One of the most popular questions I get from retirees is, “Should I pay off my mortgage?” Easy enough question without, unfortunately, an easy answer. The concept make sense, pay down the largest monthly bill that you have, your mortgage, and this will eliminate the need for large monthly distributions from your retirement accounts. Unfortunately, taking a large distribution from your retirement accounts to pay down a mortgage can also have very negative consequences. This article addresses when it may be appropriate to pay down your mortgage in retirement and the best strategy for paying off your mortgage.
Paying Off Your Mortgage Doesn’t Always Make Sense
My initial thought when someone tells me that they want to pay off their mortgage in retirement, is to figure out how to talk them out of it. Paying off a mortgage can cause a huge tax liability, and it usually doesn’t make sense to pay down a debt with an ultra low interest rate which is tax deductible. Well, I should say “was” tax deductible. The new tax code pushes most people into filing standard deductions, which now eliminates the mortgage deduction for almost everyone. The biggest concern I have though is the loss of flexibility. If you take a large distribution from your retirement accounts to pay down the mortgage, you aren’t getting that money back. You may now have less monthly expenses, but you will still have expenses and will need some money to pay for it. Personally, I would rather have more money in the bank which gives me the flexibility to use it however I choose. Paying down a mortgage may make you house rich, but that doesn’t do you any good if you don’t have the funds to pay for the rest of your bills. Still, there are times in which paying off your mortgage may make sense.
When You May Want To Pay Down a Mortgage
Again, I don’t think that paying down a mortgage makes sense for everyone, but here are a few reasons why you may pay off your mortgage in retirement:
- Significant after-tax money: This allows you to take a withdrawal basically tax-free, but I’m not talking about Roth money here (never take a large Roth distribution to pay off a mortgage)
- Significant money in a checking/savings accounts. The distribution is tax-free and not earning much interest for you anyway
- Even after paying off the mortgage, you can live on 4% or less yearly withdrawals from your retirement assets. The biggest mistake people make paying off the mortgage is not having enough remaining assets to live comfortably.
- You aren’t planning on selling your home. It doesn’t make sense to hurry up and pay off your mortgage if you are just going to sell your home and move somewhere else in the next few years. Save the money instead and you can use the savings however you would like, including paying off the mortgage in the new place.
Next, if you decide that paying off your mortgage makes sense, let’s discuss the best strategy for paying it off.
The Best Strategy For Paying Off Your Mortgage
If you are dead set on paying off your mortgage, the best source of funds is a checking or savings accounts. The distribution is tax free and probably not earning you anything anyway. I wouldn’t suggest taking a large Roth distribution to pay off a mortgage, because Roth money is the most valuable asset that you have. Withdrawing your Roth money right away in retirement really defeats some of the advantages of having a Roth account.
If you need to take a distribution from a pre-tax account to pay off your mortgage, tread carefully. A large one-time distribution can cause a huge tax liability. Here are some tips if you are taking a distribution from a pre-tax retirement account.
- Wait until the year after you retire to take the large distribution. The last year of your working career will probably be the highest earning year that you will have and therefore the highest tax liability. Wait until the next year when your tax liability is lower.
- Spread your distributions out over 3 to 5 years. Taking a huge chunk of money all at once can cause you to go into higher tax brackets and really increase your taxes. Instead of taking all of the money out at once, spread over a few years which helps reduce your tax liability on the distribution.
- Be flexible with your yearly distribution to pay off the mortgage. If the stock market and your assets do well, maybe you withdraw a little more to pay down the mortgage. If you experience a down year in the market, wait another year before taking a large withdrawal from your pre tax assets.
Paying off your mortgage tends to be a personal decision and not necessarily in your best financial interest. If paying off your mortgage is important to you, make sure that you understand the tax consequences. Don’t jeopardize your retirement, just to pay down your mortgage.