We are 65, have $650k in the IRA and $120k left on the mortgage
We are 65, have $650k in the IRA and $120k left on the mortgage
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Should you prioritize debt or savings? This is one of the most common questions in family finances, especially in the world of retirement savings. In this example, assume you have a $650,000 IRA and a $120,000 mortgage. As you approach retirement, should you invest the money or pay off your mortgage?
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The first thing to consider is why you want to pay off your mortgage. For example, do you want to eliminate monthly payments from your budget, or do you want to retire with as few commitments as possible? On the other hand, are you looking to maximize the value of your money? Perhaps this is part of your estate plan and you would like to one day leave an unencumbered estate to your heirs? Or is it an emotional decision because you simply don't like the idea of retiring with debt?
Whatever your goals are, they will ultimately influence your strategy choices.
Many retirees want to maximize their flexibility in retirement, allowing them to make changes to their lifestyle and spending as they please. In this case, paying off your mortgage may be a wise personal move. Instead, you might be trying to maximize dollar value, trying to get the most out of your money. As we discuss below, in this case you may want to review the value of that debt based on the value and risk of your portfolio's returns.
A quick rule of thumb is to compare your mortgage interest rate to the historical returns on IRAs. More specifically, if your mortgage interest rate is higher than your portfolio's average return, you may want to pay off your debt. But if your return is higher than your mortgage rate, you may want to prioritize your savings while continuing to make nominal payments.
For example, let's say your portfolio currently earns an average return of 8% and your mortgage interest rate is 3%. By investing your money at a potential return of 8%, you could make 5% more than you would lose by paying 3% on your mortgage. This means that, technically speaking, the investment will bring in more money than the money saved by paying off the mortgage.
In addition to interest rates, consider your mortgage situation. With newer mortgages, a large portion of your payment will likely go towards interest, and paying it off early will save you more money in the long run. With an older note, each payment will go toward principal more, and you'll get less value from accelerated payments. A financial advisor can help you evaluate the trade-offs for your situation.
Another important issue is cash flow. If you pay off your mortgage early, you have less savings, reducing your portfolio's ability to generate income. If you don't pay off your mortgage, your portfolio will generate more money, but part of it will go toward this fixed expense.
Review how each version of the program works. How much money do you have left after taking out your income and paying your bills? How does each version of these numbers fit into your retirement financial plans?
Finally, you need to consider how this fits into your overall tax and investment plans.
If you itemize your taxes, the mortgage interest deduction will actually reduce your mortgage payment. This likely won't change the numbers significantly since most families only take the standard deduction. However, it can be especially valuable on relatively new mortgages with higher interest payments.
Beyond that, how do you plan to change your investment strategy in retirement? Many, if not most, families will turn to more conservative practices once they retire. This often leads to more security but lower returns. Consider how this will affect your cash flow and the value of your return relative to mortgage rates.
In the meantime, if you decide to make income-based investments, think carefully before liquidating those assets. The Income Portfolio relies on strong principal to fuel its relatively low interest rate/high safety assets. The more savings you spend on debt, the less income you will subsequently earn.
Finally, consider your risk tolerance. Prioritizing return over debt is a strategy that accepts a certain level of risk. You always benefit by paying off your debt, and there's always the chance that even safe assets will lose value. While you can reduce this risk by holding safer assets, make sure you consider this.
Finding a financial advisor isn’t difficult. SmartAsset's free tool matches you with vetted financial advisors serving your area, and you can have a free introductory call with your advisor to decide which one you think is the best fit for you. If you're ready to find an advisor who can help you achieve your financial goals, get started today.
Paying off your mortgage early is a potentially beneficial way to manage your wealth. It can lower your interest rate and free up cash for additional investments. But if you want to manage your cash flow, here are some things you can do to lower your mortgage payments.
Keep an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid—held in an account that is not at risk of large swings like the stock market. The trade-off is that the value of liquid cash may be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts at these banks.
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