By Jason LaBarge, Financial Advisor and President of LaBarge Financial
My parents owned my childhood home free and clear when they decided to seek a more pleasant climate in Arizona for retirement. Property values there are lower, so they paid cash for their new home. After my Dad passed away, my mother wanted to be closer to me, so she moved to Maryland. The proceeds from her Arizona house weren’t enough to cover her new home here, meaning she’d have to either spend some of her retirement accounts or get a loan. She decided to take out a mortgage.
Right now, some of you might be wondering why she would opt to take out a mortgage when she had a home, she owned free and clear. That’s crazy, right!?
While it’s true that conventional wisdom historically says it’s a mistake, blanket statements don’t apply to everyone’s individual circumstances.
Pros of Retirement Mortgages
Many are driven to gain the peace of mind of knowing they own their home free and clear and no longer have to worry about mortgage interest and that is great. However, in some cases, paying it off early could be a tactical error.
Few people have enough money in a savings account to eliminate their mortgage. Most will need to draw from retirement accounts, and that’s where the math becomes important.
If you have a mortgage at today’s rates of 6–7%, and you withdraw money from an investment account that sees an average return of 10% in order to pay it off, you could actually lose money. While you’re no longer paying mortgage interest, you’re also no longer receiving investment returns on those dollars.
But the picture gets potentially worse: If you withdraw money from a non-tax deferred retirement account to pay off the mortgage, you increase the odds that when you need money in the future you will have to withdraw it from your IRA or 401(k). Those withdrawals are taxed at income tax rates which can generally be higher. That will generate a tax bill you otherwise wouldn’t have had to pay.
For many, there’s a good argument to be made that, because the IRS requires you to withdraw money from tax-deferred accounts every year anyway, per the Required Minimum Distributions “RMD”, you might as well put those mandatory withdrawals toward your mortgage payment.
In doing so you transition the retirement asset from a tax-deferred account — which is undesirable to pass down to an heir due to the inherent income tax burden it will generate — to real estate which may be a favorable asset to pass down from a tax perspective due to step up in basis at death. You’ve now used those required withdrawals to keep your non-deferred accounts healthy and give your heirs a better inheritance picture. For many, that’s a win-win!
To be clear, had my mother chosen not to get a mortgage and instead use some of her assets to pay the house off, that’s not a bad thing. Having a paid-off house is sometimes worth it just for the psychological benefits and savings on interest.
Everyone’s situation is unique. It’s important to work with a financial and tax professional to arrive at a decision based on your individual circumstances rather than blanket advice from experts.
Risk Disclosure: Investing involves risk including the potential loss of principal. No investment
strategy can guarantee a profit or protect against loss in periods of declining values. Past performance does not guarantee future results. This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
The content is developed from sources believed to be providing accurate information; no warranty, expressed or implied, is made regarding accuracy, adequacy, completeness, legality, reliability, or usefulness of any information. Consult your financial professional before making any investment decision. For illustrative use only.
Jason LaBarge, Financial Advisor and President of LaBarge Financial
7 Riggs Avenue, Severna Park, MD 21146 443-647-4321
www.LaBargeFinancial.com
Securities offered only by duly registered individuals through Madison Avenue Securities, LLC (MAS), member FINRA/SIPC. Investment advisory products and services made available through AE Wealth Management, LLC (AEWM), a Registered Investment Advisor. MAS and LaBarge Financial are not affiliated entities. 2947941-03/25