Pay off mortgage to reduce annual income?

[SoReadyToQuit]

I intended to keep paying a mortgage after retiring (LCOL, $600 per month principle/interest) but if I pay off the balance of $120K, I could reduce my annual retirement withdrawal by about $7K. I want to keep my income low for tax and healthcare subsidy purposes. Should I pay it off when I quit working? Hoping to retire in about 3 years. Never considered the income effect of withdrawing that extra cash and whether it will affect my health insurance cost under the ACA (if that still exists in 3 years.)

 

[38Chevy454]

There is no exactly right answer. Been debated on here a lot. It essentially comes down to your preference. Putting ACA into the mix might lean towards paying off, since that would give you $7K more potential withdrawal for living, instead of the $7K going directly to mortgage. But then you also give up any gains on that $120K over time. So you see the equation has many variables, the examples I mentioned are only two.

 

[pb4uski]

What would you use to pay it off with? Taxable accounts? Or a big one-time withdrawal from tax-deferred accounts?

 

[SoReadyToQuit]

Planned to use taxable accounts. Currently I'm where I want to be in my retirement accounts, but not where i need to be on my taxable accounts (trying to get 5 year's of expenses saved in taxable.) I read today that without the subsidy, my insurance could be much higher per month...so I want avoid that. So of course, adding the payoff to my taxable target would tack on more working time..

 

[pb4uski]

If as a result of tax efficient placement you have equities in your taxable accounts like many of us do, in the long run your taxable account earnings will exceed what you pay in mortgage interest so you'll be ahead. Plus, if your are managing your income to be low for subsidies, your taxable account income from equities will be tax free or at worst, low tax (mine is a minor net tax benefit).

OTOH, a lot of people just prefer the peace of mind of not having a mortgage payment... but having a mortgage payment has never bothered me.

 

[RunningBum]

It makes some sense, but there are a few ways to look at it. You can decide whether you want to get the biggest subsidy possible, or if just being on the right side of 400%FPL to get any subsidy is good enough. If the latter, maybe you don't have to pay off the mortgage.

Also, remember that $7000 taken from a taxable account isn't $7000 in income. If you are selling off some of your taxable assets, only the capital gains count toward your MAGI. You can probably sell specific shares of stocks or funds (unless you've already started selling some funds using average cost) to limit gains.

You might also want to take the time before retirement to make your taxable account tax efficient if possible. Index funds usually don't have capital gains distributions as some managed funds do, so you may want to shift to those.

Selling funds while you are working would presumably make more or all of the capital gains taxable, while in retirement with lower income they may not be. So you may want to look at that benefit vs. an ACA subsidy. Health insurance rates and subsidy amounts are very hard to predict but it may not be the huge deal you think it is.

You may also find that converting your 401K/tIRA to a Roth before you get hit with the tax torpedo when you start collecting social security and maybe a pension is a better deal too.

I'd run some simulated tax and subsidy scenarios for your case and try to get a better picture of where you stand. You really haven't given nearly enough information for anyone to give you good advice, and even with all the information it's not always clear.

One more thing, while you are still working, if you do pay off the mortgage you should think about getting a home equity line of credit, as an emergency fund. Once your retired and stop having regular income it will probably be harder to qualify.

 

[SoReadyToQuit]

Great points! Thanks so much for all the great feedback!

 

[jim584672]

Pay off housing was my strategy. Reduces income needed to live and lowers income for ACA purposes.

 

[Freedom56]

I intended to keep paying a mortgage after retiring (LCOL, $600 per month principle/interest) but if I pay off the balance of $120K, I could reduce my annual retirement withdrawal by about $7K. I want to keep my income low for tax and healthcare subsidy purposes. Should I pay it off when I quit working? Hoping to retire in about 3 years. Never considered the income effect of withdrawing that extra cash and whether it will affect my health insurance cost under the ACA (if that still exists in 3 years.)

Carrying a mortgage into retirement is not a good idea. It's one less worry when you pay it off. Plus with tax reform, there is even less benefit. Here in California, mortgage balances are generally high. In our area it averages about $650K. I have seen many people who planned to work into their mid 70's but had to retire in their early 60's due to health issues or job termination and found themselves in a financial crisis.

We paid off ours 10 years before retirement. We bought our second home all cash at pennies on the dollar after the last financial crisis as an investment. My generous father-in-law gave us a third one with a free and clear title. He wanted to distribute some of his assets early so there wouldn't be any issues after.

But then again, I don't like the idea of borrowing money. I pay cash for large ticket items or I don't buy them.

 

[gcgang]

If you can't use the tax deduction of the mortgage, pay it off.

 

[Mulligan]

If I didnt have a sizable pension, I would pay mine off. But now that my 3.75% mortgage sits so low below market yield now, I will just pay minimum. Cheap money and at sub $500 who really cares. It is way down my list of monthly expenditures in terms of cost... Now if I could pay off my 11 years health insurance premiums before I hit Medicare, I would cut the check today!

