I have $100,000 of net worth, I could have $150,000 in assets and $50,000 worth of debt.

If you have more than $50,000 in debt, then you are really counting on things going your way. If you have a lot less than that, you might not get that optimal approach.

That ratio must be very important.

Right. What we do in America is start out with a whole lot of debt and try to rush to come down to zero. There should be more balance.

Is there such a thing as "good" debt or "bad" debt?

There are different types of debt. There's what I call oppressive debt, working debt and enriching debt. Oppressive debt is going to be things like your credit card debt or any debt that is over a 10 percent interest rate, payday loans, all of that stuff. Get rid of it as fast as you can.

Then there is working debt. Many mortgages can have a rate of 3, 4, or 5 percent and they might be fully tax deductible for you, as well. Then you have enriching debt, which is debt that you're choosing to strategically have but that you can pay off at any point in time.

When would it not be a good idea to pay off your mortgage in retirement?

I would argue that unless you have enough money to pay off all of your house, don't pay off any of your house. The second you pay down your house, it's a one-way liquidity trap, especially for retirees. Let's say I have a $100,000 mortgage and I put down $50,000 on it and I retire. Can I access that $50,000? I can't.

Not paying it down can increase your liquidity. It can increase your flexibility. It can increase your overall rate of return. It can maximize your tax benefits. And it can actually reduce your overall risk. Companies do this all the time. Why? Because they value liquidity and flexibility.

Can't people tap that equity by taking out a home-equity loan or a line of credit?

It definitely makes sense to have that home-equity line of credit in place, but you might need more liquidity than that. And if we think about 2008, which is my base case, many home-equity lines of credit were canceled or reduced. Nothing buffers you like having money in the bank.