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Is there a benefit to paying off your mortgage in retirement?

This should probably go under another category, but my wife and I are retired and trying to figure out long terms implications of keeping a mortgage.  Long story short --- I'm looking for a layman's methodology to figuring out if it's cheaper to pay the bank (mortgage) to avoid taxes, or just take the tax hit with no mortgage interest deduction.  We have some small income streams (legal and reported: we are over the age of 70) + social security and pension income where we are claiming the max deductions (single 0 or married 0).   At the end of next year, we'll probably be starting to receive RMDs, but we usually allow for the highest deductions.  We do have some decent interest income.  I believe we would fall comfortably with the 22% tax bracket --- if those brackets stay the same.

Is there any calculator out there or way to run this scenario?  I can start by looking at mortgage amortization tables to calculate the amount of interest we'd owe, but I'm stumped after that.


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10 Replies

Is there a benefit to paying off your mortgage in retirement?

are you taking the standard deduction or itemizing?  the standard deduction is now over $30,000, so you get that deduction whether or not you have the interest (or the state and property taxes) to deduct.   

 

Also, what is the interest rate on the mortgage and where is the cash going to come from to pay off the mortgage? For example, if your mortgage is a 3% and you the cash is sitting in a CD making 4-5%, there is no incentive of paying it off.  However, if the mortgage is let's say 6% and there is cash in the bank earning 3%, then there is an arguement to be made to pay off the mortgage.  

 

to me, it's not really about the tax implications, it's really about what the alternative return on the cash is that would be used to pay off the mortgage.   

 

there is also the 'peace of mind' factor that the home is owned free and clear, no matter what financial mindfields occur in the future. 

Is there a benefit to paying off your mortgage in retirement?

I concur 100% with @NCperson's post.

 

Perhaps the very first step would be to determine how much your total mortgage interest paid contributes to exceeding your standard deduction (if at all and only that amount over and above the standard deduction should be counted and factored into the matrix).

 

I can also confirm, personally, as @NCperson indicated, that there is peace of mind in being debt-free.

Is there a benefit to paying off your mortgage in retirement?

Great Analysis.  Right now, the mortgage interest is at 2.75%.  As our CDs are maturing, we've been rolling them over into other term deposits earning between 3 & 4.5%.  We have typically itemized, and our charitable contributions usually take us a bit past the standard $30K deduction.

Is there a benefit to paying off your mortgage in retirement?


@wjgrayson wrote:

..... our charitable contributions usually take us a bit past the standard $30K deduction.


There you go; basically, not really worth it unless you prefer to do so for the "peace of mind" attribute.

Is there a benefit to paying off your mortgage in retirement?

as long as you cash is earning more than 2.75%, why payoff the mortgage? Unless there is peace of mind that gives you the satisfaction ? 

Is there a benefit to paying off your mortgage in retirement?

This is really messy and there is a ton of factors to consider, some of which I don’t think were mentioned above.

 

Considering the matter purely as a return on investment question, I would look at the interest rate you are paying on the mortgage compared to the interest rates you might get from investing the money.  And remember to compare interest rates of reasonably safe investments, because your home (assuming it’s in a decent area with rising property values) is one of the safest investments you can make.  And don’t forget to include the effect of the mortgage interest itemized deduction. If you have a 5% mortgage but you are deducting the interest and you are in the 22% tax bracket, your effective interest rate would be 4%. So the question would be, can you earn more than 4% in a reasonably safe investment?  If yes, then you should invest the money, if you can’t find a safe investment that pays that interest rate, pay off your house.

 

 

However, you also want to consider asset diversification.  For example, suppose you have a $200,000 mortgage and $250,000 in a balanced investment portfolio with diversified assets at various risk levels.  40% of your portfolio is in a single non-diversified asset. If you withdrew all the funds and paid off the mortgage, then you would have a fully paid off house but only $50,000 in diversified investments. More than 90% of your total assets are in one single investment.

