Should You Retire Your Mortgage Before You Retire?
Tanya Gierut, CPA
For most people with a mortgage, paying it off — ideally before retirement — is a major financial goal. But the percentage of Americans still making monthly mortgage payments when they receive that last paycheck is rising. According to the Federal Reserve’s Survey of Consumer Finances, 35% percent of households headed by people ages 65 to 74 still have a mortgage — about 15% more than in 1998. Not surprisingly, the amount of debt they carry has also climbed.
Many personal finance experts recommend retiring your mortgage before you retire. There are also strong arguments in favor of prioritizing other financial goals.
Eliminating Your Largest Bill
For many people, a mortgage is their largest monthly expense. If this payment is still lingering into retirement, then more money must be withdrawn from retirement savings to cover this payment among other living expenses. Without this payment, imagine the financial freedom that could result. Your retirement funds could have more time to grow so you can spend your hard earned savings on activities you enjoy, not just paying bills.
Some argue you can use the money you would put toward your mortgage to make other investments that could possibly earn a higher return. However, because almost all investments fluctuate in value, paying off your mortgage is likely to offer a more risk-free return.
Many people believe that having a mortgage is not a total loss, as you can deduct your mortgage interest from your taxable income. However, due to the 2017 Tax Cuts and Jobs Act, this benefit may not be as significant as it was in previous years. The new tax bill increased the standard deduction to $12,200 for single filers and $24,400 for joint filers in 2019 (even higher for those who have reached age 65, which includes an additional $1,650 for single and $2,600 for married filers). In 2019, if you are married filing joint and both taxpayers are over the age 65, the standard deduction is $27,000. Your itemized deductions must be greater than $27,000 to see any benefit. With the state and local tax deduction capped at $10,000, this may be difficult to achieve.
Putting Other Priorities First
Although entering retirement mortgage-free can be a sensible move for many people, it is not right or possible for everyone. If you have credit card or other debt that carries a higher interest rate, you will want to whittle down those balances first. And if you have not adequately funded your retirement accounts, you should do everything you can to boost those savings. Also, liquidating a large portion of your investments to pay off your mortgage might leave you “house poor,” with much of your wealth tied to your home and not easily accessible in an emergency.
Finally, before paying off your mortgage, check to ensure there is no prepayment penalty. The Dodd-Frank Act of 2010 limited lenders’ ability to impose penalties on many mortgages, but it still makes sense to confirm this.
Factor In Everything
The decision to pay or not to pay off your mortgage should be made after reflecting on all of your personal circumstances, including your retirement plans, tax concerns and total wealth. Discuss these factors with a financial professional who can help you come up with a holistic plan.
Time Is Money: How Millennials Can Take Advantage Of It
Justin L. Sylvan, CPA, MST
When it comes to investing for retirement, millennials — usually defined as people born between 1981 and 1996 — face some unique challenges. Most millennials entered adulthood after 9/11, the 2008 financial crisis and the Great Recession. Many are burdened by student loans and other consumer debt. And all are affected by rapidly rising health care expenses and other costs of living. So, it is no surprise that many young people are gun-shy when it comes to investing.
At the same time, a higher life expectancy means millennials have to make their retirement savings last 20 to 30 years or more. Given the daunting prospect of potentially outliving the nest egg, millennials need to start saving for retirement while still young.
Power of Compounding
The good news is that time and the compounding effect of reinvesting earnings are a powerful combination. The earlier you start saving, the longer your time horizon, which means you can set aside less money but end up with more. Compounding makes a sum grow at a faster rate than simple interest, because in addition to earning returns on the money you invest, you also earn returns on those returns over time. It causes your wealth to snowball over time and means that you do not have to save as much to reach your money goals.
Suppose that Jessica begins investing $7,000 per year at age 25 and stops at age 45. Assuming she earns a 7% annual return, she will have accumulated more than $1.1 million by the time she reaches age 65. In contrast, Jessica’s friend, Ben, does not start saving until age 45, when he begins to invest $14,000 per year and also earns a 7% annual return. When Ben reaches age 65, his savings will have grown to around $574,000. By starting early, Jessica invests half as much as Ben, but ends up with nearly twice as much.
Investment and brokerage account fees can have an enormous impact on your long-term returns, so it is important to understand these fees and, when possible, take steps to reduce them. Examples include brokerage fees, commissions, transaction fees, advisory fees and sales loads. It is particularly easy to overlook mutual fund expense ratios because these fees are built into a fund’s return and may be difficult to ascertain.
It pays to do your homework and compare fees among various investment options. Even a small reduction in fees can substantially increase your returns over time. For example, suppose you plan to invest $10,000 per year for 30 years in a mutual fund that earns a 7% annual return. You are considering two comparable funds, but one charges a 0.75% expense ratio and the other charges 0.25%. A difference of 0.5% does not sound like a lot, but choosing the more expensive fund will cost you more than $75,000.
Don’t be afraid of risk
Although stocks are risky investments, millennials who steer clear of them are missing potentially sizable gains during their peak earning years. The average return (price gains and dividends) of the S&P 500 index historically is about 10% a year, though its annual movements vary widely. History shows us that, over the long term, stocks generate higher returns despite short-term fluctuations. In fact, the stock market has not declined in value during any rolling 15-year period since 1926. Keeping money in cash, such as a savings account or money market fund, might be more suitable for your short-term goals but over time, the value and purchasing power of cash are eroded by inflation.
Of course, past performance is no guarantee of future results and it is possible to lose money in any stock investment. Millennials with a well-balanced, diversified portfolio of stocks, bonds and cash should feel reasonably comfortable about their ability to achieve their retirement goals with a tolerable level of risk.
You can also build a diversified portfolio as part of an IRA account or employer-provided retirement plan, such as a 401(k). These vehicles allow your savings to potentially grow on a tax-deferred basis — or even tax free, if you have the option of contributing to a Roth IRA or Roth 401(k) — substantially increasing possible returns. Some employers offer matching contributions, which can boost savings even more. If your employer matches, try to contribute at least that percentage of your salary to ensure you do not leave matching funds on the table.
Millennials struggling to pay off student loans and other debts may be tempted to put off investing for retirement. But as you can see, there are enormous advantages to starting early. No amount is too small and even modest investments now can pay off handsomely down the road.