Believe It or Not: Paying Off Your Mortgage Has a Cost (132)

That “debt-free” feeling is powerful, but the number on your mortgage statement may not be the real price of paying it off. A retirement planning trap that catches a lot of homeowners: Using taxable IRA or 401(k) withdrawals to wipe out the loan, then realizing the tax bill turns a $300,000 payoff into something closer to $395,000. If you’ve been tempted to write a big check for peace of mind, this conversation helps you slow down and measure the full trade-off.

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Transcript

The Dream Of Being Mortgage-Free

SPEAKER_00 0:02

For many retirees, the dream is simple. Make that final mortgage payment, own the house free and clear, and never send another payment to the bank or mortgage company again. And honestly, I understand why. I've worked with hundreds of retirees, and very few things provide the same level of peace of mind as knowing your home is completely paid for. But here's what many retirees don't consider. Paying off your mortgage could actually cost you far more than the balance shown on your statement. Today I'm going to walk you through and talk about the trade-off between being debt-free and maintaining flexibility in retirement. I'll show you an example where a $300,000 mortgage effectively could cost for a retiree nearly $400,000 to eliminate. My name is Jonathan Bedner, certified financial planner with Paradigm Wealth Partners, and we help individuals and families make informed decisions so they can retire with confidence. Let's

Emotional Wins And Real Benefits

SPEAKER_00 1:08

jump in. First, let's acknowledge the emotional side of this decision. Retirement is different from your working years. When you're working, a mortgage is usually just another monthly bill. Once you've retired, every dollar spent feels different because you're no longer receiving those steady paychecks from your employer. Oftentimes retirees will tell me, Jonathan, I don't care if the math says I should keep the mortgage. It's a valid feeling for people. There are some real benefits to paying off your mortgage, to having no house payment, being completely debt-free. And the first benefit is having peace of mind. When markets decline, retirees without a mortgage often feel less stress. They know that regardless of what happens in the stock market, they own their home outright, and that's really powerful. The second benefit is it's lower monthly expenses. Let's say your mortgage of payment is $2,000 per month. Eliminating that payment reduces your annual spending by $24,000. So that means less pressure on your portfolio, lower withdrawals, which may mean lower tax liability, more flexibility during market downturns. The third benefit is uh the guaranteed return. So if your mortgage rate is 7%, paying it off effectively is earning a risk-free 7% return. That's really attractive, uh, especially today when when uh if you have a mortgage that has a higher rate, 6 or 7%, like we're seeing in today. So there's absolutely situations where paying off your mortgage makes tons of sense. But now I want to look at what retirees often overlook.

The Hidden Tax Cost Example

SPEAKER_00 3:07

And there's some hidden costs that people oftentimes don't calculate. Let's look at an example. We'll call them Tom and Janet. Tom's 65, Janet 67. They've done a really good job saving for their retirement. And they've got about $1.5 million in retirement accounts, a $300,000 mortgage, and a mortgage rate of 4%. No other debt. One day they decide we've worked really hard on entire lives. Let's just pay off the mortgage, be completely debt-free. You know, they've talked through that. So, you know, it sounds simple enough. They owe $300,000. They want to withdraw $300,000 from the IRA, right? Not exactly. Because IRA withdrawals are taxable. Now, maybe there's assets uh outside of an IRA, maybe there's some non-qualified assets or non-retirement assets that they could utilize and and uh use to pay these off. Most people, most of their assets, uh aside from equity in their house, is built into their retirement plans. Uh 401ks, 403Bs, 457s, things that um when they withdraw them is going to cause additional tax liability. So let's assume Tom and Janet are in the 24% federal tax bracket. If they withdraw $300,000 from the IRA, they're not going to receive $300,000 after taxes. They'll actually have less because they have to pay the tax liability on that $300,000. So they would need to withdraw about $395,000 from their IRA in order to account for the 24% tax liability they would owe on that distribution out of their retirement account. So think about that for a second. They don't spend $300,000 to eliminate the mortgage. They've actually spent nearly $400,000 of retirement assets to help eliminate that mortgage. The mortgage may have been $300,000, but the after tax cost of eliminating it was $395,000. That's books for considering things like state income taxes if you're in a state that has state income tax liability. Medicare IRMA surcharges if you're already taking Medicare and the increased cost of those distributions and what that does to your IRMA or your Medicare premiums. Increased taxation on Social Security benefits, and then potential loss of other tax planning opportunities. So there are some things to consider, there's some hidden things to consider that frankly, I would say nine out of 10 times just gets overlooked because they're so laser focused on just pay off the debt, just take the money out, pay off the mortgage. There's a few questions that you know you could consider uh in in this conversation. So most retirees ask, should I use the $300,000 to pay off my mortgage? And that's actually probably the wrong question to be asking. The question is, should I spend the $400,000 or $395,000 of retirement assets to eliminate a $300,000 mortgage? This is where advisors are really good, where we can help shed some light on, you know, the actual all-in cost of paying off your mortgage. And again, I'm not saying paying off your mortgage is a bad idea. Being completely debt-free, including your mortgage, is a completely satisfying feeling and a huge weight off your shoulders, knowing that you don't owe anybody anything. What

Growth Trade-Off And Opportunity Cost

SPEAKER_00 7:00

I want to kind of talk about now is um what about the kind of investment growth side of this? So let's, if we take this one step further, if Tom and Janet's mortgage is you know 4%, by paying it off, they've effectively earned a guaranteed rate of 4%, a 4% guaranteed return. That's not bad. But they've also removed nearly $400,000 from the portfolio. So 1.5 is now worth $1.1 million. And now nobody knows what the markets will do. They will fluctuate, they ebb, and they flow, and there's no guarantee that the market will outperform the 4% in the long run. But historically speaking, a diversified portfolio has often generated returns above that 4% over long periods of time. What happens year over year, who knows? But over a period of time, historically speaking, the market has outpaced that 4%. So what they're giving up is future growth potential, liquidity, flexibility, where those extra assets in the portfolio could be used for, you know, maybe an unforeseen expense that pops up. So in exchange for eliminating a relatively inexpensive loan in today's standards, uh, again, this doesn't automatically make paying off the mortgage wrong. It simply just means the decision isn't as obvious as many people think or make it out to be.