 

You also want to consider liquidity. If you have money in an investment account or an IRA, you can withdraw it at any time for any purpose. You just have to deal with whatever income taxes come along with. If the majority of your funds are tied up in your house, that is not considered a liquid investment, and it would be very difficult to extract money if you needed funds for an emergency. 


Yet another factor is Medicaid asset protection. Medicare does not provide long-term residential or nursing home care. In order to qualify for a nursing home coverage under Medicaid, you must be “poor.“ The rules may vary, but the rules that stick in my mind (and I might be remembering wrong) are the following:

 

If you require long-term nursing home care, Medicaid will not pick up the tab until you have spent all of your assets first.  You are allowed to keep $3000 and a car. If you are married, and your spouse was living in your joint home before you require long-term nursing care, your spouse can keep the house. But if you are unmarried, or if your spouse goes into a nursing home first, then you can be required to sell your house to pay for your medical care before Medicaid will start picking up the tab.  However, funds in a traditional IRA don’t count as “assets.“ The IRA is protected and you cannot be required to liquidate it before Medicaid will step in. You are only required to give your RMD each year to Medicaid to offset what they are paying for your medical needs, but the balance of the IRA is protected. 

For that reason, using funds from an IRA to pay off your home could backfire if you unexpectedly require long-term medical care and don’t have enough assets to cover the cost yourself.  (Also note that because a Roth IRA does not have an RMD, a Roth IRA is not protected from Medicaid.).

 

Your home and other assets can be protected from Medicaid by placing them in a Medicaid asset protection trust, but this requires the assistance of an attorney or firm that specialize in elder law and estate planning.

 

In fact, consulting with an estate planner is probably a good idea at this stage of life. They can help you find an answer to your question that is most suited for your individual needs.

 

TomD8
Level 15

Is there a benefit to paying off your mortgage in retirement?

Another relevant issue to consider is inflation, currently running over 4%.  If you have a fixed-rate mortgage, inflation means that you are paying off your mortgage with ever and ever cheaper dollars, compared to their value when you first took out the loan.  Advantage: borrower.

**Answers are correct to the best of my ability but do not constitute tax or legal advice.

Is there a benefit to paying off your mortgage in retirement?

I'm not at all certain why this scenario is "really messy" nor why there are a "ton of factors to consider".

 

The facts present a relatively simple matter of whether or not to use proceeds from the maturation of CDs to pay off a (primary) home mortgage at the rate of 2.75% or to invest those proceeds in another cash deposit account (presumably at a rate that well exceeds 2.75%).

 

Formulating hypotheticals is fine, but here they are all inapposite.

 

The mortgage rate is not 5% and the stated rate of return was well above the mortgage rate.

 

Further, the funds to be used to pay off the mortgage are not invested in a "balanced investment portfolio", they are invested in time deposits (which, apparently, will continue to be the case in the event the funds are not used to pay off the mortgage).

 

Finally, there is no indication that the funds to be used to pay off the mortgage are in a retirement account and, in fact, it was mentioned that RMDs would be taken within the next few years. 

 

If @wjgrayson needs estate planning services for other reasons or issues, then that would be a good route. Otherwise, this is a relatively simple financial/tax decision.

Is there a benefit to paying off your mortgage in retirement?

I appreciate the thoughtful answer. I wasn't thinking ROI, just a mortgage payment as an expense to remove from our annual budget. The medicaid angle is a new one I will have to consider. I just hate paying banks interest (having worked in financial services for so many years). Thx for sound advice.

Is there a benefit to paying off your mortgage in retirement?

@wjgrayson 

I would just make sure to take a holistic approach. If you and your spouse are in good health, you could pay off the house fully, and then place it in a protection trust. It takes five years for the trust to become fully effective, so it’s something you should think about while you are still in good health.

 

I also like Tom’s point, that, due to inflation, your house payment becomes relatively cheaper over time, even if the dollar amount is fixed.  

In any case, no one on this board knows every facet of your financial situation, and we wish you the best of luck in whatever you decide.

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