Welcome back to another round of Sound Retirement Radio. You are listening to episode #435 and the title is: Pay Off Your Mortgage at Retirement or Invest? Pros and Cons Explained! This is one of the most common questions people face: Should you pay off your mortgage at retirement, or should you invest the money instead? This decision can have a significant impact on your financial security and peace of mind in retirement.
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Articles, Links & Resources:
IRS – Itemized Deductions Worksheet
Standard Deductions for 2023 & 2024 – Forbes
Amortization Calculator – Bankrate
YouTube Video – Pay off mortgage or invest?
Transcript:
435 Pay Off Your Mortgage at Retirement or Invest? Pros and Cons Explained!
[00:00:00] Welcome back, America, to Sound Retirement Radio, where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom as you prepare for and transition through retirement. And now, here is your host, Jason Parker. America, welcome back to another round of Sound Retirement Radio.
This is episode number 435, and the title is Pay Off Your Mortgage at Retirement or Invest. The pros and cons explained. And this is one of the most common questions people face. Should you pay off your mortgage at retirement or should you invest the money instead? And this decision can really have a significant impact on your financial security and your peace of mind in retirement, but before we get started, let’s start out by renewing our mind.
And this is Galatians chapter six, verse nine. Let us not become weary in doing good for at the proper time, we will reap a harvest. If we do not give up [00:01:00] and then something fun for the grandkids, did you hear about the ice cream truck that got into an accident? It crashed on a rocky road. Remember, articles, links, and resources mentioned in today’s podcast can be found at soundretirementplanning.
com. Just click on episode number 435. Before we dig into this question about paying off the mortgage or investing, I have a few quotes that I think you’ll enjoy. These quotes enjoy some on debt and also on the power of compound interest, both of which are topics that I’m going to cover in this episode.
Proverbs 22. 7 says the rich rule over the poor and the borrower is slave to the lender. Johnny Hart once said, remember the golden rule, he who has the gold makes the rules. Benjamin Franklin said, rather go to bed without dinner than to rise in debt. An unknown author said, The only man who sticks closer to you in adversity than a friend is a creditor.
Albert Einstein said, Compound [00:02:00] interest is the eighth wonder of the world. He who understands it earns it, and he who doesn’t pays it. And then one last one from Benjamin Franklin. He said, Money makes money, and the money that money makes, makes money. Okay, so here are some key considerations when looking at this financial question.
Number one is the interest rate expense and the opportunity cost. If you have a low interest mortgage, you might wonder if it makes sense to pay it off. One of the biggest factors to consider is the opportunity cost. Could the money used to pay off your mortgage be better invested somewhere potentially earning a higher return than the interest rate on the mortgage?
Number two are tax implications. With the standard deduction being so high, fewer people are itemizing their deductions, which means that fewer are deducting mortgage interest. And this change occurred as a result of the Tax Cuts and Jobs Act of 2017. And it might change how you view your mortgage tax benefits.
Before the law changed, around 30 percent of [00:03:00] taxpayers itemized. Now it’s estimated that closer to 10 percent take the itemized deduction over the standard deduction. Also, the Tax Cuts and Jobs Act capped the amount you could include in your itemized deductions for state and local taxes, sometimes called SALT.
So if you have high property taxes, the most you can include in the itemized deductions is 10, 000. In addition to considering the tax benefits of owning a mortgage, you also need to consider the tax implications if you take a lump sum out of a qualified retirement account such as an IRA or a 401k, which would typically all be taxed as ordinary income in the year of the distributions.
which could potentially bump you up into higher tax brackets. If it’s important to pay off the mortgage and the only money you have is a qualified retirement account, you might consider spreading the payoff over a few years to better manage tax brackets. Number three, cash flow and flexibility. Paying off your mortgage freeze up monthly cash flow, reducing the amount of guaranteed income you need in retirement, and increasing [00:04:00] your secure income score.
In the Retirement Budget Calculator, one of the benchmarks we created to help you know if you’re on track for a secure retirement is to compare your lifetime of guaranteed income versus a lifetime of inflation adjusted essential expenses. This is the information that we use to create that secure income score.
One way to increase your score is to lower your essential expenses, such as a mortgage. However, it could also mean tying up a significant amount of your liquid assets in your home, which could limit your financial flexibility in the future. Number four, comfort with investing. Are you comfortable with the risks associated with investing?
If so, the money, instead of paying off the mortgage could potentially provide you with a better long term outcome. If you’re more conservative, being debt free might give you more peace of mind, even if it means sacrificing some potential growth, one thing to consider is that when you have money in an IRA, they can appreciate in a house that can appreciate, you have two assets that can grow and appreciate.
