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Are you heading for a retirement bankruptcy?

heading-for-a-retirement-bankruptcyA seaside cottage. The golf course. Perhaps just a safe and cozy home.

Those are the types of settings people imagine for their retirement years. Unfortunately, a radically different setting is becoming a reality for many retirees - bankruptcy court.

An alarming study shows that older Americans are filing bankruptcy papers more frequently, which makes it a good time to ask yourself if you might be on the same track for going bankrupt in retirement. Even if you are not yet retired, it is never too early to examine these issues - in fact, the earlier you do, the better.

Bankruptcy and retirement: red is the new gold

More and more Americans are spending their golden years in the red. A recent paper based on data from the Consumer Bankruptcy Project identified some disturbing trends about bankruptcy and retirement:

While bankruptcy rates fell for every age group between 18 and 54 during the 25 years from 1991 to 2016, they tripled over the same period for people in the 65-to-74 age group and went up more than four times for those 75 and over.

The paper, entitled "Graying of U.S. Bankruptcy: Fallout from Life in a Risk Society," identifies a variety of reasons for this trend toward more people going bankrupt in their retirement years. Prominent among these conditions are:

  • a shift over the past few decades from comprehensive pension programs to 401(k) plans which place the onus for retirement saving on the employee rather than the employer
  • the soaring cost of healthcare

Thinking about downsizing? Read 7 ways retirees can profit from downsizing


How to assess your risk of going bankrupt

These conditions are not going away any time soon. For this reason, a central part of retirement planning should be to examine whether these factors could leave you at risk of filing bankruptcy. The following questions can help you evaluate your risk of going bankrupt in retirement:

  1. Are you heading toward retirement with debt?
    According to the Employee Benefit Research Institute, just over half of families headed by someone aged 55 or over had debt outstanding in the early 1990s. Now that figure is more than two-thirds as much.

    If you are heading toward retirement with debt, know that it negatively skews your retirement plans. However much you have saved in a 401(k), IRA or other retirement plan, you have to discount it because some of that amount will eventually be offset by what you owe. Also, chronic debt can be a sign you are habitually living beyond your means, and this can only get worse when your budget gets tighter in retirement.

    Part of your retirement plan should be to become debt-free well before you retire. If you are already retired and have debt, organizations like the National Foundation for Credit Counseling can help you find senior citizen debt help.

  2. Have you planned for income sustainability?
    You might feel you have a healthy nest egg saved up, but have you used a retirement calculator to test how it will hold up when stretched over what might be a few decades of retirement?

    Income sustainability means making sure your money will last. Be sure to plan for long-term retirement income needs, and consider the benefits of downsizing before you deplete your resources by keeping up a larger house than you now need.

  3. Have you saved for healthcare expenses?
    The typical person aged from 25 to 34 spends $3,163 a year on healthcare, according to the Bureau of Labor Statistics. For the average person 65 and over, though, that figure is more than twice as large at $6,620.

    Since healthcare costs are rising across the board and represent a particularly large portion of your expenses in retirement, one way to protect yourself is to use a Health Savings Account (HSA) to supplement your retirement savings.

    An HSA has what is commonly called a triple tax advantage - contributions are tax-free, investment earnings within the HSA are not taxed, and there is no tax on withdrawals as long as you use them for qualified medical expenses.

  4. Are you taking advantage of catch-up contributions?
    If you are approaching retirement age and are concerned you haven't saved enough, be aware that you can make extra contributions to 401(k) and IRA plans once you reach age 50. As of the 2018 tax year, the annual allowable amount for these catch-up contributions is an extra $5,000 for 401(k) plans and $1,000 for IRAs.

    Besides the tax advantages, an added plus to doing this extra savings inside a qualified retirement plan is that those plans are protected from bankruptcy. This protection extends up to a cap of $1,283,025 for IRAs, and is unlimited for 401(k)s.

  5. Do you have an emergency fund?
    Sometimes bankruptcy is caused by cash-flow problems. You might have sufficient wealth tied up in your home or other property but are unable to get your hands on enough liquidity in an emergency.

    Whether you are 25 or 65, the best protection against an unexpected cash crunch is an emergency fund. Set one up by choosing a savings account that pays a competitive rate of interest, or you might even do better with a CD if you think the likelihood of an emergency is slim.

  6. Are you adjusting your plan in retirement?
    Once you retire and form a budget based on your retirement income, don't assume you can set this course once and forget it. Changes in investment returns and the cost of living can shake up even the best-laid retirement plans.

    Revisit your retirement plan each year to make sure your spending rate is still sustainable given the value of your assets. This will help you avoid drawing down those assets so quickly that you suddenly find yourself facing bankruptcy.

These may be tough questions to face, but better to deal with them when you still have some viable options for fixing your finances rather than to wait until bankruptcy looms as your only choice.


More resources on retirement planning

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Retirement calculator

Checklist: How to manage your money better


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More resources for bank depositors:

Want a consistently competitive bank? Read America's Best Rates survey of the top ten

Shopping for the best CD rates? Use our CD rate finder tool

Ready to work on your savings goals? Try the savings goal calculator

Emergency funds: Why opening multiple money market accounts is a smart move

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