When it comes to whether retirees should pay off their retirement mortgage, there is usually no one-stop answer.
Because, as with most planning for (and in) the years after work, the decision depends on your specific situation.
Of course, there are several advantages to paying off a mortgage: Your monthly obligations decrease, which can give your cash flow more headroom.
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However, depending on your tax situation and your available remaining assets – as well as where the cash would come from – you can face financial repercussions that should be good for you.
That’s what the experts say.
Maths
Sometimes the calculation can be cut and dried. That said, if you were paying more interest on your mortgage than the interest you earn on the money you would use to repay it – and the tax implications would be minimal – the decision can be an easy one.
“Do you have the cash just lying around in a checking account? If so, paying off a debt that costs you a few percentage points if you don’t make any cash in today’s interest rate environment can be a piece of cake.” said certified financial planner Brian Schmehil, director of wealth management at The Mather Group in Chicago.
If you invest in bonds that yield 1.5% and pay more than that on your mortgage, you are essentially negating the gains on the bonds, said CFP Allan Roth, founder of Wealth Logic in Colorado Springs, Colorado.
He also pointed out that if, for example, you pay off 2.5% of your mortgage and pay it off, you essentially only earned that interest rate on the money you used to pay off the loan.
“It would be a risk-free, tax-free return of 2.5%,” said Roth.
Plus, you didn’t have to sell an asset for that return: your home, which could go up in value, remains yours.
If, on the other hand, the money that you would use to repay the mortgage is invested in a retirement account, the interest comparison cannot be in your favor.
“If so, it may not be in your financial best interests to withdraw money from a retirement account to pay off a debt that is costing you less than you would otherwise bring in through an investment,” Schmehil said.
If you were able to deduct mortgage interest on your tax return – you need to list your deductions to get this break – remember that benefit is gone. (Most taxpayers don’t list this, however.)
Taxes
A distribution from your pension fund can also have tax consequences.
If the account is not a Roth account whose payments are made after tax, but distributions are generally tax-free, your withdrawals are usually taxable. Traditional 401 (k) plans and individual retirement accounts offer a tax break on contributions, while distributions are taxed as ordinary income.
“If that distribution ranks you from the marginal 12% to 22%, or from the 24% to 32%, then you are paying Uncle Sam an 8% to 10% tax premium just to pay off a debt that may only cost you 3%, “said Schmehil.
However, if you choose to use that retirement savings to get rid of your mortgage and minimize taxes, you could spread the payout out over several years, said Roth of Wealth Logic.
“If you’re in the marginal 12% mark, I’d say you’re withdrawing an amount that will keep you at that 12% rate every year,” said Roth.
Also, be aware that when you repay your mortgage, the cash you use will essentially be converted into equity in your home – which you may or may not be able to easily tap into later.
In other words, if an illiquid asset – your home – were to hamper the achievement of your financial goals, it might be better to keep the money elsewhere, either in a cash or investment account, depending on your goals and risk tolerance (how long to You need the money and whether you can take the volatility in the markets).
I’ve never had anyone come back to me and say they were unhappy that they paid off their mortgage.
Larry Ginsburg
Owner and President of Ginsburg Financial Advisors
However, Schmehil and other financial advisors said that even if you determine that it would make more financial sense to keep paying your mortgage, the emotional factor can – and maybe should – weigh heavily in the calculation.
“Yes, customers could potentially make more money by letting us manage capital and get higher after-tax returns than the cost of interest on their mortgage,” said CFP Larry Ginsburg, owner and president of Ginsburg Financial Advisors in Oakland, California.
“Why speculate with home equity? What is the great benefit of that for a customer?” said Ginsburg. “We generally recommend paying off the mortgage and getting the emotional benefit of lowering fixed costs.”
For example, he said, it helps alleviate retirees’ anxiety during the market downturn, as they are less concerned about the impact of their income even when they have nothing to worry about.
Ginsburg said that customers who initially disagreed with his advice on getting rid of their mortgage thanked him later.
“I’ve never had anyone come back to me and say they were unhappy that they paid off their mortgage,” he said.
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