Should I Pay Off My Mortgage Before Retirement?
Written by Gregory Palacorolla, CFP ®
As with so many other questions, the frustrating answer is…it depends. There are many factors that go into the decision-making process, such as cash-flow/liquidity needs, goals, taxes, and risk tolerance. Determining which option fits your situation best is an exercise worth some time. Have you imagined your ideal retirement? Have you identified your goals? Perhaps you would like to travel or help fund your grandchild’s college education. Do you want to move to be closer to children? Do you have plans to downsize? Whatever your goals may be, it is important that you factor them into your overall plan.
Have you developed your post-retirement budget? This budget can look very different from your pre-retirement budget, depending on your specific situation. For example, increasing healthcare costs will be the tattoo of retirement—a permanent mark all retirees will have to bear. So, before you make any sudden moves, consider the benefits as well as the drawbacks, and how they apply to your specific situation.
One obvious benefit is the money you’ll save by accelerating your mortgage repayment plan until eventually it is paid off. The amount of money you will be saving in interest is substantial. If you are ultra conservative, holding most of your assets in bank accounts and/or certificates of deposit, the rate of return you would get warrants paying off the mortgage, as these risk-free investment’s returns will not exceed the interest rate you pay on your mortgage. However, if the assets are in a taxable investment portfolio, there are more layers to peel back. You will have to consider the level of risk you are taking being invested and the rate of return of those investments.
Paying off your mortgage is a guaranteed risk-free return. When you invest in the stock market, there are no guarantees. You are trying to carefully keep the scales of risk and reward balanced.
Peace of Mind
Peace of mind is yet another benefit many retirees cite. For many, owning their home outright provides a sense of security. A life of less debt and more liquidity is especially attractive for someone living on a limited fixed income.
Forgoing Tax Savings
It is only fair that we discuss the drawbacks since we explored the benefits. Paying off your mortgage will cause you to lose the mortgage interest deduction. This could place you in a higher tax bracket. However, it is important to point out that the Tax Cuts and Jobs Act reduces the tax advantage of having a mortgage since the new tax bill nearly doubled the standard deduction to $12,000 for individuals and $24,000 for married couples filing jointly. Many people are no longer itemizing as a result since you only receive a tax benefit if your itemized deduction exceeds your standard deduction. If you’re in a lower tax bracket, the benefit of holding onto a mortgage is also less. On average, the higher the marginal tax bracket and larger the mortgage payments, the greater the tax benefit associated with holding on to the mortgage.
Another issue to keep in mind is that using your funds now to pay off a mortgage rather than applying it to a retirement account such as a 401(k) or IRA, may hurt you in the long term from a tax savings standpoint. You are forgoing the tax advantages of those plans. For example, employees 50 and older can put as much as $25,000 in their 401(k) plan this year in pre-tax dollars. Workers 50 and older can save as much as $7,000 this year in an IRA with the $1,000 catch-up contribution limit.
Missing Out on Returns
There is also a chance you could be missing out on some solid returns. The stock market can and has many times returned twice the amount of an average 4% mortgage rate. Again, there are never any guarantees, and there is a risk inherent in investing in the stock market. If you can stomach risk and have a surplus of funds put aside for retirement justifying your ability to do so, keeping your mortgage and investing the funds could be a viable option.
The other factor to consider is that life is full of unexpected events and unknowns. Using a large portion of your funds to pay off your mortgage may leave you in a vulnerable position, should an unforeseen expense come up. Ensuring there is a financial cushion in place to support these unexpected moments is smart. One tool some retirees use for this purpose is a home equity line of credit so they have additional liquidity for emergencies that may arise.
Where Should You Pull the Money from If You Decide to Pay Off Your Mortgage?
- Typically, you would liquidate risk-free investments in taxable accounts first such as a bank savings account.
- Second, you would liquidate riskier investments in taxable accounts like brokerage accounts with stocks, mutual funds, ETFs, and Index funds.
- Lastly, if you are over 59 ½, you may consider withdrawing from your tax-deferred account, but you need to exercise caution in doing this. Withdrawals are included in your taxable income in the year you take the withdrawal, which could possibly push you into a higher tax bracket. One strategy you can use to avoid this is withdrawing smaller amounts over multiple calendar years.
Unfortunately, there is no one size fits all answer to this question. The key lies in understanding your specific financial situation and gaining clarity around your goals and future cash flow needs. No matter which path you decide to take, if you plan properly, and allow a financial cushion for unexpected expenses, you can do well in either scenario.
Sources: The Balance/ Motley Fool/ CNBC
© Geier Asset Management, Inc. March 2019. Gregory Palacorolla, CFP ® is Director of Wealth Management for Geier Asset Management, Inc., a Registered Investment Advisor. The articles & opinions expressed in this material were gathered from a variety of sources, but are reviewed by Geier Asset Management, Inc. prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of March 2019 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual circumstances. In all cases, please contact your investment professional before making any investment choices. Geier Asset Management, Inc. is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.