Should I pay off my mortgage with my retirement savings? 4 things to consider

More people than ever enter retirement with a mortgage: The percentage of those age 65 with home debt increased nearly 13% in just five years. And that mortgage balance for those individuals has nearly doubled, to approximately $109,000.

A mortgage and retirement aren’t incompatible, but a debt of that size may cause some people to worry, especially the closer they get to retirement. Whether you’re decades away from stepping back from work or already in the thick of retirement, you might consider using savings, like retirement, to pay off your mortgage and be rid of the debt. But should you? And, what are the tradeoffs? Here’s some insight.

Most retirement savings like a 401(k) or individual retirement account (IRA) allow you to withdraw funds after a certain age—typically 59½—without penalty. If you’re thinking about making a withdrawal earlier than that, you’ll be charged a 10% penalty. That applies no matter the intended purpose, even for a mortgage. For example, if your mortgage balance is $20,000 and you withdraw $20,000 from retirement savings, you’ll only receive $18,000, plus get a tax bill (see next question). So, consider the penalty charge as you’re doing calculations to compare the costs of an early retirement withdrawal for a mortgage payoff.

If you’ve not yet reached age 59½ and want to withdraw retirement funds to pay off a mortgage, you’ll pay taxes in addition to the 10% penalty mentioned above. If you’re retired, any pre-tax money taken out of your 401(k) or IRA is treated as income, no matter how little or how much you withdraw. So, the more you need to withdraw, the greater your potential tax burden.

One more tax impact to consider if you’re thinking of withdrawing retirement funds to pay off a mortgage: the mortgage interest deduction, used when you file income taxes. Your tax advisor can help you sort through what the effect may be.

Any withdrawal you make from retirement savings to pay off a mortgage reduces your debt obligation. But it also reduces, perhaps permanently, the potential income you have to live on in retirement.

Here’s a way to think about it: The average retirement budget is $50,000. Say you have a mortgage balance of $50,000, so you withdraw retirement savings to pay it off. You’re sacrificing two things: a year of retirement income, and potential growth from those funds. The question is, do you have enough remaining savings to last the entirety of your retirement?

On average, retirement savings have historically earned about 6% over time. Right now, most Americans hold an existing mortgage that’s charging about 4% interest. Translation? There’s more room for growth in your retirement savings than there is a cost to your mortgage, so a withdrawal wouldn’t make financial sense.

Is it having a mortgage, or is it the size of your mortgage payment that has you contemplating options? If it’s the size of the payment, perhaps there are other options such as paying down the balance and refinancing, which in turn could open up additional funds you could add to retirement savings.

Sometimes emotional factors are just as important as financial impacts. “Who you are and how you feel about debt can outweigh the math,” says Stanley Poorman, a financial professional with Principal^® . “Are you a person who sees a mortgage balance as the world on your shoulders, or are you comfortable carrying it into retirement?”