 

[USGrant1962]

At $600/month it is really a personal preference. I paid mine off because it was over $3K/mo, requiring a draw from my portfolio that would be a substantial fraction of ACA limits, 0% cap gain limits, and other horrible cliffs in the tax code

I learned fairly late in the ER game that tax diversification was very important. When you are working with all W-2 income plus a few dividends you don't have much control over your tax bracket, and no control of all the tax benefits available to middle/lower income folks. And later when you are taking SS and RMDs, that is all essentially ordinary income at the "normal" tax brackets.

So there is an ER window where you are Pre-SS/RMD and Post-W-2 where you actually have substantial control over your taxable income. That is where a mortgage pay-off may be very helpful.

Anyway, having maximum flexibility on your portfolio draws gives you maximum flexibility to accept the tax benefits that our wise politicians have bestowed upon us.

But it is a bit of a trade-off because you would pay off your mortgage with taxable funds (using tax deferred accounts would not make sense in most cases). Using a substantial fraction of those funds also decreases your tax diversification.

 

[RunningBum]

For those with limited taxable account money, keeping a mortgage makes a lot of sense to bridge until you can tap tax deferred accounts, SS, and pensions. Sure, your monthly expenses are higher but paying off the mortgage can drain your taxable account. The ACA subsidy issue can swing it the other way though.

I just can't see how anybody can come in and say "Do this or do that" based on so little information.

 

[harley]

Carrying a mortgage into retirement is not a good idea. It's one less worry when you pay it off. Plus with tax reform, there is even less benefit. Here in California, mortgage balances are generally high. In our area it averages about $650K. I have seen many people who planned to work into their mid 70's but had to retire in their early 60's due to health issues or job termination and found themselves in a financial crisis.

We paid off ours 10 years before retirement. We bought our second home all cash at pennies on the dollar after the last financial crisis as an investment. My generous father-in-law gave us a third one with a free and clear title. He wanted to distribute some of his assets early so there wouldn't be any issues after.

But then again, I don't like the idea of borrowing money. I pay cash for large ticket items or I don't buy them.

Paying off a mortgage before retirement is not a good idea. You end up with a lot of money locked into a non-liquid investment. Plus with a low interest mortgage you can probably make more on the invested money than what you are paying in interest.

I buy everything I can on credit cards. I never pay interest or fees, and get tons of cash back from things like food, insurance, and doctor payments. The only things I pay cash for are things that charge a fee for using a CC.

Actually, I don't think any of these are a "bad" idea, one way or the other. I just get so tired of seeing people assuming that their way of thinking is the only one that is valid.

 

[Freedom56]

Paying off a mortgage before retirement is not a good idea. You end up with a lot of money locked into a non-liquid investment. P

Don't assume that a home represents "a lot of money locked into a non-liquid investment" for everyone. It's all relative. We took a 15 year fixed mortgage and paid our home off in 8 years. My wife and I were both professionals and made very decent salaries and lived well below our means. We just don't like to being in debt. We were brought up that way by our parents. We pay cash for big ticket items like cars and save a lot of money exactly the same way our parents did it. We also use credit cards for small purchases, airline tickets, car rentals, and pay balances in full, never pay fees, get 1-5% cash back, and other perks. I can tell you that when shopping at many stores you can get far better discounts with cash than the 1-5% rebates you get with credit cards. Everyone has their own comfort level with debt. We just like living completely debt free.

 

[seabourne]

You might find it a bit easier to get good advice if you are comfortable providing a bit more information about your position. I'm in a similar position - I'll be retiring shortly at 39 with about $100k mortgage.

As some of the others have mentioned, for me the decision to keep the mortgage is largely based on low rate (<4%) and the tax structuring of my accounts. I'll be converting over significant sums each year from 401k/IRA to RothIRA, and will be using my taxable accounts for both living expenses and taxes due on conversions. By keeping my mortgage, I have $100k extra available to manage that process. 5 years in, when the conversions are considered aged-in contributions, I'll have much more flexibility, and may reconsider.

With potential increases in interest rates, I may well keep it for the remaining 18ish years, as I may not get a chance at a non-callable loan at these rates again, and if I rent my place out while travelling, I may be able to take advantage of the interest deductions down the road even if I'm not itemizing now.

 

[harley]

Don't assume that a home represents "a lot of money locked into a non-liquid investment" for everyone. It's all relative.

I don't. If you read my entire post all I was doing was reacting to the fact that you were assuming that a mortgage is a bad deal for everyone. It's all relative.

 

[SumDay]

If as a result of tax efficient placement you have equities in your taxable accounts like many of us do, in the long run your taxable account earnings will exceed what you pay in mortgage interest so you'll be ahead. Plus, if your are managing your income to be low for subsidies, your taxable account income from equities will be tax free or at worst, low tax (mine is a minor net tax benefit).

