Federal employees who have excellent credit scores can expect their scores to decrease after they retire from federal service. A drop of income, a result of transitioning from a higher income in the form of a salary to a lower income in the form of retirement income, will not necessarily affect a retiree’s credit score directly.
But the actions of “scaling back” one’s lifestyle in retirement and paying off existing loans such as mortgage can result in lower credit scores.
The credit score referred to is the FICO score. FICO stands for Fair Isaac Corporation, a company which has developed a numerical score used to predict how likely an individual is to pay back a loan. FICO scores range from 300 to 850. Usually, a higher FICO score makes it easier to qualify for a loan and may result in a better interest rate on the loan.
The FICO score should matter to the average retired individual, even if a retired individual is less likely to apply for a mortgage, for a short-term loan, or for other forms of installment debt. FICO scores are also used in a range of insurance and healthcare decisions, from setting car insurance premiums to whether an individual is accepted to live an assisted living facility.
Many Americans including retirees have over the last few years (especially during 2020 and 2021 when home values increased, and mortgage interest rates decreased) taken on more mortgage debt. As more retired Americans carry mortgage debt and car insurance premiums increase, FICO scores remain important.
According to FICO data, FICO scores increase as individuals get older, peaking when individuals at a score of 762, when individuals are in their early 70’s. After age 70, the average score falls to 756. According to most lenders, FICO scores that are in the “good” range – between 660 and 780 – are important. A score between 660 (getting into the “fair” range) should be of most concern.
While retirees typically have longer credit histories (thereby keeping FICO scores at least in the “good” range), there are certain actions that a retiree may perform that could cause a deep drop in the FICO score. These actions include closing out multiple old credit card accounts (even if the credit card account is inactive) too rapidly. Income and employment data are not included in the calculation. But an individual’s FICO score tends to be higher if the individual has a mixture of diverse types of loans. This mixture includes mortgages, credit cards and other types of installment debt including auto loans and student loans.
What Retirees Should Do to Keep Their FICO Scores Up
There is no secret formula for building a strong FICO score. The following are a few suggestions that can help build and maintain a strong FICO score:
(1) Making installment loan payments on time every time a payment is due;
(2) Not spending close to the credit card limit for credit cards; (3) Having and maintaining a long credit history;
(4) Applying for a loan and a credit card only when necessary; and
(5) Fact checking one’s credit reports (the credit reports issued by Equifax, Experion and TransUnion) and removing any incorrect information and closing out credit cards no longer used.
There are some financial advisors who counsel their clients to pay off as much debt as possible (including a mortgage) before they retire. However, for a growing number of retirees, paying off a large debt is not an option because of their lack of “liquid” savings held in passbook savings and money market accounts. According to the Federal Reserve Bank of New York, over the past 20 years senior citizens have accumulated debt faster than any other age group. Total household debt for those individuals over age 60 has more than quadrupled to $4 trillion over the past 20 years, according to Federal Reserve data.
Many federal employees have asked the question whether they should use their Thrift Savings Plan (TSP) and/or individual retirement arrangements (IRAs) to pay off their mortgages, home equity lines of credit and any other debt such as credit cards and student loans once they retire from federal service.
The answer is no for two reasons:
(1) A lump sum withdrawal from the traditional TSP is fully taxable.
The TSP automatically withholds 20 percent in federal income tax when a lump sum withdrawal is requested. The TSP does not withhold state income taxes from a lump sum withdrawal. The TSP participant is responsible for paying any state income taxes due. When requesting a lump sum traditional TSP withdrawal to pay off an existing debt, the TSP participant therefore needs to take into consideration federal and state income taxes.
For example, if a TSP participant wants to pay off a $300,000 mortgage balance and the TSP participant lives in a state that has an 8 percent state income tax, then the TSP should request a $300,000/0.72 equals $416,667 lump sum withdrawal in order to pay the taxes due and to net (after paying the taxes due) $300,000. In case a lump sum withdrawal from the Roth TSP (or a Roth IRA) is requested, while there are no taxes due when a qualified distribution is made from the Roth TSP, any further tax-free growth in the portion of the Roth TSP account withdrawn will be permanently lost; and
(2) A lump sum withdrawal from the TSP or IRA means that the funds withdrawn will not be available to help pay for any future major expenses such as the cost of long term care.
For example, a retiree and/or retiree’s spouse has to go to an assisted living facility and/or nursing home and long-term care insurance was not purchased to pay the cost.
The combination of lower income during retirement coupled with higher interest rates and inflation can quickly make debt burdens unmanageable for many retirees. That is why retirees are advised to routinely monitor their debt by annually checking their credit reports (by going towww.annualcreditreport.com) and their FICO score (by going to www.myfico.com).
Re-posted from MyFederalRetirement.com
Written by Edward A. Zurndorfer
Edward A. Zurndorfer is a Certified Financial Planner (CFP®), Chartered Life Underwriter, Chartered Financial Consultant, Registered Health Underwriter and Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019
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