Debt-to-asset ratio: the right balance for a comfortable retirement

Increase your solvency, free up money from debts by lowering your debt-to-asset ratio and use the saved sum to create retirement funds for a secure life.

Debt-to-asset ratio: the right balance for a comfortable retirement

After retirement, elevated debt levels can eat into your saved corpus. Therefore, you should focus on reducing your outstanding debts before you reach retirement age. And the first step to achieve this is to find out your debt to asset ratio.

What is the debt to asset ratio? 

Your debt to asset ratio is the total sum of your debts compared to the value of your assets. For example, if your debt ratio is 0.4, for every financial holding worth one rupee, you owe 40 paise in loans. If the ratio is higher than 1.0, your assets are not sufficient to cover your dues. 

How to calculate the debt to asset ratio?

Debt to asset ratio = Value of total liabilities ÷ Value of total assets

Here, total liabilities indicate all your outstanding loans, such as:

  • Home mortgage
  • Personal loan
  • Car loan
  • Credit card dues
  • Total assets include the sum of all your financial resources, such as:
  • Income/salary
  • Investments (bank deposits, stocks, life insurance, pension funds, etc.)
  • Cash in hand
  • Real estate
  • Car
  • Jewellery/gold

To estimate your solvency (that is, your ability to repay debts) you must first arrive at the total value of your unpaid loans. Then you need to find the total amount of your monetary assets. When you divide the former with the latter, you get your debt to asset ratio.

Related: Tomorrow Makers' Guide To Becoming Debt-Free In 6 Months [Premium]

Why is it important to know your debt to asset ratio?

This ratio helps you understand if you are over-borrowed or have enough assets to repay your debts. Moreover, your current debt to asset ratio mirrors your ability to pay off future loans. It reflects your degree of leverage or the amount of debt you are leveraging to finance your needs. A high debt ratio shows high leverage from loans. 

Lenders look at this financial ratio before granting new loans. If the figure is high, you may not be able to avail of credit in an emergency. The lender may doubt your capacity to service a new loan after meeting your existing liabilities. If you have a spotless credit history, you may get a loan, but you may have to pay higher interest rates. 

From a retirement perspective too, it is crucial to be aware of this financial ratio. After you retire, your steady paycheck stops. You start relying on the assets you have built up through your working years for your sustenance. So, if you have to serve sizeable debts, with no fresh inflow of income, your assets may get depleted faster than your life expectancy.

If you are aware of your debt ratio, you can take steps to lower it and keep your debts at a manageable level. Ultimately, it will help you create enough corpus to fund a comfortable retired life.

Related: 6 Steps To Calculate Your Retirement Corpus

What is the ideal debt to asset ratio for a comfortable retired life?

At any point in time, your debt to asset ratio should not exceed 0.5, implying that your debts should never exceed 50% of your assets. Otherwise, repaying it can lead to a severe financial crunch. 

As you approach retirement, your goal should be to lower your debt to asset ratio to 10% or less. You should also have as little debt as possible. However, reducing outstanding credit requires careful planning. You should work towards it before you reach your retirement age.

Financial planning in your 20s

When you are young and have just started earning, you might want to enjoy the freedom of having disposable cash in hand. However, you should start planning for your retirement as early as possible. The longer you stay invested, the more you benefit from the power of compounding. So, as soon as you start your job, you should start looking at the features of various pension funds.

Related: What Is The Right Age To Start Planning Your Retirement?

Atal Pension Yojana benefits 

You may not wish to invest large sums for your retirement fund at this early age. So, you can consider the Atal Pension Yojana (APY) scheme. The Indian government initiated this pension fund, which is overseen by the Pension Fund Regulatory and Development Authority (PFRDA). Every Indian citizen aged 18–40, with a savings account with a bank or post office in India can opt for APY.

APY is meant for the unorganised sector. So, the required minimum monthly contribution is low, starting at just Rs 42 for 18-year-old subscribers. You must contribute for at least 20 years. After retirement, you will receive a fixed income, starting from a monthly pension of Rs 1000. If you want to know the amount you can obtain every month, consult the Atal Pension Yojana chart.

You can also claim tax deductions up to Rs 50,000 under Section 80CCD (1B) of the Income Tax Act 1961 for your APY account outlay. After your income increases and you wish to invest in other schemes, you can exit from the APY scheme. The proceeds will go into your bank account.

Related: Understanding the Atal Pension Scheme And Its Benefits

Working towards the ideal debt to asset ratio in your 30s

Your 30s are a time when you are likely to have achieved some of life’s milestones. You might have started a family. You may have bought a house, a car, and other commodities. While some loans like home loans and car loans become essential, you should avoid debt traps. 

If you reverse your debt to asset ratio and divide your total assets by your total loans, you get your asset-to-liability ratio. Financial experts recommend that this ratio should always be 3 at least. That is, you should not have liabilities exceeding one-third of your assets. Any lower and you need to reduce your loan outgo to ensure your financial stability.

You also need to prioritise your monthly EMIs. With a home loan, you acquire an asset on credit. The loan fetches tax benefits, and the value of your property can appreciate over time. In contrast, a car will decrease in value in the future. And the interest rates on auto loans are also much higher. Hence, you need to plan how much of your debt budget needs to be allocated on expensive loans. 

In addition to this, if you have multiple credit cards with revolving credit, it is advisable to repay the dues and close all but one.

Reducing the ratio further in your 40s 

If you have not started your retirement planning even by your 40s, you cannot afford to delay things any further. A fair debt ratio for this age is between 0.3 and 0.2. You should focus on the following factors in this phase of life:

  • Start by closing your loans. 
  • Make sure your EMIs do not exceed 40% of your monthly income. 
  • Settle high-cost debts like personal loans and credit card dues. 
  • Consider part-prepayment of your home loan so that you can repay the entire amount over the next decade.
  • Save and invest the surplus that frees up to maximise your retirement fund contribution.
  • You can use a retirement calculator to estimate how much you need to save for your old age needs. Remember to factor in inflation to assess the time value of money after you retire.

Related: Why Ignoring To Plan For Retirement Can Be Financially Damaging

Paying off remaining debts in your 50s

This is a time when retirement is knocking at your door. Debts after retirement can reduce your lifetime wealth sufficiency and reduce your monthly pension income. Try to lower your debt ratio to 0.1 (10%).

However, it may not always be possible to become completely loan-free. And some debts may not be harmful. If it allows tax savings (as with home loans) it can also work in your favour. Besides this, you can consider refinancing a high-interest mortgage with a lower-interest loan. You can also pay children’s college fees by considering a student loan instead of using up your savings. The repayment is your child’s responsibility and will not affect your debt ratio.

Lastly, you need to look into the actual value of your debts and assets. For example, if your assets amount to Rs 25,00,000 and debts are Rs 10,00,000, your debt ratio is 40%. It can be considered moderately high. But paying off your debt will deplete 40% of your assets. So, this may not be the right move.

Last words

Your debt to asset ratio represents your financial health. At any point, your goal should be to keep it as low as possible. You will also be able to get loans if your debt ratio is already low. And to maintain a low balance, you need to work towards settling your debts. Moreover, a low debt ratio will enable you to save more for your advanced years. This way, you can ensure your retirement benefits will allow you to live life on your terms.

Additionally, increasing your assets can lower your debt ratio. You can study the benefits of investing in mutual funds to utilise its higher return potential for boosting your corpus.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.

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