I was a big fan of going into retirement mortgage-free, but our financial planner ran the numbers for us and convinced us that leaving the money invested was far more beneficial. We're at 3.75% and payment is <$500, so we'll just keep plugging along. If a load of cash drops on us (I have some real estate that could sell soon) then I'd pay it off.

 

[harley]

Due to the changes in the tax plan I'll have to reconsider the value of carrying a mortgage. I haven't worked through the process yet (I haven't done this year's taxes, much less next year's), so I'm not sure whether we'll be itemizing or not. But I'm pretty sure I'll still keep the mortgage just based on the low rate vs. what I can make on it with my investments. In my case I used the money that was freed up by the mortgage to buy two rental properties 6 or 7 years ago. The return on the investment is far greater than the mortgage rate plus the original investment and ongoing costs. Plus at this point the value of the properties has risen at 6+% per year. I know that can change, but so far it's been a much better use of the money than having it locked into the equity of our house. And, since going forward our rental income will be tax free for 20% of it, it's an even better use of the money.

I can certainly understand the appeal of not having debt, although I don't consider savvy use of credit cards debt any more than I consider not paying my water bill each time I turn on my shower debt. But every time I run the numbers having a mortgage comes out as a winner financially. And since I can pay it off out of my after tax cash bucket at any time I choose, it's not worrisome debt, it's just another conscious use of a financial tool. YMMV.

 

[SoReadyToQuit]

Just to provide more info, bought a house last year for $160K. Had the cash to buy it, but opted to invest my cash instead of paying for the house outright. So I put $30K down to avoid PMI insurance, and I have a 4.31% interest rate on a 30 year mortgage. I don't plan to stay in this house more than 2-4 years, and will then sell it or rent it out. In my FI budget, I have plugged in a similar cost per month for a permanent house (don't know if I will stay in this cheap rural area or not - so that amount is something I may have to adjust.) I had $830 per month in my FI planned spending per year for house pmt plus property taxes and insurance. Then I was reading the "Our Next Life" blog post about the difference in qualifying for ACA subsidies vs not qualifying, and it's a pretty big difference in premiums. That got me thinking that instead of having a mortgage pmt after FI Retirement, I should just buy a place and reduce my taxable income. I plan to start IRA conversions as soon as I retire, so that will be taxable income.

Depending on some job change possibilities, I will work at least 3-4 more years, then I will need to know for sure whether I try to pay cash for a place or not. Maybe by then I'll have more clarity around the insurance situation.

 

[harley]

Just to provide more info, bought a house last year for $160K. Had the cash to buy it, but opted to invest my cash instead of paying for the house outright. So I put $30K down to avoid PMI insurance, and I have a 4.31% interest rate on a 30 year mortgage. I don't plan to stay in this house more than 2-4 years, and will then sell it or rent it out.

Don't forget, there is more to home ownership costs than the mortgage rate. I don't think I would ever buy a house if I was planning to stay less than 5 years. The closing costs on both ends would likely eat up any profit you might make in that period of time. If you are going to keep the house and rent it out, that's one thing. But if you are going to sell it, I would consider renting for that short period of time. JMO.

Of course, it's too late now, but something to keep in mind for the next time.

 

[RunningBum]

Don't forget, there is more to home ownership costs than the mortgage rate. I don't think I would ever buy a house if I was planning to stay less than 5 years. The closing costs on both ends would likely eat up any profit you might make in that period of time. If you are going to keep the house and rent it out, that's one thing. But if you are going to sell it, I would consider renting for that short period of time. JMO.

Of course, it's too late now, but something to keep in mind for the next time.

Depends on the area. I faced a rent/buy decision for 5 years back in 2003, and because of fairly high rents but reasonable purchase prices, it looked a bit better to buy, even with a 3BR house vs 2 BR apt. I much preferred to have my own house with garage, no shared walls, etc., and didn't mind a bit of yard work and other maintenance. As it turned out, house prices went up quite a bit in 5 years, and the stock market was only fair, so it worked out even better financially than expected. I was so much happier in the house too.

 

[harley]

Me too. I prefer my own space. And 2003 was an unusual time in the housing market. Still, for under 5 years I'd probably rent. A house, though, not an apartment. I hate sharing walls.

 

[samclem]

I was a big fan of going into retirement mortgage-free, but our financial planner ran the numbers for us and convinced us that leaving the money invested was far more beneficial. We're at 3.75% and payment is <$500, so we'll just keep plugging along. If a load of cash drops on us (I have some real estate that could sell soon) then I'd pay it off.

Just to mention it: For those who use an advisor who is compensated as a percentage of your assets under management (AUM), be aware that they have an incentive to advise you against paying off the mortgage. A $100K mortgage and a 1% AUM = 1000 reasons per year that an FA would urge a client to keep the mortgage. That can influence the assumptions they make when they do their modeling of the future.
I think there are plenty of good reasons for some people to keep a mortgage in retirement (it is what I'll do).

 

[SoReadyToQuit]

Thanks for that tip. I don't have any AUM and don't plan to, but I have friends who do so I will make sure they realize that.