Question: My $1.2 million vacation home has a $360K mortgage. I don't need my upcoming $45,000 RMD. Should I use it to pay down the mortgage?
Answer: There can be benefits to carrying a mortgage rather than paying it off with a lump sum of cash. For one thing, if you itemize on your tax returns, you may be able to lower your IRS bill via the mortgage interest deduction. And if you have a relatively low interest rate on your mortgage, it could pay to invest your money elsewhere at a higher return.
On the other hand, at the end of the day, a mortgage is a form of debt. And you may not love having debt in retirement.
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If you have a $360,000 mortgage on a vacation home worth $1.2 million, you clearly have plenty of equity in that property. But you may be tired of having to make monthly payments on that loan.
If you’re on the hook for a $45,000 required minimum distribution (RMD) you don’t need for other expenses, you may be inclined to use it to pay down your mortgage and shed that loan more quickly. But is that a good idea?
It’s a matter of liquidity
The amount of interest you’re paying on your mortgage might help dictate whether it makes sense to use an RMD to pay off that loan sooner. But regardless of your mortgage’s interest rate, as long as it’s not astronomical, you’ll want to consider how putting more money into your home will impact your overall liquidity.
“When I walk clients through decisions like this, we look at which option leaves them better positioned for the unknown,” says Drew Lunt, founder and adviser at Scratch Capital. “Investing the after-tax RMD or using it for QCDs can preserve liquidity and allow total-return compounding to do the heavy lifting.”
Matt Hylland, financial planner at Arnold and Mote Wealth Management, agrees.
“Using an unneeded RMD for proceeds to accelerate the paydown of the mortgage can be a great way to guarantee some interest savings in the long run,” he says.
But first, he says, you must make sure you have enough liquid assets and savings as a buffer.
As Hylland explains, “Building up additional equity in a home can pay off eventually, but it will be expensive to access that equity if it is needed before selling the home.” This especially holds true in today’s borrowing environment, where interest rates remain stubbornly high.
Hylland suggests evaluating the interest rate on other safe investments, like money markets and Treasury bills, to see how it compares to your mortgage rate. If you could earn a comparable interest rate outside of paying down the mortgage, the benefit of greater liquidity may ultimately be a better option.
As Lunt cautions, “A vacation home is already an illiquid, concentrated asset. Adding more equity may feel productive, but it can reduce resilience when unexpected repairs, rising insurance costs, or life changes inevitably show up.”
There are other ways to maximize an RMD
If you don't need your upcoming RMD for living expenses but you're not sure you want to tie another $45,000 up in a vacation home, there are other ways to use that money productively.
Lunt suggests looking at qualified charitable distributions (QCDs) if you're eager to reduce your tax burden. You can also invest your RMD in a taxable brokerage account that can generate income.
Another option, says Hylland, is to use the RMD to pay the tax bill on a Roth conversion that reduces or eliminates future RMDs.
"This strategy will help reduce future year RMDs, potentially saving taxes for the rest of their life, and give this person additional money that will grow tax-free in a Roth IRA, which may ultimately be much more valuable than saving some interest on their mortgage," he explains.
Think about what gives you the most peace of mind
Money you don't need for pressing expenses in retirement can be used to serve another key goal — improving your sense of financial security. That's why you may want to base your decision on what gives you the most peace of mind, provided you've done a personal liquidity analysis first (either on your own or with the help of a financial adviser).
As Lunt says, "Paying down the loan can legitimately reduce financial stress and create more stability."
However, if putting more money into an illiquid asset will introduce more financial fragility over time, then it may not be worth it. You'll need to think about what's best for you in a broad sense — not just in the context of dealing with this year's RMD.
"The right choice here isn’t about maximizing short-term math," Lunt says. "It’s about increasing long-term optionality and making sure [you] can adapt when life doesn’t follow the plan."
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