In “You Can Retire Sooner Than You Think” and my latest book, “What the Happiest Retirees Know: 10 Habits for a Healthy, Secure, and Joyful Life,” I found that the decision to this important question depends on many factors specific to your unique situation.
First off, figure out how your tax bill would be impacted by such a move. Most expect that paying off a mortgage leads to a juicy interest deduction come tax time, but that could shrink once you retire for a couple of reasons. First off, your tax rate might be lower because instead of bringing in the big paycheck, you’ll be collecting Social Security or a pension and drawing funds from the nest egg you spent all those years building. This often means your total taxable income should be lower.
Second, as the years pass, more and more of your mortgage payments will directly pay down the principal rather than the interest. This consistently reduces the size of your mortgage interest deduction for your tax return over time.
Your other itemized deductions will likely be lower because you only receive a tax benefit to the extent that your itemized deductions exceed your standard deduction, so you may see less of a tax break from mortgage payments. And remember that the recent tax laws ushered in increased standard deduction limits, so you may not be itemizing your deductions going forward anyway. All of that matters.
What about rates of return? Try comparing the benefits you expect to earn from the greener pastures of a post-mortgage payoff to the benefits of keeping more of those funds in investments or savings. Should you choose to pay off your mortgage, your rate of return is certain. You “earn” by saving the interest rate charged on your mortgage. If you choose to invest your savings, things are a little less clear.
The argument you’ll hear from the “keep the mortgage” folks is that you can earn more by leaving those savings invested despite continuing to pay interest on your house. As an example, these planners say that, instead of using $100,000 to pay off a 4% mortgage, you should invest it in the market, where you could see a return of, say, 8%. The result would be a net 4% gain of $4,000.
This logic looks good on paper, but may not hold up in the real world. As we all know, the market is unpredictable. You might see that 8% return, but you might also see the market lag, stumble, or crash.
I’m a believer in the one-third rule. If you can pay off your mortgage with no more than one-third of your non-retirement savings, consider doing so. If you owe $50,000 and have $160,000 in savings, it could be a good idea to drop that on the mortgage. You’ll still have $110,000 in liquid assets to ease you along the retirement road.
One of the intangibles that makes this such a complex decision is on the emotional side. Emotional health is just as important as financial health. Fearless folks might be able to roll the dice and keep all their savings invested in the market, but most of us need some sense of stability to sleep well at night.
The scenario of a market crash is hypothetical, but the fear is real. Humans no longer need to run from saber-toothed predators to survive, but the reptilian parts of our brain don’t yet seem to know it. Any kind of perceived danger, whether it be from a grizzly bear or a bear market, can cause the body to release fight-or-flight hormones (adrenaline and cortisol) that can trigger intense anxiety.
Conversely, I’ve learned from the happiest retirees that there is a real sense of peace and serenity that comes with knowing that you own your house free and clear. It just feels good to have some stability as you enter a new phase of life that is changing in so many other ways.
Eliminating a house payment also dramatically lowers your monthly retirement living expenses, thus taking pressure off your nest egg and other sources of monthly income. Not having a mortgage payment leaves you with more money to follow your dreams and passions, take vacations, give to charity, and keep up on your core pursuits (hobbies on steroids). After all, that’s what a happy retirement is all about. You’ve worked your entire life. Now it’s time to explore the things that you’ve never had time to try.
As crucial as it is to have peace of mind, you have to make sure you can afford it without damaging your financial fitness. It’s not a great idea to use retirement account — IRA, 401(k) — money to pay off a mortgage. Non-retirement accounts are the ideal sources for the big payoff but be careful here, too. These funds also play an important part in your ongoing security by providing a source of liquidity for emergencies or opportunities. Use my one-third rule as a guide when deciding which route might work best for you. Even if you can’t allocate a large portion of capital toward your mortgage right now, be proactive to consider paying a little extra each month.
The house your mortgage paid for wasn’t built in a day. The carpenters, electricians, and laborers chipped away at it over time. In much the same way, you can hammer a few more financial nails with each payment, shave months or years off the finish date, and be well on your way to living a mortgage-free, happy retirement.
Wes Moss is the host of the podcast “Retire Sooner with Wes Moss,” found in the podcast app right on your smartphone. He has been the host of “Money Matters” on News 95.5 and AM 750 WSB in Atlanta for more than 10 years now, and he does a live show from 9-11 a.m. Sundays. He is the chief investment strategist for Atlanta-based Capital Investment Advisors. For more information, go to wesmoss.com.
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