If you take money out of [00:05:00] your IRA to pay off your mortgage, you now only have one asset that’s appreciating. Number five, how long do you plan to stay in your home? If you plan to stay in your home for a long time, paying off the mortgage might make more sense, but if you’re considering downsizing or moving, keeping the mortgage and maintaining liquidity could provide more options.
Now, before we jump into this case study, I have to tell you the artificial intelligence that we built into the new Retirement Budget Calculator Pro version 4. 0 is absolutely game changing. And if you don’t have access to this type of retirement intelligence, I think you’re at a disadvantage. Okay. So let’s get into the case study.
So this case study, we’re going to look at a hypothetical retiring couple. They’re both currently age 65 and they plan to retire in 2027 at age 68. Now I’m going to walk through the scenario to illustrate these points, but it can be challenging to share a bunch of numbers on a podcast. So remember to visit soundretirementplanning.
com and click on episode number 435 so that you can watch a video and see how this all [00:06:00] works and how I use the retirement budget calculator to create these scenarios. Okay. So here’s. Here’s the scenario. They’re a couple, they’re both age 65, they’re getting ready to retire. In 2009, they originally borrowed 600, 000 on a 30 year fixed rate mortgage at a 4 percent interest rate.
Now, in 2024, they have approximately 15 years of payments remaining. They have saved 1 million in their 401k, which we will assume is growing at 4 percent per year. Their home is now valued at 800, 000 and they currently owe 356, 443 on their mortgage. Their monthly spending is broken down as follows.
Essential expenses are 5, 000 per month. Discretionary expenses are 2, 000 per month. And their mortgage payment, just for the principal and interest, is 2, 864 per month. The total of their monthly expenses is 9, 864 per month before taxes, which is 118, [00:07:00] 368 per year. Now once the mortgage is paid off in 15 years, their expenses would drop down to only 7, 000 per month in today’s dollars before inflation and before taxes.
The husband is currently working and he’s earning 9, 000 per month in wages and he expects to retire on December 31st, 2027, when he’s 68 years old and she, she’s already retired. They both plan to start their social security at their full retirement age of 67, which will be in the year 2026. His social security is projected to be 3, 500 per month.
And he’s already And her social security is projected to be 2, 000 per month. And in this example, we will assume social security mortality tables and say that they live to average life expectancy. So for him, it’s age 83 and for her, it’s age 86. The question is, should they pay off the mortgage with a lump sum from their IRA in January of 2026?
Or, continue making payments for the years remaining on the mortgage? Before we look at this answer, which one would you [00:08:00] choose? In the first scenario, we will look at paying the mortgage off early. The amortization schedule of a mortgage favors the banks because the way the repayment of the loan works is that a larger amount of each payment goes to interest than to principal in the early years of the loan.
In this example, If they just pay off the loan over the original 30 year term, they will have paid total interest expense of 431, 216. But after 15 years of paying on the mortgage, they’ve already paid 301, 569 of interest. And over the next 15 years of the loan, they only have 129, 647 of interest payments remaining.
As you can see, they paid more of the interest expense in the first 15 years, which benefits the banks. If they pay off the mortgage in a lump sum in 2026, they’ll eliminate about 100, 000 in future interest expense. Now, if they pay the mortgage off early by taking an IRA withdrawal all in one year, [00:09:00] their liquid assets at age 86, the second person’s life expectancy, would be 381, 460 remaining.
And that assumed a 4 percent growth rate. If they were able to get 6 percent per year, the liquid assets remaining would be 755, 339. And their total lifetime taxes that they would have paid would have been 261, 000, assuming that today’s tax rates stay constant, which we know is never going to happen because Congress is always fiddling with those numbers.
Okay, the next option is what if they keep the mortgage, what if they don’t pay it off in 2026? If they keep the mortgage, they would continue to incur an additional 100, 000 of interest expense that they could have avoided paying if the mortgage had been paid off early in 2026. And this is because they would continue to pay the mortgage until the loan is paid off in the year 2039.
Because they did not take a big chunk out to pay off the mortgage, their money continues to work for them. Their liquid assets at age 86 would be [00:10:00] 459, 232, assuming a 4 percent growth rate. or 1, 051, 916 if they were to earn a 6 percent average growth rate over that time. And their lifetime taxes at life expectancy would be slightly lower at 248, 587.
So to summarize the analysis, if they pay off the mortgage early, the ending balance of their account at life expectancy is 381, 000 compared to keeping the mortgage at 459, 000. Additionally, if they pay off the mortgage early, their lifetime taxes would be 261, 000 versus 248, 000 if they just continue to pay on the mortgage over the remainder of the term.
