This is a question that comes up often in meetings with clients and not one that can necessarily be answered easily. There’s not a one-size-fits-all answer when it comes to paying off your mortgage. Many different things need to be considered and your situation can be very different from the friend you were talking to over lunch that said they just paid off their mortgage and are enjoying not having to make that payment every month. You especially need to be careful if you are considering using tax-deferred dollars from your retirement accounts!
Here is a recent question during a meeting with a new client: I’m 60 and plan on retiring in the next 2 to 6 years. I have about $350,000 in a 401(k). I owe about $48,000 on my home. I would like to pay off my 30 year, 2.75% interest rate mortgage. This would free up $800 a month and leave us debt-free. Everyone I talk to says this is a bad idea since I’d lose my mortgage interest deduction and I’d be “investing” in a low-interest vehicle (my mortgage). Am I crazy to pay off this mortgage?
Answer: You’re not crazy, but you might not have thought this all the way through. The money in the 401(k) hasn’t been taxed. If you withdraw enough to pay off your mortgage in one lump sum it would push you into a higher tax bracket and require you to take out considerably more than $48,000 to pay the tax bill. You could easily end up paying a marginal federal tax rate of 25% plus any applicable state tax — all to pay off a 2.75% loan!
Like we said earlier, every situation is different and there are a few instances where using tax-deferred money to pay off a mortgage can make sense. We have to look long-term to make sure we are making the best decision possible. We have many people that come into our office that have so much saved in retirement plans that the required minimum distributions at age 70½ push them into higher tax brackets causing more of their Social Security to be taxed. And by the time they actually do retire they have paid down their mortgage to the point they’re no longer getting a tax break.
In these circumstances, it can be worth withdrawing money earlier than required to put you in a better tax situation later. This is not a decision that you want to take lightly. It’s complex and is irreversible, so if you are contemplating such a move make sure you review it with a qualified professional that knows investments and taxes.
In fact, any time you are considering taking money from a retirement fund it’s a good idea to get an objective second opinion. Most financial advisors know very little about taxes so make sure you choose wisely.
During that meeting it would be a good idea to ask a couple more important questions concerning your retirement plan. If you plan to retire prior to 65…
- Have you planned for health insurance costs for the years prior to qualifying for Medicare?
- Statistically 73 out of 100 of us will need long term care. How will you pay for this since it is not covered by Medicare?
These are just a couple of questions people tend to forget when talking about retirement. Social Security is another topic that is typically addressed but not normally from a tax perspective. We need to look at when is the best time to start receiving Social Security, but that is not where the discussion ends. Putting more in your pocket and less in Uncle Sam’s is very important in retirement!
Taxes on retirement income is not something that most financial advisors talk much about. As far as we are concerned here at Senior Tax Advisory Group they are missing a very important aspect of retirement planning that must be addressed in order to have a comprehensive plan.
Make sure you have a plan. A recent survey of 1,000 retirement savers revealed…
- more than half spent an average of more than 5 hours researching a new car purchase
- 39% spent more than 5 hours exploring vacation possibilities
- and a mere 11% said they spent that amount of time evaluating investment options
- In fact, one-third of savers said they spent less than one hour on investment research.
If you would like a second opinion on your plan “Request a Meeting” with one of our advisors and we will be happy to sit down with you, with no obligation, and go over your current plan. IF YOU DON’T HAVE A PLAN let us know and we will look forward to helping you develop a comprehensive plan that meets your retirement goals.