What is the real cost of a mortgage during retirement?

The cost of a mortgage payment during retirement depends on your personal Tax Hump situation. The following is an example of a $1,300 monthly mortgage payment made by an individual who retired at age 66 with an average inflation adjusted working income level of $70,000. Their State tax rate from $20,000 to $100,000 is 4.75% and their local tax rate is 3%.

Their $1,300 monthly payment is composed of $1,000 for principal and interest and $300 for taxes and insurance. They can reduce their after tax income by $1,000 a month or $12,000 a year if they can eliminate their mortgage payment.

The cost of the extra $12,000 each year for the principal and interest on the mortgage is actually $17,374 taken from your IRA account. Your marginal tax rate on that extra income will be 30.93%. The same $12,000 at the 22% Federal Tax rate would only cost $15,385, almost a $2,000 annual savings.

These numbers were created using the spreadsheet supplied on this website which does not include state and local taxes, so I added a couple of extra cells on my copy of the spreadsheet to make the adjustment the extra taxes. My final result was that getting the extra $12,000 necessary for the principal and interest portion of the mortgage payment required an extra $19,291 withdraw from your IRA with a total Federal, State, and Local tax of $7,291 for an overall marginal tax rate of 37.8%.

If you divided space in the graph between the solid green taxable tick mark and the dotted green + TI (Taxable Income) tick mark into 12 equal spaces for each of the 12 monthly mortgage payments, it is easy to see that each payment happens as a different marginal tax rate on the solid red line. Here is a table that illustrate the cost of $1,000 after all taxes at various Federal Tax rates plus the state and local tax rates from this mortgage example.

What is the pre-tax cost of a $1,000 mortgage payment?
$1,000 While working   Marginal taxes during retirement 
Federal22.00%24.00%22.20%49.95% 40.70%22.00%
Fed Cost$1,282$1,316$1,285$1,998 $1,686$1,282
And if you include 8% combined State and Local taxes!
 Total Cost $1,429$1,417$1,433 $2,378$1,949$1,429
Savings$0$42$4$950$521 $0

If you are NOT facing a sizable Marginal Tax Hump, paying off your mortgage early will have little value. If however you are facing a sizable Marginal Tax Hump, paying off your mortgage early could save you thousands of dollars each year!

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