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How to Decide if You Should Retire With a Mortgage

Brian Preston, Bo Hanson

Leaving the workforce and counting on retirement assets to pay your bills is a major life change. You must change your entire thought process from saving for the future to using your assets for retirement. The situation gets even more complicated when you continue to have mortgage debt in retirement.

Mortgages currently have historically low interest rates. A mortgage is likely to be the cheapest money you can borrow because houses typically appreciate, and the lender keeps the growing asset if you don't make your house payments. As a result, the lender is taking on minimal risk and rewards you with a low interest rate.

[See: 10 Ways to Reduce Your Housing Costs in Retirement.]

Mortgage debt also has the benefit of being tax deductible. The tax deduction offsets your ordinary income from wages and other income sources. Proponents of mortgage debt will also tell you about the benefits of investing the money that could be used to pay off your mortgage debt. If the money is invested in a diversified portfolio, the majority of the gains will be treated as long-term capital gains with a favored tax rate of 15 percent. So, you receive a tax deduction (which can be especially valuable if you are in a high tax bracket) for the debt and only pay taxes amounting to 15 percent on the investment gains.

To decide if this strategy is right for you, it's important to do the math. Calculate how much you are paying for mortgage interest, and compare it to the value of your investment returns and tax break. That's the logical, rational and numbers-driven answer to whether you should pay off your mortgage before retirement.

But there's also a tremendous emotional benefit to entering retirement completely debt-free. No matter what economic, geopolitical or financial turmoil our society is facing, you will own your home outright. There is a big peace of mind benefit from having this level of financial independence and knowing that you will have a safe place to lay your head down at night because you own your residence.

[See: 50 Affordable Places to Buy a Retirement Home in 2016.]

Entering retirement debt-free can also allow you to have a simpler financial life. You will likely be able to take advantage of the standard tax deduction on your income tax returns, since the biggest deduction for most individuals is mortgage interest. It's common for individuals approaching retirement to be in the final stages of debt repayment. As a result, older workers have more of their monthly mortgage payment applied to principal than deductible interest. If your itemized deductions barely exceed the standard deduction, you might not be benefiting much from having a mortgage in retirement. This simplification will also result in easier and cheaper annual tax preparation.

There is also a strong argument to be made for not taking on more risk than necessary in retirement. While you might be able to come out ahead by forgoing paying down debt and investing the money in a growing financial market, there could also be a downturn similar to 2008 and you could lose a big chunk of your savings. If you're retired, you might not have time to wait for the market to recover. Retirement is not all about maximizing returns and growth. A successful plan should be a balance of risk and return.

[See: How to Reduce Your Tax Bill by Saving for Retirement.]

As you age you should moderate the level of risk you take in your investment portfolio. Debt management is not any different. Even if you have to give up the mortgage interest tax break and the possibility of a higher return, there is nothing wrong with keeping your life unencumbered and debt-free during retirement. While your analytical brain might want to try to squeeze as much return out of your assets as possible, your emotional heart might prefer to minimize stress by avoiding debt and paying off the mortgage.

Brian Preston and Bo Hanson are fee-only financial planners who host the podcast, "The Money-Guy Show".

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