It’s a pretty common question, “Since I’m planning on retiring, shouldn’t I retire my mortgage too?” It makes sense because most likely, your mortgage is your biggest ongoing monthly expense and by eliminating your mortgage, you are freeing yourself from what can be a large cash drain. Generally speaking, yes, it is a good idea. However, before you plan your mortgage burning party, you may want to consider a few reasons why you may not want to send out the invitations just yet.
You are planning on paying it off from your 401(k) or IRA.
For many workers, this is where the vast majority of their wealth lies so it seems like a logical place to withdraw money. However, unless your mortgage is very small, this could be a huge mistake. Money that you withdraw from your 401(k) or IRA (unless it is a Roth) will be taxed at ordinary income rates upon withdrawal. To make matters worse, because of the progressive nature of our tax system, the money withdrawn gets increasingly more expensive. Additionally, as income rises, social programs like Social Security and Medicare can be affected by a large withdrawal. Here’s an example:
John and Jane Smith are 68 and 67 respectively. They each have $750,000 in an IRA that they’ve rolled over from a previous employer giving them a total of $1.5 million in assets. They have a mortgage with a balance of $250,000 and 10 years remaining on the note. They each collect $2,600/month in Social Security and plan to withdraw $1,000 from each of their IRAs for living expenses. Given their current situation, the Smiths would be in the 10% federal tax bracket. This is due to the standard tax deduction of $24,000 and only having a portion of their Social Security income considered taxable. Additionally, they would be paying the base amount for Medicare, which is currently $135.50 (2019). However, to eliminate their mortgage, the Smiths decide to withdraw $250,000 from their IRAs, which changes their picture dramatically. First, 85% of their Social Security income becomes taxable. Second, Medicare premiums are also affected by taxable income, such that John and Jane could see their Part B premium jump 300% for a temporary period after the distribution. Lastly, the Smith’s would go from the 10% federal income tax bracket, up to the 32% Federal Tax bracket, meaning that they would need to withdraw somewhere around $320,000 to net the $250,000! (note: this doesn’t include state taxes, which would further increase the withdrawal amount.)
You have consistent sources of income.
Another situation where holding on to the mortgage may make sense is if you have multiple and consistent sources of income (i.e. government pension, Social Security, rental properties) which supports your lifestyle. Because most of these flows are not affected by the market (except rental properties), a major expense like a mortgage won’t require a large sale of assets at a depressed price. This allows the retiree to be flexible about when withdrawals are taken, enabling them to hold off on selling investments during a period of market turmoil. This helps them avoid falling into the cycle of having to sell more and more assets at lower prices which in turn becomes a larger and larger percentage of the portfolio and never allows the retiree to recover.
It will make you house “rich” cash “poor.”
If paying off your mortgage drains your savings account, it can leave you vulnerable to the unpredictability of life. Whether it’s a large medical expense or having to support an adult child, having money in the bank allows you to weather life’s storms, spend your money on people or situations that are important to you and have the ability to maneuver around the tax code, no matter who is currently in office.
The bottom line is that while paying off your mortgage is generally a good idea, it needs to be considered in the context of your overall financial plan. Here at GBB, we have advisors that focus on distribution strategies that help guide our clients to maintain flexibility as well as minimize taxable impact during the golden years, allowing them to worry less about their money and spend more time enjoying their retirement.
To speak with a GBB financial advisor, give us a call at (916) 924-7527 or complete our contact form.