How to Defeat Debt

Defeating debt is always important, but it becomes more critical as one nears retirement. Here are some strategies to help you navigate this stressful situation.

This article originally appeared in MarketWatch. EKS Senior Wealth Advisor, Howard Hook, contributed to this article.

Dear Tax Guy,

I am 65 years old and receive a pension and Social Security. I work full-time.

I have been penalized for the last two years because I went over the limit on earnings for Social Security as I was making around $50,000 each year. Next year, at 66 and 8 months, I can earn as much as I want and not be penalized by Social Security.

I have debts, including a $30,000 car loan, a $2,500 credit card bill, and a $6,000 personal loan. I also owe $8,000 to the Internal Revenue Service, and I pay back $250 a month.

Once I pay off the debt, how can I be prepared for taxes? Or even reduce them?

I am fairly healthy and plan to work for another 10 years. I need a game plan. I want to create an emergency fund, build my savings, and be better prepared for the future.

~~Defeating Debt

Dear Defeating Debt,

You want a game plan and there’s a playbook. You may have to deal with Social Security’s bureaucracy, and you will certainly have to be disciplined on your saving and spending habits, and debt repayments. Some tax planning could help. But you can do this.

There’s no problem with working and getting Social Security benefits, but until you reach full retirement age, administrators deduct $1 from your benefit payments for every $2 you make over the inflation-adjusted limit.

This year, the Social Security Administration starts cutting payments once people earn at least $21,490 a year. Next year, it will put the earning limit at $22,320, and start nipping beyond that point.

You say you will reach your full retirement age of 66 years and eight months in 2024. The Social Security earnings limit jumps higher from January of the year when people reach their full retirement age.

The earnings limit for people hitting their full retirement age next year will increase to $59,520. Once you hit the full retirement age, the limit vanishes.

Paying taxes on Social Security

You are planning to earn around $55,000 a year. That would put you just under the earnings limit in less than two months. Assuming this continues, you’re going to be in good shape, said Devin Carroll, owner of Carroll Advisory Group in Texarkana, Texas.

However, Social Security recipients pay federal income taxes on up to 85% of their benefits if their “combined income” exceeds $34,000 a year, the Social Security Administration says. (Combined income is adjusted gross income, plus one-half of a person’s Social Security benefits, plus nontaxable interest income.)

But how do you get yourself on a firm financial footing? The good news: building your retirement savings can also reduce your future tax bill. Find out what retirement accounts are offered through your job.

A 401(k), for instance, would do the double duty of reducing your taxable income while helping you save more for retirement. If you do have a 401(K), contributing to the employer match is a good idea, said Howard Hook, principal at EKS Associates, a Princeton N.J.-based fee-only financial planning firm.

One bold move would be suspending your Social Security benefits, so long as you could still pay all your other bills and debts, Carroll added.

If you determine that you don’t need the benefits while you work, you could hit full retirement age and suspend your benefits until age 70. That would get you a more generous benefit when payouts resume. It could also shrink your income and, thereby, your tax bill.

Paying down debt ‘ferociously’ 

The counter-argument is that you could spend more time paying down your debt with your larger income based on the higher earnings limit in 2024. And you need to build up a rainy day fund too. If you are ready for another decade of work, “I’d recommend attacking the debt ferociously,” Carroll said.

One tried-and-true tactic: zero in on the debts with the highest interest rates, said Hook. That strategy involves paying the debts with the highest interest first, paying the minimum amount on the rest, and working your way down.

Credit cards carrying balances had an average annual percentage rate of 22.77% in the third quarter, according to the Federal Reserve. The interest on an IRS installment plan is under 10%. (To put that in context: a high-yield savings account could offer interest in the 4% to 5% range right now.)But you have a limited amount of time to build savings — including a six-month emergency fund — cut your debt and save for retirement while reducing your tax bill. So, depending on your finances and your lifestyle, you could take an “all-of-the-above” approach.

“From a psychological perspective, you can say to yourself, ‘I’m working toward all three goals immediately,’” Hook said.

You know yourself best. What approach you take will depend on your lifestyle, and income, and will ultimately require both patience and determination.

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