Paying off a mortgage

Situation: A client wants to pay off his mortgage with a retirement account distribution and is wondering about the short- and long-term financial ramifications. Solution: While living debt-free is appealing to many people, it might not make the most financial or tax sense. In order to determine whether paying off the mortgage would be beneficial, the client has to consider several factors. The starting point is determining how much your client owes on his current mortgage or mortgages. This will determine the lump sum that he will have to come up with. If the source of the money is the client’s retirement account, the client needs to understand the ramifications of liquidating the account. The proceeds he gets are taxable. Also, if he is under 59 ½ years of age, additional penalties will be assessed on the account distribution. The client could lose a substantial portion to taxes, which would require a larger payout in order to obtain the necessary amount. Taking cash from a retirement account would make sense only if the account was earning less than the current interest rate on the client’s mortgage. Also, by liquidating now, any future appreciation on the account would be lost, as would the tax deduction on the mortgage interest. Put simply, your client would pay more taxes now and lose future tax deductions. Another point to consider in paying off the existing mortgage in full is turning a liquid asset into a non-liquid asset. If your client was to pay off his mortgage and then decide he wants or needs to remodel his home or purchase a new car, he won’t then have the option of a home equity line of credit. However, even if the client doesn’t pay of his mortgage and eventually applied for a home equity loan, keep in mind that this type of loan is more difficult and more expensive to get these days. Furthermore, even though the interest on an original home mortgage is deductible, only the interest on the first $100,000 of the equity loan is a tax deduction.