Q. I am on the threshold of retirement. I am wondering how to correctly understand the benefits of continuing with a mortgage financing versus paying off the loan. I reviewed the home ownership model on your website and it calculates a (lower taxes) benefit of approx $4,000/yr. However, AFTER retirement my withdrawals from IRA's etc. would have to be higher if I continued to make payments versus paying the loan off now. My marginal tax rate would be 25%.
Can you help? It would appear that withdrawing additional income to pay the mortgage each month is different than earning an income from employment that would not change regardless of whether I was paying a mortgage or paid off the note?
---B.H., by e-mail, from Houston
A. Unless you have a very high retirement income and substantial assets, having mortgage payments after retirement isn't a good idea. For those with lots of income and assets, mortgaging their houses is a portfolio leveraging decision.
For most people mortgage payments in retirement present two very real dangers. The first is that the need to make the monthly payments from investments will subject your portfolio to a higher rate of withdrawal. As I have pointed out many times, the higher the annual withdrawal rate, the smaller the odds that your portfolio will survive through your retirement. (You can read more about this on my website, www.scottburns.com, in the Portfolio Survival Reader. Access to the website is free of charge but requires registration.)
The second danger is triggering the taxation of Social Security benefits. When your income, including one-half of your Social Security benefits, exceeds $32,000 on a joint return, your Social Security benefits are subject to taxation. As a consequence, many couples will find that every $1,000 they remove from their retirement accounts to pay mortgage debt will cause between $500 and $850 of Social Security benefits to be taxed. It can make mortgage payments very expensive.
I suggest a visit to your accountant: it will be worth the money to have your accountant show you the difference in taxes--- and suggest the lowest tax cost route.
Q. I need to help my recently widowed mother allocate her finances for a safe return. She is 77 years old and in good health. Her financial assets are a $100,000 life insurance death benefit, $25,000 in various stocks, $15,000 in a Roth IRA invested in a Mid Cap mutual fund from which she is drawing $200 a month, and about $3,000 in cash. She also has a $50,000 whole life policy with a cash value of about $5,000 that she'll have to begin paying high premiums in to in no less than four years to keep.
How should she reallocate her finances? And how can one determine how much of her principal she can withdraw each year without depleting it too fast?
---E.G., by e-mail from San Antonio
A. First, have her either cash in her insurance policy or convert it to a paid up death benefit. The insurance amount will be smaller but it won't drain her income. Beyond that she has $143,000 in financial assets from which she can safely withdraw at about 5 percent a year or nearly $600 a month. She could do that by adding her $100,000 to her $25,000 in stocks, selling the stocks, and investing the proceeds in a good no load balanced fund. She should stop making withdrawals from the Roth IRA account, sell the fund and invest the proceeds in an inflation protected bond fund, holding it as a reserve.
Another alternative would be to use a portion of the funds to purchase a life annuity. She would invest the remaining funds as above--- but make smaller withdrawals.
Scott Burns is the retired Chief Investment Officer of AssetBuilder, the creator of Couch Potato investing, and a personal finance columnist with decades of experience.