The idea of paying off the mortgage – usually our largest single debt – has an iconic and seemingly straightforward appeal. But is it really the best financial strategy?

The relative benefits of paying off a mortgage versus saving for retirement can be complicated. To answer the question it is important to consider your individual situation:

  • Are you close to retirement age, or many years away?
  • Do you have significant retirement savings or not?
  • What tax bracket are you in?
  • how much benefit do you receive from the mortgage interest deduction?
  • Will the returns on your retirement investments exceed what you are paying for the mortgage?

I will provide some guidelines to help you think through your particular situation. If you are already feeling dizzy contemplating all the moving pieces, you are not alone. Professional guidance may be needed.

Paying Off The Mortgage By Retirement

Paying off the mortgage by the time you retire can have great benefits. For example, say your retirement plan is based upon spending $100,000 per year for expenses. Without mortgage payments you may only need $80,000 per year. This would reduce your annual expenses by $20,000. Over a 25-30 year retirement this represents significant savings and increases your probability of success.

On the con side, you may still be in a high tax bracket when you retire and won’t have the benefit of the mortgage interest deduction. The consolation is that if you’re in the last five to eight years of your mortgage, the deduction probably doesn’t help much anyway.

If You Plan to Retire in 15 Years or Less

If you’re in late career and have the ability to make extra mortgage payments, should you? The answer can depend on how much you have saved for retirement, and your tax bracket. If you haven’t saved much you’re better off socking away the money in a retirement account, not only as a way to save, but also to lower your taxable income. If you have a large retirement account and little in liquid savings outside your 401k/IRA it may be advantageous to fund a taxable brokerage account instead. Your house isn’t likely to be a source of income if you plan to live in it (though more people are renting portions of their homes through Airbnb and VRBO for additional income.)

If you have saved a lot and are in a high tax bracket, there may still be tax advantages to keeping the mortgage – a more complex situation.

If You Are More Than 15 Years From Retirement

Early to mid career people with sufficient income may find paying down the mortgage attractive. Having no debt (in the form of a mortgage) is very appealing, but may not make the most sense from a financial perspective. Again, having all of your money tied up in the home doesn’t necessarily translate to providing a source of income in the way retirement accounts do.

If you are in a higher tax bracket, you may benefit from the mortgage deduction. With a low interest rate mortgage chances are good you could earn a higher return by investing in tax deferred accounts like 401k’s, etc. Recall that the return from paying down debt is the interest rate you are being charged.

To summarize

• Lowering your annual spending in retirement by 10 to 20 thousand dollars or more by paying off the mortgage can increase your chance of retirement success.
• If you haven’t saved a substantial amount for retirement, it doesn’t make sense to pay off the mortgage. You need to fund those tax-deferred accounts to create a supplementary source of income in retirement.
• People more than fifteen years from retirement should focus on building their savings as opposed to having their house paid off. Money invested early in retirement accounts has more time to grow and may provide a better return than paying off a low rate mortgage.

Each situation is unique. The framework above provides generalizations that may not apply to you. The decision must take into account your tax bracket, whether or not you benefit from the mortgage interest deduction and the likely returns on your retirement investments. If the math gets too complicated for you, we can help. Feel free to book a complimentary 30 minute session.

Call: 415-706-7800
Email: jeff@stofferwealthadvisors.com
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