Freedom from Your Mortgage: Is Early Payoff Right for Your Retirement as a WA Public Servant?

As you approach retirement, you might ask yourself, "Should I pay off my mortgage before I retire?" It's a question that many Washington state public employees grapple with. While the idea of entering retirement debt-free is appealing, the decision isn't always straightforward.
The Washington State Context
Before we delve into the pros and cons, let's consider some factors specific to Washington state public employees:

1. Stable Pension Income: Many WA public servants have access to defined benefit pensions through PERS, LEOFF, or another plan [1].
2. No State Income Tax: Washington doesn't have a state income tax, which can affect retirement income calculations [2].
3. High Property Values: Many areas in Washington have seen significant property value increases, which can impact your decision [3].

Keep these factors in mind as we explore the advantages and disadvantages of paying off your mortgage before retirement.
The Pros: Why Paying Off Your Mortgage Could Be a Smart Move
1. Reduced Monthly Expenses
Entering retirement without a mortgage payment can significantly lower your monthly expenses.
Number Crunch: If your mortgage payment is $1,500 per month, that's $18,000 per year you won't need to withdraw from your retirement accounts.
2. Emotional Security
There's a peace of mind that comes with owning your home outright.
Psychological Benefit: Reduced financial stress can contribute to a more enjoyable retirement [4].
3. Simplified Finances
One less bill to manage can simplify your financial life in retirement.
Time Saver: Less time spent on financial management means more time for retirement activities.
4. Potential for Reverse Mortgage
A paid-off home provides the option for a reverse mortgage later in retirement if needed.
Flexibility: This can serve as a financial safety net in your later years [5].
The Cons: Why Keeping Your Mortgage Might Make Sense
1. Opportunity Cost
Money used to pay off the mortgage could potentially earn higher returns if invested.
If you have a low-interest rate mortgage currently, this may be especially true.  If your mortgage rate is 3% for example and you make 8% on your investments, by keeping the mortgage you earn the 5% difference over the life of the mortgage.
Historical Perspective: The S&P 500 has historically returned about 10% annually over the long term [6].
2. Reduced Liquidity
Paying off your mortgage ties up a significant portion of your wealth in a non-liquid asset.
Emergency Fund: Ensure you maintain adequate liquid savings for unexpected expenses.
3. Loss of Tax Deduction
Mortgage interest is tax-deductible, which can be valuable even in retirement.
Tax Consideration: However, with the higher standard deduction introduced in 2017, fewer retirees itemize deductions [7].
4. Inflation Benefit
Fixed-rate mortgages become cheaper over time in real terms due to inflation.
Inflation Effect: Your mortgage payment stays the same while the dollar's value decreases.
5. Diversification
Keeping a mortgage and investing instead can provide better portfolio diversification.
Risk Management: This can help spread your financial risk across different types of assets.
Special Considerations for Washington Public Employees
1. Pension Security
With a stable pension income, you might be better positioned to manage mortgage payments in retirement.
Action Step: Review your projected pension income and compare it to your expected expenses, including your mortgage payment.
2. Deferred Compensation Program (DCP)
The DCP offers a way to save extra for retirement on a tax-deferred basis [8].
Strategy: Consider whether increasing DCP contributions might be more beneficial than paying extra on your mortgage.
3. Housing Market Dynamics
Washington's housing market has seen significant appreciation in many areas [3].
Consideration: Factor in potential continued appreciation when deciding whether to prioritize mortgage payoff.
4. No State Income Tax Advantage
Washington's lack of state income tax means you won't lose the mortgage interest deduction at the state level.
Tax Planning: This might reduce the tax incentive to keep a mortgage in retirement.
Crunching the Numbers: A Washington-Specific Example
Let's look at a hypothetical example for a Washington state employee:

• Current Age: 55
• Hoping to retire ASAP
• Home Value: $500,000
• Mortgage Balance: $200,000
• Mortgage Rate: 3.5%
• Monthly Payment: $1,500
• Annual Pension Estimate: $60,000
• DCP Balance: $300,000

