Plenty of people planning for retirement may dream of a future life that doesn’t include a home loan. The reality can be much different, according to a new survey.
Four of five non-retirees with a mortgage expect to pay it off before retirement, according to a new survey from Voya Financial, but the experience of current retirees suggests some of those plans will be dashed. More than one in four retirees surveyed still have an outstanding mortgage, with one in six of them owing $50,000 or more.
The good news is that carrying a mortgage into retirement isn’t necessarily a financial mistake. In many cases, it might be a savvy strategy.
“Pay off the mortgage or not? This is ultimately a question of cash flow and financial resources,” says Kevin Gahagan, principal and senior advisor at Mosaic Financial Partners in San Francisco. “While the appeal of being ‘debt free’ is completely understandable, maintaining a mortgage in retirement can be a sound financial decision.”
Of course, handling a mortgage in retirement — like any financial decision — won’t make sense for everyone. Financial planners caution that this strategy is best for those who have saved more than enough for retirement and have substantial cash flow. Given the state of retirement savings among Baby Boomers, that’s largely not the case.
Consider these numbers from Brad Rosley, president of the Fortune Financial Group in Glen Ellyn, Illinois: “Did you realize that you may need a $500,000 portfolio just to pay a $1,500 mortgage bill?” he says, noting that withdrawing 4 percent per year — an old retirement rule of thumb — equals $18,000, or $1,500 a month. (That calculation accounts for 10 percent going to taxes.) “That just covers your mortgage payment. You better start planning for this sooner rather than later,” he says.
Also, if you have just enough to meet your monthly retirement costs, then you’re one big unexpected expense away from falling on difficult times. And if you have to withdraw more from your investments to cover an unexpected expense or your mortgage payment, that has a long-term negative impact on your investment returns.
“Needless to say, there are quite a few factors that go into making this decision,” says Edward Vargo of Burning River Advisory Group in Westlake, Ohio. “Does the person need liquid assets more than a lower monthly payment? You can't just sell your kitchen if you need to raise cash.”
With those warnings in mind, here are four reasons why it might be wise to carry your mortgage into retirement.
1. It can be a valuable tax deduction. Those in a higher tax bracket may find the mortgage payment reduces how much they owe Uncle Sam come April 15. The IRS allows you to deduct any interest you pay on a loan secured by a primary residence or second home, limited to home loans that total $1 million or less. The average deduction in 2013 — the latest data available — was $8,900, nothing to sneeze at.
There are some important caveats, says Tom Davison, a certified financial planner in Columbus, Ohio. First, the interest payments on a mortgage, which are tax deductible, drop as the loan matures. Half of the total interest is paid in the first third of payments, while only a sixth is paid in the last third, according to Davison. Income in retirement also may fall, while the standard deduction increases after 65. That means retirees who used to itemize to get the mortgage interest deduction may take the standard deduction instead.
2. You may be able to generate a higher rate of return than the interest you pay. Retirees may find they can make more money without paying off their home loan, considering the average annual return on the S&P 500 since its inception is about 10 percent (factoring both good and ugly years).
“If the mortgage rate is low — say 3.5 percent — then it might not be a great use of their money to pay off 3.5 percent debt when they could earn more than that with investments and thus increase their chances of having their money last longer,” says Megan Donnelly, a certified financial planner at Quabbin Advisors in Moosic, Pennsylvania.
3. The loan can provide certainty and serve as an inflation hedge. If you’re considering selling your home to pay off your mortgage before retirement and then renting, think about the potential threat posed by inflation. Each year, you will need to renew your lease, which would likely increase with the market.
By contrast, a fixed-rate mortgage provides protection against inflation, says John Scherer, principal of Trinity Financial Planning in Middleton, Wisconsin. “If you have a $1,500-per-month mortgage today at the beginning of a 30-year retirement, your payment will still be $1,500 at the end,” he says. That would likely be cheaper than the rent you would be paying three decades down the road.
4. Paying off the mortgage can bring other costs. Another factor to consider is how you would pay off the mortgage and if raising the money to do so costs you in other ways, says Robert Braglia, president of American Financial & Tax Strategies in New York. “It may be a bad idea to recognize taxes from (selling) appreciated stocks or (taking) IRA withdrawals to pay off a tax-smart and manageable mortgage,” he says.
It’s worth considering a life insurance policy that would cover the mortgage balance if the cash being used to make mortgage payments comes from a pension or is otherwise tied to someone's life, says David Haas, president of Cereus Financial Advisor in Franklin Lakes, New Jersey. Buying a new insurance policy when you are older can be cost-prohibitive, he says, so this should be planned for in advance.