Let Me Clarify

A question we are often asked when working with individuals and families approaching retirement is “should I pay off my mortgage?” After all, many families would enjoy not bearing the burden of having a mortgage payment once they retire and income sources change. Living in retirement with no mortgage or other forms of debt is a wonderful place to be but shouldn’t be the only goal at the cost of hard work in the form of retirement savings.

A detrimental mistake that families can make is using retirement funds to pay off their mortgage leading up to retirement. The justification is often, “although I have less money in savings and investments, I also don’t have a mortgage”. We can agree with the idea of having less debt but what happened to the opportunity of using those funds to invest in a diversified portfolio? And what are the tax consequences of using those funds?

Funds taken from an IRA or qualified accounts have taxes associated with distributions at ordinary income rates. If taken before age 59 ½, these distributions can have penalties assessed as well. Other accounts such as an individual or jointly held non-qualified accounts could have capital gains on the sale of securities. Without going into a deep dive on taxes, you can see that there are consequences to pulling assets from investment accounts to be used for any purpose.

Even if the cash is held in a checking account with no taxable implications upon disbursement, using the cash to pay off a mortgage removes the ability for the funds to be invested in assets that have historically generated positive returns or invested in securities that pay income in the form of interest and dividends.

Paying off your mortgage doesn’t increase the value of your home. Not having to make that monthly mortgage payment is great but using a sizable amount of assets to pay off the loan will not increase the value of the home. This is simply a shift on the balance sheet moving money from an asset to reduce liabilities by that same amount. Property taxes, insurance, and maintenance costs still apply. Additionally, mortgage interest is a deductible expense from your taxes.

Below is an article from the IRS website, publication 936, that explains how you can deduct mortgage interest.

‘In most cases, you can deduct all your home mortgage interest. How much you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds.

If all your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on those mortgages. (If any one mortgage fits into more than one category, add the debt that fits in each category to your other debt in the same category.) If one or more of your mortgages doesn’t fit into any of these categories, use Part II of this publication to figure the amount of interest you can deduct.

The three categories are as follows.

1. Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
2. Mortgages you (or your spouse if married filing a joint return) took out after October 13, 1987, and prior to December 16, 2017 (see binding contract exception below), to buy, build, or substantially improve your home (called home acquisition debt), but only if throughout 2021 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
   Exception. A taxpayer who enters a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and who purchases such residence before April 1, 2018, is considered to have incurred the home acquisition debt prior to December 16, 2017.
3. Mortgages you (or your spouse if married filing a joint return) took out after December 15, 2017, to buy, build, or substantially improve your home (called home acquisition debt), but only if throughout 2021 these mortgages plus any grandfathered debt totaled $750,000 or less ($375,000 or less if married filing separately).

To read the full article, visit IRS publication 936, Home Mortgage Interest Deduction.

If paying off your mortgage is something that is important to you leading up to retirement, discuss that with your advisor. Calculated steps can be made so that your assets have the potential to grow, money is saved for near term needs, and debts are being reduced to make that a possibility.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual.