Debt Causing Financial Vulnerability for Pre-Retirees

Researchers suggest that analysts and policymakers should explore ways to enhance debt management practices as they examine factors driving retirement security.

According to a National Bureau of Economic Research (NBER) working paper, older persons today appear more likely to enter retirement in debt than in past decades. Researchers examined older individuals’ debt patterns using the Health and Retirement Study (HRS) and the National Financial Capability Study (NFCS). With the HRS, they compared cohorts of people on the verge of retirement (ages 56 to 61) as well as people slightly older (ages 62 to 66).

Total debt is measured in the HRS as the value of mortgages and other loans on the household’s primary residence, other mortgages, and other debt (including credit card debt, medical debt, etc.). The researchers found the percentage of people age 56 to 61 arriving at the verge of retirement with debt rose from 64% in the HRS baseline group to 71% among Early Boomers. Additionally, the value of debt held rose sharply over time.

While the median amount of debt in the baseline group was about $6,800, it more than quadrupled among War Babies and almost quintupled among Early Boomers (respectively, $31,200 and $32,700, all in 2015 dollars). In addition, debt distribution appears to have changed across cohorts. The top quartile of the debt distribution held around $51,000 in debt in the baseline group (75th percentile), while in the two cohorts surveyed more recently, this same quartile of the population held more than double ($106,000) and almost triple ($146,800) that amount. Additionally, the top 10 percent of the debt distribution (90th percentile) reported debt of over $272,000, more than double what had been seen for respondents in this same age range 18 years earlier.

The researchers point out that, depending on the interest rate charged on this debt, these families would be very likely to face sizeable monthly debt repayments and to carry debt well into retirement. As debt levels increase, borrowers’ ability to repay becomes progressively more sensitive to drops in income as well as increases in interest rates.

The analysis found that one factor driving this rise in debt across time is that cohorts surveyed more recently have taken on substantially more debt and face more financial insecurity as they near retirement, mostly due to having purchased more expensive homes with smaller down payments. The percentage of people ages 56 to 61 having mortgage debt has risen by eight percentage points, from 41% in the baseline group to 49% among Early Boomers. Moreover, mortgage debt amounts grew as well. For instance, looking at the third quartile (75th percentile) of the mortgage debt distribution in the whole sample (not conditional on having a mortgage), mortgage debt more than tripled among Early Boomers compared to the baseline group.

Other debt for persons on the verge of retirement also rose across cohorts, from 37% for the HRS baseline group, to 42% for the Early Boomers. “Our concern regarding these indebtedness trends is that older households’ debt and financial situation will deteriorate as short-term interest rates start to increase,” the researchers say.

Ratio of debts to assets

The analysis found it is not just the value of debt that has increased over time, but the proportion of debt to assets as well. For example, the median value of total debt over total assets was rather small for the HRS baseline cohort, i.e., only about 4%, but this ratio rose to 11% and 15% in the War Baby and Early Boomer cohorts. In addition, a sizable fraction of Early Boomers had ratios over 50% and some held debt worth as much as 90% of total assets.

One important decision after retirement is how to decumulate wealth, and the researchers note that recent cohorts will also need to manage and pay off their rising debt burdens in retirement. They point out this is made more difficult by the fact that older persons often move some of their assets to fixed income assets. In addition, if equity returns are lower in the future than they were in the past (as many predict), it will be important for current older cohorts to manage assets and liabilities wisely and pay off some of their higher-interest debt first. “Accordingly, it appears that cohorts entering retirement will need to ensure that their income and asset drawdowns suffice not only to cover their target consumption streams, but also to service their mortgage and other debt during retirement,” the working paper says.

Comparing the 56 to 61 and 62 to 66 age groups, the researchers find indebtedness decreases as people age. Factors reducing exposure to debt include having higher income, more education, and greater financial literacy. Factors associated with greater financial vulnerability include having had more children, being in poor health, and experiencing unexpected large income declines.