Retirement is a significant milestone, bringing with it the challenge of making decisions that can have a lasting impact on your financial security. One of the most common dilemmas retirees face is whether to pay off their mortgage or invest their savings. This decision is not just about the numbers—it’s also about peace of mind, financial flexibility, and long-term goals. In this post, we’ll explore the pros and cons of each option to help you make an informed decision.
Key Considerations: Should You Pay Off Your Mortgage or Invest?
1. Interest Rate Expense and Opportunity Cost
If you have a low-interest mortgage, you might wonder whether it makes sense to pay it off early. The key factor here is opportunity cost. Could the money used to pay off your mortgage be better invested elsewhere, potentially earning a higher return than the interest rate on the mortgage? If your investments could yield higher returns, keeping the mortgage and investing the difference might be the more financially advantageous route.
2. Tax Implications
With the Tax Cuts and Jobs Act of 2017, fewer people are itemizing deductions, which means fewer are deducting mortgage interest. Additionally, if you plan to pay off your mortgage using a lump sum from a qualified retirement account, such as an IRA or 401(k), the withdrawal would be taxed as ordinary income. This could push you into a higher tax bracket, so you might consider spreading the payoff over several years to manage your tax liability.
3. Cash Flow and Flexibility
Paying off your mortgage frees up monthly cash flow, reducing the amount of guaranteed income you need in retirement. This can increase your financial security by lowering your essential expenses. However, tying up a significant portion of your liquid assets in your home may limit your financial flexibility in the future. It’s a trade-off between reducing your fixed expenses and maintaining access to liquid assets.
4. Comfort with Investing
Your comfort level with investing plays a crucial role in this decision. If you’re comfortable with the risks associated with investing, your money could potentially grow more by staying invested rather than paying off your mortgage. On the other hand, if you’re more conservative, the peace of mind that comes with being debt-free might outweigh the potential for higher returns.
5. 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. However, if you’re considering downsizing or moving, keeping the mortgage and maintaining liquidity could provide more options and flexibility.
A Case Study: To Pay Off or Not to Pay Off?
Let’s consider a hypothetical couple who are both 65 years old and plan to retire in 2027 at age 68. They currently have a $356,443 balance on their mortgage, with 15 years of payments remaining. They’ve saved $1 million in their 401(k), and their home is valued at $800,000. The question is: Should they pay off the mortgage with a lump sum from their IRA in 2026, or continue making payments?
Scenario 1: Paying Off the Mortgage Early
If they pay off the mortgage early, they’ll eliminate about $100,000 in future interest expenses. However, by withdrawing a lump sum from their IRA, they reduce the amount of capital that could benefit from compound growth. By age 86, their liquid assets would be around $381,460 (assuming a 4% growth rate), and their total lifetime taxes would be approximately $261,000.
Scenario 2: Keeping the Mortgage
If they keep the mortgage, they’ll continue paying interest but allow their investments to grow. By age 86, their liquid assets could be $459,232 (assuming a 4% growth rate), with total lifetime taxes of about $248,587. Despite paying more in interest, they end up with higher liquid assets and lower lifetime taxes by keeping the mortgage.
What’s Your Decision?
The decision to pay off your mortgage or invest the funds is deeply personal and depends on your financial goals, risk tolerance, and comfort with debt. Here are some questions to consider:
- How comfortable are you with investment risk?
- How important is tax planning to you?
- How long do you plan to stay in your home?
- Are you okay with less liquidity if you pay off the mortgage?
- What makes you feel more secure: no debt or more liquid assets?
Ultimately, the choice you make should align with your overall financial plan and long-term goals. Whether you choose to pay off your mortgage or continue investing, the most important thing is to ensure that your decision supports a secure and fulfilling retirement.
Proverbs 15:22 reminds us, “Plans fail for lack of counsel, but with many advisors, they succeed.” Consider consulting with a financial advisor to explore which option is best for your situation.
For more resources and tools to help you make informed retirement decisions, visit Sound Retirement Planning and explore the Retirement Budget Calculator to see how these scenarios could play out in your own life.
Ready to kickstart your retirement planning? Head over to Retirement Budget Calculator. Need assistance with investment management? Explore our services at Parker Financial.
