After You Retire
It Usually Makes Sense to Pay Off the Mortgage
Before you pay off the mortgage, pay off any higher-interest loans.
- You want to reduce fixed expenses. The higher your fixed expenses, the harder it is to adjust should your income fall or a big bill arrive — and mortgage payments are large fixed expenses. You especially want to cut fixed expenses after you retire as you really can’t respond to a shock, as you could before you retire, by working longer.
- The mortgage-interest deduction is usually worth less. If you deduct mortgage interest on your tax return, the cost of the mortgage is actually the interest less the deduction. If you will be in a lower tax bracket after you retire, and most are, the value of that deduction is less. So the cost of your mortgage after-taxes rises.
- Your savings usually earn less. If you shift your savings from stocks to bonds or bank Certificates of Deposit – as most experts recommend – the interest you earn on these investments is usually less than the after-tax interest you pay on your mortgage. So if you use those savings to pay off the mortgage, you pocket the difference.
Before You Retire
It Usually Makes Sense to Wait
You probably have to use savings in a 401(k) or IRA to pay off the mortgage. And the reason to wait is the difference in the taxes you’d pay before and after you retire.
- Before the year you turn 59½. You would generally pay a 10% penalty on savings withdrawn from a 401(k) or IRA. So it almost always makes sense to wait and avoid the penalty.
- From that year to retirement. You pay ordinary income tax on savings withdrawn from a traditional 401(k) or IRA. If you will be in a lower tax bracket when retired, you will pay less tax if you wait.
- But it usually makes sense to pay off high-interest loans, such as credit card debts. The interest is usually much higher than what you pay on a mortgage and it’s not tax-deductible. And you don’t want to carry these debts into retirement. But keep enough savings in reserve for emergencies.