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.
Here’s what to consider.
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.
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.
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.
Additionally, be aware that when you pay off your mortgage, the cash you employ essentially converts to equity in your home — which you may or may not be able to tap easily down the road. In other words, if having an illiquid asset — your house — would interfere with meeting your financial goals, it may be better to keep the money elsewhere, either in a cash or investment account, depending on your goals and risk tolerance (how long until you need the money and whether you can stomach volatility in the markets).
“Yes, clients could potentially make more money by leaving capital with us to manage and attain higher returns net of taxes than the interest cost of their mortgage,” said CFP Larry Ginsburg, owner and president of Ginsburg Financial Advisors in Oakland, California.
“Why speculate with their home equity? What major benefit does this furnish to a client?” Ginsburg said. “We generally recommend paying off the mortgage and receiving the emotional benefit of lowering fixed overhead.” For instance, he said, it helps ease retirees’ anxiety level during market downturns because they worry less about how their income is affected, even when they have no reason to be concerned.
Ginsburg said that clients who have initially disagreed with his advice to get rid of their mortgage have later thanked him. “I’ve never had someone come back to me and say they were unhappy that they paid off their mortgage,” he said.