The decision of whether or not to pay off your mortgage before retirement can be complicated. Tax benefits and investment mathematics blurs a relatively simple answer.
Retirement should be the time for easily living and time well spent, but for many, it comes as one of the most financially difficult times of life. High medical expenses, along with the desire to travel and live effortlessly, are the largest threats to your retirement nest egg.
Retirees often hold mortgages until retirement before making the decision to pay it off with retirement cash, or to continue making monthly payments. With all things taken into consideration, the best decision is usually to pay the home mortgage off with cash.
Calculating your tax savings
This is where the decision can get tricky. Tax benefits for mortgages make your real interest rate much smaller by comparison. To calculate the actual rate you are paying on your current mortgage, subtract your marginal tax rate from 1, and then multiply that number by your interest rate. For someone in a 28% tax rate and a 9% rate on their home, they are effectively paying 6.48% in interest each year.
Taxes on withdrawals
Taxes paid on withdrawals from investment accounts must also be considered. Selling investments to pay off your house will generate capital gains taxes on amounts withdrawn. In almost all cases, retirement money is untaxed until it is eventually used.
Making the best decision
Paying off your home for retirement is usually a financially intelligent decision, especially if you have enough saved post-tax to complete to the mortgage. For people with low interest rates and high returns on investments, it is generally a good idea to keep the mortgage and let your capital work for you.
It is likely that returns from retirement accounts will not cover even the after tax mortgage rates. Paying off your mortgage is not only a great investment, but will also free up hundreds of dollars each and every month.
For 90% of people, paying off your mortgage is the best bet. Most retirees will never see the chance to earn more, risk-free, on their investment than the returns generated from paying off the mortgage. In addition, if you pay off your mortgage, you eliminate your monthly payments – giving you more cash to enjoy your retirement.