Should You Pay Off Your Mortgage Before Retirement?

Paying off your mortgage before retirement has long been considered a smart financial move. But is it always?

The long standing rule of thumb is that you want to reduce expenses as much as possible before retirement so that it takes less money to live on. In theory, this will help your savings to last as long as possible. But if your mortgage does not reach the end of its term by the time you retire you have a decision to make. Either you pay off the balance using your savings, or you continue to maintain the mortgage. Since a mortgage tends to be one of the largest liabilities a household has, how you choose to handle it can have a significant impact on your life in retirement.     

On one hand, maintaining a mortgage even for a few years could prove to be a burden that your retirement savings may not be able to outlast. Of course, if you have enough income to pay all of your expenses without touching your savings, this is a moot point. But if not, the more money that you need to take from savings each month/year to pay expenses, the less that money can continue to grow and generate income, and the faster your balances will decrease.

On the other hand, using a large chunk of your savings to pay off a mortgage all at once may also prove to be a burden. You will reduce your expenses but you will also reduce the amount of spendable savings that you have, and the amount of income the remaining savings can generate. This is especially true if you would need to use tax-deferred savings to pay off the mortgage since any distributions from traditional 401k/IRA's will be taxed, adding to the amount needed to pay both the mortgage and the taxes on the distribution. Taking a large distribution while receiving Social Security may also affect your benefit amount (and taxes on it) since the distribution counts as income. Having a large portion of your net worth tied up in home equity means that the liquid savings you have left may not be able to support you for the next 25-30 years. The best approach is ultimately an individual decision, but you will need to figure out which approach will likely be less risky for you.

These are some questions to consider:
• How do you feel about debt? Once you are retired, will it stress you out more to have a high level of monthly expenses but a larger amount of savings, or lower monthly expenses but also less savings overall?
• If you maintain the mortgage will you be able to itemize the deduction for mortgage interest? The standard deduction for federal taxes is $24,800 for married couples filing jointly (add $1,300 for each spouse over 65)($12,400 if single, plus $1,650 if over 65), enabling fewer homeowners to itemize deductions such as mortgage interest on their federal taxes. Even if you can itemize this deduction, remember that you pay less and less interest for every year that you have the mortgage, making this less and less of an advantage with each year that passes.
• How does the interest rate on the mortgage compare to the net return rate on your investments? The difference between the two is the amount of advantage the mortgage provides over using your investments to pay it off. In general, your investment return rate should be roughly double that of the mortgage interest rate to be considered a good return on your money.
• Paying off a mortgage is the same as getting a return on your money equal to the interest rate on that mortgage. The elimination of that debt is a guaranteed return.
• If you paid off your mortgage all at once, would your remaining savings be enough to sustain you for 25-30 years?

As you consider whether to pay off your mortgage or not, make sure to be aware of how liquid your assets are. Review the balances in your tax-deferred retirement accounts vs. after-tax savings/investments. You should always maintain enough liquidity to pay at least 2 years of net expenses (after any income), including some "squish" room for unexpected events. This level of cash on hand can also make it possible to postpone claiming Social Security for a few years (your benefit increases by ~8% per year for each year that you wait), or even until you can maximize your benefit at age 70. Regular income and cash flow is essential in retirement, so it's never a good idea to leave yourself cash poor just to pay off a mortgage.

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