It’s one of those debates that rarely seems to have a clear-cut winner: Should retirees pay off their mortgage or continue making those monthly payments?
The answer — probably somewhat annoyingly — is that it depends.
Of course, there are a couple of immediate benefits to paying off a mortgage: Your monthly obligations drop and you may get more wiggle room in your cash flow.
However, depending on where the pay-off money would come from — as well as your tax situation and your available remaining assets — there could be financial implications that would need to sit well with you.
Here’s what to consider.
The numbers
Sometimes, the math can be cut and dried. That is, if you’re paying more in interest on your mortgage than the interest you’re earning on the money you’d use to pay it off — and the tax consequences of doing so would be minimal — it may be an easy decision.
“Do you have the cash just lying around in a checking account? If so, then it may be a no-brainer to pay off a debt costing you a few percentage points when you’re earning nothing on cash in today’s rate environment,” said certified financial planner Brian Schmehil, director of wealth management for The Mather Group in Chicago.
Likewise, if you’re invested in bonds that are yielding 1.5% and you’re paying more than that on your mortgage, you essentially are negating the gains from the bonds, said CFP Allan Roth, founder of Wealth Logic in Colorado Springs, Colorado.
He also pointed out that if you’re paying, say, 2.5% on your mortgage and you pay it off, you essentially just earned that rate on the money you used to retire the loan.
“It would be a risk-free, tax-free, 2.5% return,” Roth said.
Additionally, you didn’t have to sell an asset for that return: Your home, whose value could rise, remains yours.
On the other hand, if the money you’d use to pay off the mortgage is in a retirement account, the interest-rate comparison may not work in your favor.
“If that’s the case, it may not be in your financial best interest to pull money out of a retirement account to pay down a debt that’s costing you less than what you otherwise might make by investing it,” Schmehil said.
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Also, if you’ve been able to deduct mortgage interest on your tax return — you must itemize your deductions to get that break — keep in mind that this benefit will disappear. (Most taxpayers do not itemize, however.)
The tax factor
There also may be tax consequences to taking a distribution from your retirement funds.
Unless the account is a Roth — whose contributions are made post-tax but distributions are generally tax-free — your withdrawals would typically be taxable. Traditional 401(k) plans and individual retirement accounts provide a tax break for contributions, while distributions are taxed as ordinary income.
“If that distribution moves you from the 12% to 22% marginal bracket, or from the 24% to 32% bracket, then you’re paying Uncle Sam a tax premium of 8% to 10% just to pay off a debt that may only cost you 3%,” Schmehil said.
