It comes as no surprise that many federal employees want to simplify their personal balance sheets as they head into retirement. For many, this could involve paying off various debts, such as credit cards, auto loans, or a mortgage. With a new post-work, fixed-income life approaching, who wouldn’t want to reduce— if not eliminate— remaining liabilities?
With that thought in mind, we encounter many clients who use their TSPs to accomplish that goal. The thinking goes, given that you’ve accumulated this nest egg over the course of your working career, you can dedicate a portion of those savings to reducing your liabilities in retirement, thus minimizing your financial and mental stresses during your golden years. So if you have the desire and the means to use your Thrift Savings to pay off your mortgage, should you?
On the one hand, some say it's a bad idea to use tax-deferred assets, like your TSP, to pay off a tax-advantaged ones, like a mortgage. By using a TSP to pay off a mortgage, you will lose the mortgage-interest deduction that reduces your AGI, or adjusted gross income. Further, because tax-deferred assets are being used to pay off the mortgage, the tax consequences are compounded¹. In addition, by using invested savings to pay off a mortgage, you bear an unforeseen opportunity cost: should the market perform well, you miss out on the effects of compounding interest.
This decision may also hinge on the mortgage details too. Depending on the type of mortgage, be it fixed-rate, interest only, ARM, or a balloon, it may make good sense to pay it off sooner rather than later, as interest payments made over the course of many years gradually erode your savings base. Of course, this advice could also be flipped if the loan’s interest rate is very low, or if you have recently refinanced.
Whether paying off your mortgage at retirement makes good financial sense is particularly case-dependent. At PARCO, we analyze the specifics of each client in order to provide advice on the numbers and finances of each situation. What we are unable to do, however, is place a value or a dollar sign on the peace of mind that comes with knowing you don’t owe the bank or other debtors any money. Thus, the real answer lies somewhere in between the cold, hard numbers and the psychological impact of your decision. Let us talk with you about your priorities and goals in retirement, see how your numbers break down, and allow you to make the decision that is best for you.
¹Horton, Melissa. “Using Your 401(k) to Pay Off a Mortgage.” Investopedia, Investopedia, 28 Aug. 2020, www.investopedia.com/articles/personal-finance/101315/using-your-401k-pay-mortgage-pros-and-cons.asp.