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The Basics

If you retire before your mortgage does

Paying it off may not be the best idea -- especially if the money would come from an IRA or 401(k). You might want to consider refinancing to shrink your payment.

By The Wall Street Journal

It's an increasingly common dilemma: You want to retire, but you haven't yet retired your mortgage.

Even before the recent debt-driven housing boom and bust, the numbers were getting ugly. Among households headed by someone age 65 to 74, more than 32% had a mortgage on their primary residence in 2004, up from less than 19% in 1992, according to the Federal Reserve.

Carrying a home loan into retirement? Here's how to handle it.

Living free

Start with this question: Should you strive to pay off your home loan so you can live mortgage-free in retirement, or should you aim instead to shrink your monthly loan payments, thus freeing up cash that can then be spent on other items?

If you have a heap of savings and a modest mortgage, go for the loan payoff. To that end, you might trade down to a smaller home or, alternatively, work part time until you're rid of the mortgage.

If you have cash sitting in, say, a money-market fund held in a regular taxable account, also consider using these savings to reduce your loan balance. Sure, your mortgage may be costing you just 6% and the interest might be tax-deductible. But your money-market fund is likely yielding only 5% -- and you have to pay tax on that income.

Things get trickier when dealing with individual retirement accounts and 401(k) plans. An AARP study found that many departing employees cash out their 401(k)s, often using the money to pay down debt.

But this is foolish, because a big 401(k) withdrawal would likely trigger a huge income-tax bill. Instead, you're better off slowly tapping your 401(k) or IRA to make your regular monthly mortgage payments. That way, you would also continue to enjoy the mortgage-interest tax deduction.

If this strategy makes you nervous, consider using a chunk of your IRA or 401(k) to buy a "period certain" immediate fixed annuity, says Rich Lindsay, a senior vice president with Symetra Financial in Bellevue, Wash. Let's say you have 15 years left on your mortgage. To ensure you can make those payments, you could buy an annuity that will kick off 15 years of monthly income.

"If you're risk-averse, this is a better strategy than taking a big withdrawal from your 401(k)," Lindsay argues. Avoiding the big 401(k) withdrawal makes particular sense if you are in a high tax bracket or if your mortgage has a low fixed rate, he adds.

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One warning: If you buy the annuity, arrange to roll over the necessary retirement-account money directly to the annuity company. Don't cash out the account first, or you could trigger the big tax bill.

Shrinking payments

What if your mortgage is so large that paying it off will seriously crimp your retirement?

"If you don't think you'll ever get to live mortgage-free, you might as well get the mortgage payment down as low as possible," reckons Denver investment adviser Charles Farrell.

Imagine that, some years ago, you took out a $400,000 30-year mortgage at 6.5%, giving you a $2,528 monthly payment. You're now about to retire, the loan's balance is down to $300,000, and your home is worth $600,000.

You could simply refinance that $300,000 back over 30 years. Even if you get the same 6.5% rate, that will trim your payment to $1,896.

Better still, trade down to, say, a $400,000 home. After forking over a 5% real-estate commission and paying off your current mortgage, you could put down $270,000 on your new home, leaving you with a $130,000 mortgage. If you financed that over 30 years at 6.5%, your monthly payment would be $822.

You might even refinance later in retirement, further shrinking your monthly payment by again extending the loan over 30 years. Even in today's tight credit environment, you shouldn't have a problem qualifying for a new loan, as long as you have a reasonable amount of retirement income.

"My father bought a home two years ago, and he got a 30-year mortgage," recounts Keith Gumbinger, a vice president at mortgage-information provider HSH Associates. "He was 77 at the time, and he didn't have any trouble."

This article was reported and written by Jonathan Clements for The Wall Street Journal.

Published Oct. 15, 2007

TAGS: RETIREMENT PLANNING - HOME LOANS - 401(k) - REFINANCING - IRA

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