Your Mortgage, Tax Strategies and Retirement
I get the question a lot – should I pay off my mortgage. The answer is that depends.
If I told you that I had a vehicle that allowed you to pay $10 in interest to save $3 in taxes, would you do it? The answer is probably no. Assuming that you are in a 30% tax bracket to keep the numbers easy, that’s what a mortgage is – and that math doesn’t always go in your favor. Please be sure to consult your tax advisor with regards to the tax strategies discussed in this article.
The reason that I said doesn’t always go in your favor, is there are some other tax strategies you should consider before paying off your mortgage. Are you maxing out your 401(k), 403(b), 457 Deferred Compensation and IRAs? These vehicles may allow you to put aside funds pre-tax to grow tax deferred. Following our example from above, if you invest $10, your current year tax bill goes down by roughly $3. It’s the same immediate math, but there are long term differences. First, the money that you invest in these retirement vehicles will grow tax deferred – so you don’t pay taxes while the funds are growing. Hopefully, over the long run, these funds will grow. Secondly when you withdraw them in retirement, hopefully, you’ll be in a lower tax bracket. – And the $10 is yours, not the banks.
How about Roth IRAs and Roth 401(k)s? While you won’t be receiving the immediate tax breaks, you will still receive the long-term benefits of tax deferred growth and tax free withdrawals – so they are still good long term strategies.
The bottom line is, there are limited tax strategies for you to tax advantage of. Consider doing so before paying extra on your mortgage.
Now let’s assume now that you are putting the maximum into the tax strategies above. Then, by all means, consider paying down your mortgage. Again, paying out $10 in interest to save $3 in taxes – the math doesn’t work in your favor during your working years.
After you have retired, the math shifts. Clients frequently ask me if they should take money out of their IRAs in order to pay extra on the mortgage. Again, assuming a 30% tax bracket, if you withdrawal $10, you pay roughly $3 in taxes. You are paying 30% to pay extra on what is most likely a less than 4% mortgage – the math doesn’t work.
If you are retired and want to pay extra on the mortgage, consider waiting until you are 72 and have to take Required Minimum Distributions. At that time, you may be taking more out of your IRAs than you need. Then, by all means, pay extra on the mortgage.
The bottom line is – before you pay extra on your mortgage, consider the tax strategies available to you at your current stage in life.