Strategic Debt Can Help in Retirement


Baby boomers are entering retirement in record numbers and 44 percent of them have concerns about their level of debt, according to a 2014 report by the Employee Benefit Research Institute (EBRI). While concern and responsibility with debt are warranted, one expert argues eliminating all debt is actually a mistake that has led too many retirees to lose the opportunity for what could have been a secure financial future.

Most financial planners agree that carrying debt into retirement is a very dangerous move, one that can risk your financial future and drain your retirement savings. Contrary to this belief, Tom Anderson, author of, “The Value of Debt in Retirement,” says anyone can use debt strategically to add value to their financial goals -- like many of the nation’s most successful companies and ultra-high-net-worth individuals do every day.

“Debt is such a huge piece of the economy and our lives but we don't study or talk about it, so what happens is there are many people who tend to have way too much debt or they’re completely debt-averse and they don't have any debt at all,” says Anderson.  “I think very few people are in the optimal middle target zone and being strategic about it.”

Anderson, a wealth management advisor, discussed with me how the right kind of debt can help complement one’s assets. His book offers a bold point-of-view on debt as being a strategic asset in the management of individual and family wealth.

Boomer:  What kinds of assets should one have in order to make debt work to his or her advantage?

Anderson:  Eighty percent of America does not have $100,000 in liquid, investible assets – stocks, bonds, things you can buy and sell quickly and easily. Something has to be wrong with our education and our system if we’re one of the wealthiest countries in the world, but eighty percent of America doesn’t have liquidity.

When you get a paycheck the government takes out taxes, Medicare, Social Security, and then you save into your retirement plan and you’re left with cash. Cash is the most precious money for you in your life and in many cases people use it to pay down the wrong debt, putting it into things that aren’t liquid. Taking that money and building up a liquid investment account will give you survivability in bad times especially if you don’t position it in a high risk way.

But you need to have a conservative, diversified account. In my opinion, people should consider a world-neutral approach to asset allocation. History has proven unkind to those who overemphasize their home country. Debt only magnifies your asset allocation strategy. Everything else being equal, a lower-volatility portfolio with debt is better than a high-volatility portfolio with no debt.

Boomer:  Why might rushing to pay off a mortgage before retirement be financially unsound?

Anderson:  My story isn’t that I think debt is good. My story is that I think liquidity is very valuable. It’s flexible. Liquidity will protect you in tough times. A lack of liquidity is what drives you to bankruptcy. I would suggest to you that if you don’t have enough money to pay off all of your house, you might not want to pay off any of it.

Let’s say you’re in a $400,000 home and you have $100,000. You put down the $100,000 on that house and then two months later, you lose your job. You can’t refinance that house because you don’t have a job anymore. You don’t have the liquidity. You actually could find yourself in a situation where you end up going bankrupt. If you keep that $100,000, you still have interest payments on that house. But you also have cash to ride out almost any storm that could come your way. And you can use that cash to start building up your asset pile, all the while, reducing your risk.

Boomer:  How can utilizing a proper debt strategy potentially help to nearly eliminate one’s taxes?

Anderson:  Most people spend more time deciding what TV they’re going to buy than they do trying to figure out our tax code. It’s understandable because our tax code is highly complex. But there are many ultra-high net worth individuals taking advantage of the tax code every year. I simply want to level the playing field and share these same strategies with everyone else.

Think about all the times you’ve had someone prepare your taxes. They take the information you give them and prepare a return based on that information. Rarely do people give you proactive advice on how to reduce your taxes. In most cases, things like mortgage interest are right off the top deductions, not subject to the alternative minimum tax, up to a million dollars. It’s an incredibly powerful tax tool.

Mortgage interest is just one type of debt deduction. Increasing your charitable giving before you’re retired and early in retirement can also have its advantages. And securities based loans have advantages as well. When you take out money from your taxable investments, like stocks and bonds, as millions of Americans do in retirement, you have to pay capital gains tax. But if you choose instead to borrow from that portfolio, you do not have to pay taxes on what you borrow. I recommend that you do not borrow more than 25% of your portfolio, so that should the market drop dramatically you don’t end up in a maintenance call being forced to deposit additional collateral, cash or sell securities held as collateral to bring the account back in to good standing.  I strongly recommend you make these decisions with the help of a financial professional. If you don’t already have a sizable taxable portfolio, you may to consider putting some money into those taxable accounts in addition to your tax-deferred accounts like an IRA or 401(k). Finding the right combination can help you reach the most efficient solution to lower your taxes.

Boomer:  How can one determine his or her optimal debt ratio, or debt “sweet spot”?

Anderson:  This is where I encourage people to think like companies. We’ve all heard the phrase it takes money to make money.  It takes time for companies to profit, but they’re able to do that in large part because they increase the amount of debt that they have over time. As their assets grow, so does their debt. Companies are maximizing value with their optimal debt ratio. People have the ability to do the same thing!

I take the ideas used by companies and make them more conservative for individuals. I’ve found that an optimal debt ratio is typically between 15 and 35%. To calculate your debt ratio is simple – divide your total debt by your total assets.

Take John, a 35-year old doctor who has still has a mountain of student loan debt. But he also has a healthy investment portfolio. He can borrow from that portfolio and pay off the entirety of his student loans.  He still has to pay back what he borrowed, but it’s less than what he was paying before. And he has no required minimum monthly payment. Less money out is more money in. I call it capturing the spread. If you can make more money on the money you borrow than that money costs you, you may be able to be like John and increase your return. He is simply taking the ideas successful companies use every day and making them more conservative for the individual. John is choosing to maintain some debt in order maximize the growth of his assets. As with any strategy, there are risks and you should talk to your financial advisor to help determine what will best suit your specific circumstances.

Boomer:  Other financial advisors advise the exact opposite on a lot of these points —why would you say you are right and your critics are wrong on the value of debt in retirement?

Anderson:  Some of the best ideas have arisen by challenging conventional wisdom. In my twenty years in the industry, I have found it astounding how little information is available about debt for individuals and especially how it relates to retirement.

The mainstream advice is generally geared to people that have a low net worth and/or lack the responsibility to handle debt. I understand that these strategies may not be for everyone, but I think people deserve the opportunity to learn about these ideas and then determine if utilizing a debt strategy might be right for them. I want to empower people to make their own decisions because if used in the right way, debt can be an incredibly powerful tool.