Some participants age 50 or older, with many educational expenses for children paid, may be considering whether to use excess cash to pay off a mortgage early or increase contributions to a retirement plan.
- With many looking to cut monthly expenses in retirement, reducing or paying off a mortgage balance is an attractive prospect.
- On the other hand, participants age 50 or over have an opportunity to boost retirement savings by making catch-up contributions to a qualified plan.
Payoff Mortgage Early or Ramp up Retirement Savings? The reality is there is no “right” decision. Instead, there are pros and cons to consider for each scenario which need to be factored into each participant’s unique situation.
Early Mortgage Payoff Considerations
One of the largest expenses for many Americans is their mortgage payment. In recent years, this expense has increased for many retirees. According to The Wall Street Journal, the average 65-year-old has nearly 50% more mortgage debt in 2016 than their 65-year-old peers had in 2003.
For participants looking to retire in the near future, the most sensible solution may seem to be to payoff a mortgage early using additional savings to increase their monthly payments. This applies in particular if their monthly mortgage payment represents a significant portion of the monthly income they anticipate having in retirement. In addition, paying off a mortgage early can significantly reduce the interest paid over the life of the loan with potentially thousands of dollars saved.
While lowering expenses in this way is an important consideration, there are also trade-offs to consider. For example, mortgage interest payments are often fully tax deductible if itemized on a tax return. This tax deductibility can both reduce the real cost of the loan over time and provide tax savings.
Retirement Contribution Considerations
On the other hand, interest rates on mortgages have been historically low for the past several years. It is likely that many of today’s mortgages have been financed at lower rates relative to the historical long-term return of stocks. Looking ahead, if the participant believes their retirement account could earn more by investing than they would save in mortgage interest payments, then it may make sense for them to increase their retirement plan allocation with any extra savings they may have.
In addition, due to increased life expectancies, more assets need to be accumulated over a lifetime to cover longer years in retirement. The Center for Retirement Research at Boston College anticipates that by 2020, the retirement period for women aged 65 could be 22 years; for men, it may be nearly 20 years. Yet, retirement balances may not be sufficient, as the Center found that the average 401(k) and IRA balance for the typical working household was only $111,000 in 2013.
Depending on the participant’s age and current retirement plan balance, it may make financial sense to use any additional savings to make catch-up contributions to a plan. If those participants have contributed the maximum of $18,000 to their 401(k) for 2016, they can also add to their retirement nest egg by contributing an additional $6000 as a catch-up contribution. The value of time cannot be understated when it comes to investing for retirement. Putting any extra savings to work in a retirement plan may make the best sense for a participant who wants to increase the value of their account over the long term.
ABG – Your Retirement Resource
Using additional savings to payoff a mortgage early or to make additional contributions to a 401(k) is really dependent on the participant’s unique situation. Ideally, a balanced compromise between meeting both goals can be made. ABG specializes in retirement plan services and is always available to help with participant education and communication for whatever stage your participants may be in. Contact your local ABG representative to learn more.