Liquidity Risk When Money Is In Home

SPEAKER_00 8:31

There's also a liquidity problem. This part kind of concerns me the most as a financial planner. And when I'm talking to clients, I want them to understand when Tom and Janet had $1.5 million invested, they had options. If a major expense came up, they had access to capital. If the market declined, they had flexibility. If healthcare costs or long-term long-term care needs arise, they had resources available. After paying off the mortgage, that money is now trapped inside the house. Now they would still have $1.1 million, which is a lot of money, and could still be used for some of those things, but it does reduce some of the flexibility and some of the uh assets available to be used had it still been in investable assets or readily available cash not tied into equity in their home. Now, it is still equity, they still have it in their house, but you can't easily pay medical bills with home equity. You can't pay for a new roof with home equity, you can't take a family vacation with home equity, the money becomes much less flexible. Now, obviously, there are ways to get equity out of your home using a home equity line of credit. That's not what I'm talking about, because then you're really just getting a loan to pay for, say, the new roof. And so the benefit of having the money flexible is we're not having to go into debt somewhere else to use the equity from our home, right? We have cash and investments that can provide the flexibility. And that flexibility is one of the most valuable assets a retiree can have.

When Paying It Off Makes Sense

SPEAKER_00 10:12

So when does paying off a mortgage make sense? There are certainly situations where I obviously and absolutely support paying off the mortgage. Again, for example, if your mortgage rate is six or seven percent or higher, then yes, it makes a ton of sense to find a way to help pay that mortgage faster. Uh maybe if you have substantial liquid assets remaining afterwards and it doesn't hurt your uh your investments or your cash reserves, anything like that, then sure. Uh the payoff won't create a major tax burden. If you can do this without causing a big tax bill, you know, that might make sense. You know, being debt free can significantly improve your quality of life. And if if having that debt freedom uh provides that kind of sense of uh relief and confidence, then you know maybe it makes sense. And in those situations, being debt free or having a paid-off mortgage can be a great decision. On the other hand, I've become more cautious when the mortgage rate is very low, like in this situation, and even over the last several years, when rates were 2, 3, 4%. Or maybe assets are inside your retirement accounts. Most of your assets are locked up in accounts that when you make the withdrawal, it'll be taxable. That's something to consider. Or paying it off creates a large tax bill, or liquidity becomes constrained. In those cases, keeping the mortgage may actually strengthen your retirement plan so that you have enough assets for uh you know your lifetime. Our goal as financial planners is so that as long as you have life, you have money. What we don't want to happen is you run out of money, but you still have life. So that's where we're trying to think through what is the best solution for you.

Middle Ground Strategies And Next Steps

SPEAKER_00 12:08

So maybe there's a middle ground. And remember, this doesn't have to be an all-or-nothing decision. Many retirees choose to keep larger cash reserves or make extra principal payments, gradually reduce their mortgage over time. Maybe you want to have Roth conversion strategically before you're paying it off. So sometimes the best answer isn't paying it off immediately. It's creating a plan to eliminate it more efficiently over a several year period. I see retirees, you know, focus on this, make their mortgage be the primary focus instead of the after-tax cost of eliminating the mortgage. You got to think of the whole picture, not just what's on the mortgage statement. Because a $300,000 mortgage isn't always a $300,000 decision. And in this case, like we discussed, it's a $395,000 decision at minimum before you count impact to Social Security, impact to uh Social Security taxes, impact to IRMA surcharges, uh liquidity. And so before you write that check, it's important to understand exactly what you're giving up in taxes, liquidity, and future flexibility. If you'd like to see how paying off your mortgage impacts your retirement plan, taxes, long-term income strategy, IRMA, we'd be happy to sit down with you and you can schedule a complimentary consultation with me at the link below in the description, and I'll love to help you evaluate the trade-offs based on your specific situation. If you haven't already subscribed, please subscribe. Be confident in your retirement, and we'll see you in the next video. Thanks for joining me on another episode of What the Wealth. If you enjoyed the episode today, smash that subscribe button. It helps me more than you think. Also, if you found this episode insightful and a light bulb went off, share it. Your friend Aunt Judy, the random guy in the office who's always talking about investments. Wealth isn't about just the chip chain. It's about our choices, chances, and changing our financial futures. The information in this podcast is informational and general in nature and does not take into consideration the listener's personal circumstances. This podcast is not intended to be a substitute for specific in financial, legal, or tax advice. You should consult the approved qualified professional prior to making a final decision. Securities offered through LPL Financial, member FINRA SIPC. Paradigm Wealth Partners is the other business name for Independent Advisor Alliance. Investment Advice offered through Independent Advisor Alliance, a registered investment advisor, Independent Advisor Alliance, and Paradigm Wealth Partners are separate entities from LPL Financial.