Scenario A: Pay Off Mortgage

• Use $200,000 from DCP to pay off mortgage plus an additional amount due to income taxes on with withdrawal. 
• Reduce annual expenses by $18,000
• Remaining DCP Balance: $100,000

Scenario B: Keep Mortgage

• Keep $200,000+ invested in DCP
• Continue $1,500 monthly mortgage payments
• Potential for higher long-term returns

The best choice depends on factors like investment returns, tax situation, and personal comfort with debt.
Decision-Making Framework
To help you decide, consider these questions:

1. What's your mortgage interest rate? Lower rates make keeping the mortgage more attractive.
2. How does your mortgage payment compare to your expected retirement income? If it's a small percentage, keeping the mortgage might be more manageable.
3. How's your retirement savings health? If you're behind on savings, investing might be more critical than paying off low-interest debt.
4. What's your risk tolerance? A paid-off mortgage provides certainty, while investing offers potential for higher returns with more risk.
5. How long do you plan to stay in your home? If you're considering downsizing soon, paying off the mortgage might be less beneficial.

Strategies for Moving Forward
Regardless of which path you choose, consider these strategies:
If You Decide to Pay Off the Mortgage:

1. Make Extra Payments: Increase your monthly payment or make lump-sum payments when possible.
2. Refinance to a Shorter Term: Consider refinancing to a 15-year mortgage to pay it off faster.
3. Use Windfalls Wisely: Apply any windfalls (bonuses, inheritances) to your mortgage principal.

If You Decide to Keep the Mortgage:

1. Refinance to a Lower Rate: If possible, refinance to reduce your interest rate and payment.
2. Invest the Difference: Consistently invest the money you would have used for extra mortgage payments.
3. Review Annually: Reassess your decision each year as your financial situation and market conditions change.

Your Action Plan: Making the Right Choice for You
Ready to tackle the mortgage payoff decision? Here's your action plan:

1. Gather Your Financial Information: Collect details on your mortgage, retirement accounts, and expected pension.
2. Use Retirement Planning Tools: The DCP website offers retirement planning calculators. Use these to project your retirement income and expenses [9].
3. Consult a Financial Advisor: Consider working with a financial advisor who understands the nuances of public employee benefits and can provide personalized advice.
4. Review Your Risk Tolerance: Honestly assess your comfort level with debt and investment risk.
5. Create a Retirement Budget: Develop a detailed budget for your retirement years to understand how a mortgage payment fits in.
6. Consider Tax Implications: Discuss the tax consequences of your decision with a tax professional.
7. Make a Decision and Take Action: Once you've considered all factors, make your choice and implement your plan.
8. Stay Flexible: Be prepared to adjust your strategy as your circumstances or economic conditions change.

Remember, there's no one-size-fits-all answer to the mortgage payoff question. The right decision depends on your unique financial situation, goals, and comfort level. By carefully considering the pros and cons and using the decision-making framework provided, you can make an informed choice that supports your vision for a secure and enjoyable retirement.
Sources:

1. Washington State Department of Retirement Systems, 2024.
2. Washington State Department of Revenue, "Washington Tax Rates & Rankings," 2024.
3. Zillow, "Washington Home Values," 2024.
4. Journal of Financial Planning, "Psychological Factors in Retirement Planning," 2022.
5. U.S. Department of Housing and Urban Development, "Home Equity Conversion Mortgages for Seniors," 2023.
6. S&P Dow Jones Indices, "S&P 500 Returns," 2023.
7. Internal Revenue Service, "Topic No. 501 Should I Itemize?" 2024.
8. Washington State Department of Retirement Systems, "Deferred Compensation Program," 2024.
   
9. Washington State Department of Retirement Systems, "DCP Retirement Planning Tools," 2024.

-Seth Deal