Wednesday, April 11, 2007

Debt In Retirement

Although we have chosen to be debt free for many years, I am aware that one doesn't have to be debt free in order to retire. I know retired people who continue to have significant debt. They have car loans and mortgages on their homes. It all comes down to having adequate and dependable cash flow to meet all expenses. This means, that when it comes time to decide when to retire...cash flow is more critical than net worth. My straw pole, based on random observations over the years, indicates that most Canadian retirees drive newer vehicles. How can they afford to do this?

I suspect that many people retire, then later find that they have more money than they counted on having. In Canada, Canada Pension Plan (CPP) and Old Age Security programs provide significant income over and above any private employment pension plan. These sources of income alone can pay for a lot of luxuries. For example, a $300 per month car loan comes to $3,600 per year. This is well under the $470 per month or $5,680 per year average CPP income that the average Canadian retiree receives.

I will discuss more on Canada Pension Plan pension amounts in a future post.

6 comments:

Middle Class Millionaire said...

Hi Canadian Money,

I agree with you that cash flow is more important than networth, but although I’m not anywhere close to retirement, if retired I would be very reluctant to take on any debt for a depreciating assets like a car (I would consider some investment debt though).

On a totally different topic... I was just wondering what percentage of your pre-retirement income did you find you needed in retirement?

Cheers,
MCM
http://middleclassmillionaire.blogspot.com/

Canadian Money said...

Hi MCM,

Our intial percentage at retirement was about 47 percent.

My March 18,2007 post "Is 80 Percent Required?" discusses this in more detail.

With respect to retirees buying cars on credit, I agree with you. My impression, is that many people live, more or less, from pay check to pay check, both before and after retirement. They spend as much as "the system" will allow them to spend.

If they are familar with the concept of a depreciating asset, they don't care. They measure what they can afford... by whether or not they can meet the monthly payments and the balance in their savings account.

I think new car advertising reflects this by advertising monthly leasing costs or what the monthly purchase payments will be.

I expect there are other influencing factors. Might make a good future post.

Mike said...

My parents both have good work pensions - when they turned 60 they started getting CPP and used that money to finance new cars over 5 years. In their case it made sense rather than cashing in rrsps.

Ideally it would be nice to avoid debt in retirement (or any other time) but I think paying for things like cars tend to be the same whether you are working or not. It's a lot of cash to put out and most retirees don't have it handy. If you are living off an RRSP then it doesn't make sense to take an extra 20-30k out one year just to "pay cash" for a car (or whatever). I think it's better to take out the money over a number of years to minimize the tax impact. Whether the extra withdrawals get done before or after the car gets purchased is probably not that important.

the money diva said...

Unfortunately, to make sure that you don't run out of money you need to plan in a way that virtually guarantees extra money. After some years of retirement, once the extra money becomes obvious, I would suggest that spending it isn't particularly frivolous.

But you're probably right in assuming that most people just buy what they want and finance it, reagrdless of what their true siutation is. :(

MD

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