As we prepare for retirement, debt is an important topic to discuss: How much debt do you have, and how much of it can be eliminated before you leave the workforce?
If you don’t tackle your debt during your working years, those payments will need to be factored into your retirement plan, meaning you might be withdrawing more money from your savings each month.
Your mortgage is likely your largest debt. In fact, there’s more than $10 trillion in mortgage debt for family homes held at financial institutions in America. That’s 10 times greater than U.S. credit card debt! Tackling your mortgage debt before retirement will put more money in your pocket each month.
When deciding whether to pay off your mortgage before retirement, consider the pros and cons:
Increased cash flow during retirement: Eliminating your monthly mortgage payment and the interest you’re paying on that loan will free up your cash flow each month. Typically, 25% of your pre-retirement income goes to your mortgage payment.
In retirement, that expense will need to be worked into your monthly spending plan. By eliminating this expense now, you’ll be able to free up money for other wants and needs in retirement.
Potential cash crunch now: To work toward becoming mortgage-free, you’ll likely need to start making additional payments now. Dedicating more money to your mortgage payment during your working years will likely require adjustments to your monthly budget, which may alter your lifestyle.
It’s also important to note where this extra money is coming from in your budget. If you have to tap into your 401(k), emergency fund or other retirement savings to put additional money toward your mortgage debt, it might not be a good idea.
Peace of mind: Owning your home is a fairly risk-free use of your money compared to investing that money in the stock market. If you aren’t comfortable with risk later in life, this might be something to consider.
And speaking of your comfort, we all know the financial benefits of being debt-free, but have you considered the psychological benefits? Debt and stress often go hand-in-hand. The peace of mind that comes with eliminating your largest debt may ease the stress of living on a fixed income in retirement.
Losing a tax deduction: Paying off your mortgage in full could have potential tax implications both now and in retirement. If you itemize deductions on your tax return, your mortgage interest is tax-deductible. Generally speaking, the higher your tax bracket, the more potential benefit there is to having a mortgage.
If you find yourself in a lower tax bracket once you enter retirement, the mortgage deduction may no longer be working in your favor. Crunch the numbers to determine the impact of being mortgage-free both now and in retirement.
The downsizing decision
While these are just a few things to consider when deciding if you want to own your home free and clear in retirement, you might also consider downsizing to a smaller home, townhome or condo.
The first few years of retirement are usually quite active. You might be travelling often, visiting friends and family, and/or volunteering. If your kids are grown, you’ll likely no longer need the extra space. On the other hand, if you want space for visiting grandchildren, you may want that space.
Depending on the size and sale price of your current home — and how much you decide to downsize — you may be able to pay for your new home in cash. And you’ll spend less time on upkeep, which may mean more time for fun in your golden years.
Larry Kallevig, owner of Haven Financial Group in Burnsville, helps clients create financial plans that ensure dependable and comfortable income in retirement. Learn more at havenfinancialgroup.com.