It is one of those debates that rarely seems to have a clear winner: Should retirees pay off their mortgages or continue to make these monthly payments?
The answer – probably a little annoying – is that it depends.
There are, of course, a couple of immediate benefits to paying off a mortgage: your monthly obligations will decrease and you may get more money in your cash flow.
However, depending on where the money to be repaid comes from – as well as your taxation and your remaining funds available – there can be financial implications that need to sit well with you.
This must be taken into account.
Sometimes math can be cut and dried. In other words, if you pay interest on your mortgage more than the interest you earn on the money you would use to pay it – and its tax consequences would be small – it can be an easy decision.
“Do you have cash just lying in your checking account? If it is, then it may make sense to pay a few percentage points to pay you the debt when you are not earning any cash in today’s interest rate environment,” said Brian Schmehil, chief financial officer, director of asset management at The Mather Group in Chicago.
Likewise, if you’ve invested in bonds that yield 1.5% and pay more than your mortgage, you’re essentially rejecting bond gains, said CFP Allan Roth, founder of Wealth Logic in Colorado Springs, Colorado.
He also pointed out that if, for example, you pay 2.5% of your mortgage and pay it off, you will essentially earn exactly that interest on the money you used to retire the loan.
“It would be a risk-free, tax-free, 2.5 percent return,” Roth said.
In addition, you did not have to sell the property for this return: Your home, which may increase in value, is yours.
On the other hand, if the money you use to pay off your mortgage is in your retirement account, comparing interest rates may not work in your favor.
“If that’s the case, it may not be in your financial interest to withdraw money from your retirement account to pay off a debt that will cost you less than what you might otherwise earn by investing,” Schmehil said.
Also, if you’ve been able to deduct mortgage rates on your tax return – you need to specify the deductions to get this break – keep in mind that this benefit will be lost. (However, most taxpayers do not excrete.)
There may also be tax consequences for the distribution of pension funds.
Unless the account is a Roth – whose payments are made after taxes, but distributions are usually tax-free – withdrawals are usually taxable. Traditional 401 (k) plans and personal retirement accounts provide tax relief on contributions, while distributions are taxed as ordinary income.
“If this distribution moves you from a margin of 12 percent to 22 percent or 24 percent to 32 percent, you’re paying Uncle Sam an 8-10 percent tax premium just to pay off a debt that might only pay 3 percent,” Schmehil said.
However, if you decide to use these retirement funds to eliminate your mortgage and want to minimize taxes, you can split your profits over several years, Roth said in Wealth Logic.
“If you’re in the 12 percent margin, I’d say raise the amount that keeps you at that 12 percent rate every year,” Roth said.
Also, note that when you pay off your mortgage, the amount of cash you spend is largely converted into equity in your home – which you may not be able to use easily on the road.
In other words, if the use of illiquid assets – your house – would interfere with your financial goals, it may be better to keep the money elsewhere, either in cash or in an investment account, depending on your goals and risk tolerance (how long you need money and whether you can cause stomach volatility in the market).
However, Schmehil and other financial advisors said that even if you decide on the basis of mathematics that continuing to pay your mortgage would be in a more financial sense, there is an emotional side to the calculation that can – and perhaps should – weigh heavily.
“Yes, clients could make more money by leaving capital for us to manage and achieve a higher tax-free return than the interest cost of their mortgage,” said Larry Ginsburg, CFP owner and president of Ginsburg Financial Advisors in Oakland, California.
“Why speculate on your equity? What good is this to the customer?” Ginsburg said. “We usually recommend paying a mortgage and the intellectual benefit of reducing fixed overheads.”
He said, for example, that it will help ease the anxiety of pensioners in a downturn in the market because they worry less about how their income will be affected, even if they don’t have to worry.
According to Ginsburg, clients who initially disagreed with his advice to get rid of their mortgage have later thanked him.
“I have never had anyone return to me and say they are dissatisfied with paying their mortgages,” he said.