Physician Finances: The Grey Area of Paying Off a Mortgage Early
By: Frank Yozwiak, J.D., LL.M in Taxation
A key question that soon-to-be retirees often face is whether to eliminate a debt before retirement. Generally, we would love to see all our clients enter their retirement debt free. However, there could be some instances where making monthly debt payments is not necessarily a bad thing (i.e., zero-percent financing on a car). Sometimes the answer is clear and obvious, other times we are faced with a bit of a gray area. In any situation, our goal is always to help make unemotional and informed decisions.
Depending on the complexity of the question, our process can involve several methods ranging from back-of-the-napkin math to creating intricate spreadsheets and using various tools and planning software. One powerful financial planning tool we use is the Monte Carlo simulation. This software allows us to statistically quantify how multiple variables affect our clients’ ability to achieve their financial goals. In this situation, we are going to compare making mortgage payments during retirement years vs. making a large lump-sum payment to completely pay off a mortgage before retirement begins.
Look at a hypothetical couple, Husband and Wife. Husband and Wife are each 60 years old and they plan to retire at age 68. Their annual household gross income is $400,000 ($200,000 each), they each have a 401(k) plan with $600,000 of assets ($1.2 million total), and another taxable joint investment account of $500,000.
Husband and Wife each max out their 401(k) contributions ($23,000 + $7,500 catch-up because they are over age 50) and receive an employer match as well (100% up to 4%, which here equates to $8,000). They also make a point to save another $500 each month ($6,000/year) into their taxable joint investment account.
Husband and Wife are willing to live more frugally in their final working years and aggressively save for their retirement – their goal is to save enough to live on $13,500 per month in retirement. To add to their retirement enjoyment, they’ve just purchased a $400,000 condo in their favorite getaway town. They put 20% down and have a 30-year fixed mortgage at 6.5%.
So here we are: eight years from retirement with a new mortgage that has $320,000 remaining and requires $2,020 monthly payments ($24,240 annually). The question is, what is better – to pay the monthly mortgage payments starting now and continuing well into retirement years, or take a sizable chunk out of their taxable joint account close to retirement to completely pay off the new debt?
If they pay off the mortgage with a lump-sum now, Husband and Wife will save what would have been the monthly mortgage payments into their taxable joint account until they retire. Under either scenario, monthly payments through retirement or lump-sum payoff now, their potential outcome is not bad. When we plug these variables into the Monte Carlo simulation, their probabilities of success under either plan are similar.
This is a great example of one of the “gray areas” in financial planning where there is not a clear-cut right or wrong answer. In these situations, we look at other factors to help make the best decision. If the clients are more conservative in nature, we might recommend making the lump-sum payment. Yes, Husband and Wife would have to make a relatively substantial reduction to their retirement portfolio, but they would also significantly reduce their required income needed in retirement. By reducing their required income need, it allows Husband and Wife to have more control over how and when to withdraw from their portfolio. If the markets are selling off, it may allow them to temporarily reduce spending or delay a vacation/purchase to a more favorable market environment. The fewer “payments” that a retiree is required to make (i.e., a monthly mortgage payment) during retirement, the better.
Each situation is different and in general, constantly evolving. No one can predict the future (and we don’t claim to either), but by using the various tools at our disposal, including the Monte Carlo simulation, we can statistically analyze whether our clients are headed down the right path towards achieving their retirement goals, and confidently advise on potential realistic outcomes. When situations arise where there is not an obvious answer, we will use analytics as a starting point and then dive into the gray area factors to try to come to the best decision.
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About Ballast
Ballast, an employee-owned financial planning and investment management firm based in Lexington, KY, specializes in providing tailored services to high-income earners, high-net-worth clients, and individuals/businesses with complex financial situations. Our team of fiduciaries proactively anticipates and solves your needs by taking the time to understand your goals, passions, and what truly matters to you and your legacy. Ballast is built for financial security, by financial experts. You work hard every day. Let us take on some of the work for you.
Disclosure
Ballast, Inc. is a registered investment adviser with the SEC. Registration with the SEC does not indicate that the adviser has achieved a particular level of skill or ability, nor is it an endorsement by the SEC. All investment strategies have the potential for profit and loss. Ballast, Inc. is not engaged in the practice of law or accounting. Always consult an attorney or tax professional regarding your specific legal or tax situation. Any specific strategy or market/economic commentary may or may not be appropriate for your individual situation, may not have discussed all material implications of implementing said strategy, and may be reliant on data provided by outside resources. Prior to implementing any strategy or investment decision discussed in a Ballast commentary, please consult with the appropriate professionals to confirm thoroughness of the strategy presented and the appropriateness of said strategy for your individual situation.
