IRAs

Countdown to Retirement: Pay Off the Mortgage?

Do the math, and then decide how much debt you can stomach.

Retiring your home loan makes sense if your stomach churns at the idea of making payments into old age, or you aren't confident that you can get a return on your money that beats your mortgage rate. "Financial planning is not only about money—it's also about peace of mind," says Jana Davis, a certified financial planner in Manhattan Beach, Cal. On the other hand, moving heaven and earth to write that last check may not be the best use of your resources. Before you decide, follow these five steps.

Pay off consumer debt. Given today's interest rates, you're probably paying less than 5% on your mortgage, compared with, say, 13% on credit card balances. Paying credit card debt gives you an instant return on your money equal to the rate on your cards—and you can continue to deduct the interest on your mortgage (you get no such tax break on credit card balances). "A mortgage is one of the few good debts," says Ken Weingarten, a certified financial planner in Lawrenceville, N.J. "It should be the last one you pay off."

Fuel retirement accounts. The remaining few years before retirement represent your last chance to stash money in tax-advantaged retirement accounts. You'll waste that opportunity by not maxing out your accounts. In 2013, you can sock away $23,000 in a 401(k) and $6,500 in an IRA if you're 50 or older. An even worse idea is withdrawing money from your IRA to pay off the mortgage. With a traditional IRA, you'll owe tax on the distribution, plus a 10% penalty if you take a withdrawal before you're 59 1/2—and the distribution could kick you into a higher tax bracket. With a Roth IRA, you won't owe tax on withdrawals up to the amount of your contributions (no matter how young you are), but you will pay tax and a penalty on earnings for an early withdrawal if you're younger than 59 1/2 and haven't had the account for five years.

Keep a reserve fund. Even if you don't plan to touch retirement savings to pay off the mortgage, be sure to have enough in your emergency fund to cover six months of living costs; otherwise, you could end up tapping retirement accounts anyway. Also be mindful that you'll need income in retirement to cover other expenses. Draining investments to pay off the mortgage could leave you house-rich and cash-poor.

Weigh return versus risk. This calculation seems straightforward: If you're paying 4% on your mortgage and you have nonretirement cash accounts earning less than 1%, retire the mortgage. But if you think you can earn, say, 6% on your investments and your mortgage costs 4%, keep the mortgage and let your investments grow—assuming you won't kick yourself if your investment return takes a dive. "The decision is not just about the math," says Ben Birken, a certified financial planner in Chapel Hill, N.C. "It's also about how you'd feel if the plan doesn't work out."

Stay flexible. You could refinance to a shorter-term mortgage, saving thousands of dollars in interest. The downside: You would incur closing costs and could also lock yourself into a higher monthly payment, depending on your current interest rate. Consider prepaying your current mortgage each month instead. "You can cut the years dramatically and not have to go through the refinancing process," says Rocco Carriero, a chartered retirement planning counselor with Ameriprise, in Southampton, N.Y. And if your finances hit a rough patch, you can revert to the lower payment.

Haven't yet filed for Social Security? Create a personalized strategy to maximize your lifetime income from Social Security. Order Kiplinger's Social Security Solutions today.

Most Popular

Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer
Coronavirus and Your Money

Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer

The IRS has an online tool that lets you track the status of your second stimulus check.
January 18, 2021
Don’t Have a Pension? The SECURE Act Could Help
retirement planning

Don’t Have a Pension? The SECURE Act Could Help

If you’re worried about retirement, the SECURE Act has a lot to offer. It has several provisions to allow people to save more, for more years — and it…
January 22, 2021
When Could We Get a Third Stimulus Check?
Coronavirus and Your Money

When Could We Get a Third Stimulus Check?

President Biden and others in Congress are pushing for a third-round of stimulus checks, but it might be a while before we get them.
January 20, 2021

Recommended

When Roth Conversions Are the Right Move – and When They Aren’t
Roth IRAs

When Roth Conversions Are the Right Move – and When They Aren’t

Converting a traditional IRA to a Roth IRA can be a smart tax- and estate-planning strategy for some people, but it can be a mistake for others.
January 15, 2021
Fund Your IRA, Cut Your Taxes
Tax Breaks

Fund Your IRA, Cut Your Taxes

There’s still time to make a 2020 IRA contribution and lower your tax bill.
January 13, 2021
A Retiree’s Guide to Key Dates in 2021
Basics

A Retiree’s Guide to Key Dates in 2021

It's critical -- and financially sound -- to hit these important financial deadlines spaced throughout the year.
January 8, 2021
10 Things Social Security Recipients Need to Know About Their Second Stimulus Check
social security

10 Things Social Security Recipients Need to Know About Their Second Stimulus Check

It's a bit more difficult for Social Security recipients to learn the ins and outs of second-round stimulus checks, since there are a few special rule…
January 4, 2021