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.

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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.

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Jane Bennett Clark
Senior Editor, Kiplinger's Personal Finance
The late Jane Bennett Clark, who passed away in March 2017, covered all facets of retirement and wrote a bimonthly column that took a fresh, sometimes provocative look at ways to approach life after a career. She also oversaw the annual Kiplinger rankings for best values in public and private colleges and universities and spearheaded the annual "Best Cities" feature. Clark graduated from Northwestern University.