Pay off mortgage before retirement

Scott Burns
October 31, 2004

Q - I am on the threshold of retirement. How do I correctly understand the benefits of continuing with a mortgage versus paying it off? I reviewed the homeownership model on your Web site and it calculates a benefit of about $4,000 a year from lower taxes. However, after retirement, my withdrawals from IRAs, etc., would have to be higher if I continued to make payments versus paying the loan off now. My marginal tax rate would be 25 percent.

It would appear that withdrawing additional income to pay the mortgage is different from earning an income from employment that would not change regardless of whether I was paying a mortgage or paid it off.

B.H., by e-mail

A - Unless you have a very high retirement income and substantial assets, having mortgage payments after retirement isn't a good idea. For those with lots of income and assets, mortgaging their houses is a portfolio-leveraging decision.

For most people, mortgage payments in retirement present two dangers. The first is that the need to make the monthly payments from investments will subject your portfolio to a higher rate of withdrawal. The more you withdraw, the smaller the odds that your portfolio will last as long as you do.

The second danger is triggering the taxation of Social Security benefits. When your income, including one-half of your Social Security benefits, exceeds $32,000 on a joint return, your Social Security benefits are subject to taxation. As a consequence, many couples will find that every $1,000 they remove from their retirement accounts to pay mortgage debt will cause between $500 and $850 of Social Security benefits to be taxed. It can make mortgage payments very expensive.

I suggest a visit to your accountant: It will be worth the money to have her show you the difference in taxes -- and suggest the lowest-tax-cost route.

Q - I need to help my recently widowed mother allocate her finances for a safe return. She is 77 years old and in good health. Her financial assets include a $100,000 life insurance death benefit, $25,000 in various stocks, $15,000 in a Roth IRA invested in a mid-cap mutual fund from which she is drawing $200 a month, and about $3,000 in cash. She has a $50,000 whole life policy with a cash value of about $5,000 that she'll have to begin paying high premiums on in about four years to keep.

How should she reallocate her finances? And how can one determine how much of her principal she can withdraw each year without depleting it too fast?

E.G., by e-mail

A - First, have her either cash in her insurance policy or convert it to a paid-up death benefit. The insurance amount will be smaller, but it won't drain her income. Beyond that, she has $143,000 in financial assets from which she can safely withdraw at about 5 percent a year, or nearly $600 a month.

She could do that by adding her $100,000 to her $25,000 in stocks, selling the stocks, and investing the proceeds in a good no-load balanced fund. She should stop making withdrawals from the Roth IRA account, sell the fund, and invest the proceeds in an inflation-protected bond fund, holding it as a reserve.

An alternative would be to use a portion of the funds to buy a life annuity, then invest the remaining funds as above, but make smaller withdrawals.





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