Why Retirees Are Increasingly Declaring Bankruptcy

Older Americans are heading into and through retirement with a boatload of debt. They're carrying everything from mortgages and home-equity loans to big credit-card balances, and many are finding the burdens harder and harder to bear. In the last eight years, the over-55 crowd has become the age group most likely to declare bankruptcy, according to the AARP.

The statistics are unsettling. More than half of people 50 and older who carry debt spend most of their monthly income paying it down. An AARP study released before the worst of the current recession hit found that a quarter of those folks spend more than 75 percent of their income on their debts. Americans 65 and older who carry credit-card balances saw their average balance rise to $10,235, up 26 percent from 2005, according to Demos, a public-policy research group.

"We are seeing an across-the-board increase in seniors coming to us for help," says Gail Cunningham, of the National Foundation for Credit Counseling. "They are in financial distress [for a variety of reasons]: because a spouse has died, they are helping their children and grandchildren, they have credit-card debts, and their home values have declined."

Retirees have a harder time paying down those debts, too, because they don't have salaries to devote to the effort. Most have seen their nest eggs decline. Even those who want to return to work to pay down their debts may not be able to find a job, says Cunningham.

In different economic times, retirees might have downsized and cashed in their homes to pay off their debts—or at least have gotten reverse mortgages against those homes to carry them for a while. But with declines in housing markets, they may not have enough equity in their homes to do that. Some, like their younger neighbors, likely owe more on their homes than they are worth.

Not all retirement debt is cause for concern, though it can be hard to separate good debt from bad debt. Someone retiring with sufficient assets to cover what he or she owes may choose to keep their existing long-term low-interest mortgage, because it can help them keep their assets invested, offering them emergency funds and the promise of greater returns on that money. But even that can be problematic for 401(k) and IRA savers who face income taxes on the withdrawals they make to pay their bills. A couple in a 30 percent tax bracket, for example, would have to take $1,300 out of their IRA to pay their $1,000 mortgage check. So workers who expect their retirement to be fully funded by taxable withdrawals from their own retirement accounts would have more incentive to pay off those loans before they retire. If they retire before paying off the mortgage, they might be better off keeping it and stretching it out to avoid having to make a large taxable withdrawal from their savings to pay off the loan.

"In retirement, tax bills get big," says Rob Williams, a Columbia, Md., financial planner. "A retiree who wants to buy a $20,000 car must withdraw $30,000 from his or her IRA. The $10,000 difference is for taxes. Suddenly a 7 percent car loan looks like a good idea."

Nobody recommends carrying high-priced credit-card debt into retirement, and Cunningham says that card balances (and high-interest payday loans against Social Security checks) create the biggest burdens for elderly debtors. Once someone is past working age, he or she has fewer options for paying off those cards, and the interest can snowball.

In extreme cases, bankruptcy—or just walking away—can provide a reasonable answer for older people with big debts, counsels Stephen Elias, a Lakeport, Calif., attorney who advises the bankruptcy bound. Assets in IRAs and other retirement accounts are protected from bankruptcy judgments up to $1 million, so people with big medical debts can declare bankruptcy and get to keep their nest egg. Depending on the rules of their state, they might be able to hang on to their home, too. Elias tells some impoverished and debt-burdened seniors not to bother filing for bankruptcy. If they have no assets to protect, they can wait for the unlikely event that they will be sued, and notify debt collectors that they want to be left alone.

Folks whose debt burdens are less devastating can take actions that are less drastic. A first line of attack can be basic belt-tightening, says Brookfield, Wis., adviser Kevin Reardon. He tells his debt-burdened clients to cut their expenses to the bone, earn extra money around the edges and get tough with their own credit-card-carrying kids. "We won't allow clients to loan money to children when they are in or near retirement," he says. Parents may want to help the next generation extricate itself from debt. But leading by example might be a more valuable gift.