So even though paying off the mortgage over the next 15 years results in 100, 000 more in interest expense, they end up with a higher account balance and lower lifetime taxes by keeping the mortgage. And this assumes a 4 percent interest expense on the mortgage and a 4 percent growth rate on their [00:11:00] investments, with average life expectancy of 83 and 86.
Paying off the mortgage reduces future interest expenses by 100, 000, but it also reduces the amount of capital that could benefit from compounded growth, resulting in an additional 77, 000. But if you could earn a 6 percent growth rate, it results in a difference of 296, 000 of additional money remaining at death.
If they would have kept the mortgage and paid it off over the remainder of the term, making a large IRA withdrawal to pay off the mortgage could push you up into a higher tax bracket, increasing your lifetime tax liability. In this scenario, paying off the mortgage early resulted in an additional 12, 413 in lifetime taxes, given that the standard deduction is higher.
Then there are itemized deductions. There’s really no tax relief under the current tax law for keeping the mortgage. However, avoiding a large one time withdrawal at the onset of retirement helps reduce their overall lifetime tax liability. If the [00:12:00] tax cuts and jobs act expires at the end of 2025. The standard deduction would drop down significantly, and at that point they may be able to itemize again.
Most people will pay more money in taxes if the Tax Cuts and Jobs Act expires. And this is because the Tax Cuts and Jobs Act reduced the tax rates for individuals and increased standard deductions. It would also result in estate tax changes potentially resulting in more taxes upon death. Paying off the mortgage offers peace of mind and reduced monthly expenses, which increases your secure income score, but it also limits your financial flexibility.
Keeping the mortgage could lead to higher liquid assets in the long run, especially if you achieve a good return on your investments. So here’s some questions to ask yourself. How comfortable are you with risk and investing? How important is tax planning to you? How long do you plan to live in your home?
Are you okay with having less liquidity if you pay off the mortgage? What makes you feel more secure? [00:13:00] No debt? Or more money that is liquid and available. What are your financial goals? Being debt free, maximizing assets, reducing fixed expenses, maintaining liquidity, or something else. As you might imagine, there’s a lot of variables that go into this type of an analysis, such as number one, I used IRA to make the withdrawal.
It could be a different outcome if we used a savings account or a brokerage account. Number two, I assume that the entire distribution is taken from the IRA all at Whereas I could have modeled taking the distribution over a number of years to better manage the tax brackets. And here’s what a couple of YouTube comments have said.
Rhonda says, this isn’t a math question. It’s a peace of mind question. Stuart says, paying down the mortgage over three to four years allows for more tax bracket management. Donnie says, I’d rather keep my money and have a small mortgage with a low interest rate. So if you want to join the conversation and post your comments in the YouTube video, be sure to share your thoughts.
Or if you’re a [00:14:00] subscriber to the Retirement Budget Calculator, we can continue this conversation in the private community portal. In the show notes, I’m going to be providing links to some of the tools that I used to run this analysis so that you can apply this to your own situation. And in the show notes for the episode, I’m going to include a video that shows you how you can run this analysis for your situation using the Retirement Budget Calculator.
In summary, the decision to pay off your mortgage or invest the funds is deeply personal and depends on your financial goals, your risk tolerance, and your comfort with debt. While paying off the mortgage offers the certainty of reduced expenses, Investing the funds could potentially lead to better financial outcome.
The number one goal when creating a financial plan is to avoid failure. If either option does not result in plan failure, then it’s simply a matter of optimizing for the goals that are most important to you, whichever path you choose, it’s essential to consider all the variables and make sure that whatever you choose creates the optimal outcomes for your specific situation.
I’m reminded of Proverbs [00:15:00] 15, 22. Plans fail for lack of counsel. But with many advisors, they succeed. Thank you for tuning in to Sound Retirement Radio. For articles, links and resources from today’s show, visit sound retirement planning.com. If you enjoy the podcast, share it with a friend and give us a five star review.
Ready to kickstart your retirement planning head over to retirement budget calculator.com. Need assistance with investment management. Explore our services at Parker Financial. net. Information and opinions expressed here are believed to be accurate and complete. For general information only, it should not be construed as specific tax, legal, or financial advice for any individual and does not constitute a solicitation for any securities or insurance products.
Please consult with your financial professional before taking action on anything discussed in this program. Parker Financial, its representatives, or its affiliates have no liability for investment [00:16:00] decisions or other actions taken or made by you based on the information provided in this program. All insurance related discussions are subject to the claims paying ability of the company.
Investing involves risk. Jason Parker is the president of Parker Financial, LLC, an independent fee based wealth management firm located at 9230 Bayshore Drive NW, Suite 201, Silverdale, WA. For additional information, call 360 337 2701 or visit us online at soundretirementplanning. com.
