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        Investor's Insight - November 3, 2006           
          "A Digest of Investment Opinion From the 
             World's Leading Financial Advisers"


by Scott Burns

Q: In a recent column you talked about the risks of 
making mortgage payments after retirement. But this 
left me wondering: What is the alternative? If one has 
a mortgage on the day of retirement and one pays it 
off, then 100 percent of that capital is now tied up 
in the house. So it has zero chance of earning anything. 
Are you saying: Pay off all mortgages upon retirement, 
or sell the home and become a renter? 
-- M.S., Nashville, Tenn.

A: The answer depends on your personal balance sheet. 
It also depends on your income sources at retirement. 
You can get an idea of how the factors interrelate by 
considering these three examples. 

The Abundant Net Worths: retired with a large pension, 
$1 million in taxable account assets, $500,000 in tax-
deferred account assets and a mortgage balance of 
$200,000 at 5.5 percent. They live in an area with high 
real estate taxes and a state income tax. 



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Their corporate pension alone is high enough that all 
of their Social Security benefits have been taxed well 
before they count any income from their retirement 
savings. As a result, withdrawals from IRA accounts 
to support mortgage payments won't cause any additional
Social Security benefits to be taxed. 

In addition, their real estate taxes, state income taxes 
and charitable contributions put their itemized deduc-
tions above the standard deduction. So every dollar of 
interest deduction they add will reduce their income
tax bill.

For this couple, a home mortgage amounts to modest lever-
age on their personal balance sheet. They can support the 
mortgage without any squeeze on their personal spending. 
For them, a mortgage can be a good thing. They are except-

The Prudents: retired without a corporate pension. They 
have $200,000 in taxable account assets, $500,000 in tax-
deferred account assets and a $50,000 balance on their 
mortgage. They elect to pay off the mortgage because much 
of the payment is principal, not interest. Also, most of 
the interest won't be deductible because their itemized 
deductions won't be far over the standard deduction. Worse, 
withdrawals from their tax-deferred accounts will cause 
additional Social Security benefits to be taxed. In addi-
tion, reducing their taxable account assets from $200,000 
to $150,000 won't materially reduce their financial flexi-

While the money they take from their taxable account to 
pay off the mortgage might earn more than the 5.5 percent 
interest they are paying, they know that getting a return 
of 5.5 percent is neither easy nor without risk.

The Housepoors: retired without a corporate pension. They 
have $100,000 in taxable account assets, $200,000 in tax-
deferred account assets and a $100,000 balance on their 
mortgage. Fortunately, their house is worth $400,000. If 
they pay off the mortgage from their taxable accounts, 
they will have no flexible financial assets. Every dollar 
taken from their remaining tax-deferred financial assets 
will add a dollar to their taxable income. Worse, it may 
trigger the taxation of 50 cents to 85 cents of Social 
Security benefits.

Basically, having a mortgage on their house will commit 
them to a level of expenses that is likely to force them 
to make excessive withdrawals from their financial assets. 
It will increase the odds that they will run out of money 
long before they die.


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The best thing the Housepoors can do is downsize their 
house. That would allow them to put their $300,000 of 
home equity to better use. By moving to a smaller $200,000 
house, for instance, they can pay cash and still increase 
their financial assets by $100,000. They won't have a 
mortgage payment, their home operating expenses will de-
crease, and their investment income will increase. Overall, 
it's a better balance for retirement. (Note: I am not con-
sidering sales commissions, etc., in these figures.)

This is not a one-size-fits-all question. Nor is it a 
simple matter of assuming that your home equity could be 
earning much more. For most people approaching retirement, 
paying off a mortgage is the surest way to (1) reduce cash 
flow requirements and (2) bag an effective yield that is 
higher than you can get in most fixed-income mutual funds 
without the risk.

To put the yield issue in some perspective, most home mort-
gages have interest rates between 5 percent and 6 percent. 
According to the Morningstar mutual fund database, there 
were some 3,700 fixed-income mutual funds. Their average 
trailing 12-month yield at the end of September was only 
4.69 percent.

You can discuss this issue or any other topic in the new 
Investor's Insight forum. Check it out here...

Investor's Insight Forum

(Investor's Insight reflects the opinions of experts. It does 
not recommend any specific investments, and no endorsement is 
implied or should be inferred. For more information, contact 
the individual firms cited).



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