Hamilton Herald Masthead

Editorial


Front Page - Friday, January 24, 2014

Pay off the house before you retire




In 2011, the first of some 78 million baby boomers began retirement. By the year 2031, the last year of the boomer generation will reach their full retirement age (67). Many will consider moving to a less costly, low-tax state in an effort to reduce their living expenses. However, more than half of those on the verge of retirement – 55 to 64 year olds – are still carrying mortgage debt, and some households will carry it into retirement for many years to come. How will this affect their lifetime wealth?

Using the NCPA’s State Tax Calculator, I compared the tax burden from state to state, as measured by the amount of lifetime spendable income after taxes and housing or rental expense. Our calculator accounts for federal and state income taxes, median property taxes, and state and local average sales taxes for each state. But regardless of where retirees choose to spend their golden years, mortgage debt could significantly reduce lifetime wealth.

Consider the example of a 64-year-old individual living in New Jersey, with one of the highest tax burdens, who plans on moving to Texas (a state with one of the lowest tax burdens) and retiring at age 65. He currently earns $75,000 a year, and has a home valued in New Jersey at $300,000 with $50,000 left on his mortgage.

• If he moves to Texas, purchases a home for $300,000 and assumes a $50,000 mortgage for 20 years, his monthly payments will be low ($642 a month at a 5 percent fixed rate) but he will gain only $242 a year in annual discretionary income for the rest of his life. Assuming he lives to age 100, his lifetime loss will total $12,026. 

• If he instead purchases a $250,000 home and pays it in full at the time of purchase (using the proceeds from his previous home), he will gain an additional $5,405 in annual discretionary income, resulting in an additional accumulation in lifetime wealth of $239,226! 

There are two factors at play here. First, despite Texas’ overall low tax burden, the state’s median property tax rate is about the same as New Jersey. Even though property taxes and interest payments are both tax deductible, they are not enough to reduce his federal tax burden and increase his wealth. However, purchasing a slightly less expensive home and paying it in full, as in the second example, increases his wealth by reducing property taxes and interest payments.

Does more housing mean more wealth? Consider a couple earning $200,000 a year considering a move from New York to the lower tax state of Florida. One spouse, who is 64, will retire in a year. They own a $400,000 home in New York with a $169,000 mortgage balance left to pay over 15 years.

• If they move to Florida, where tax rates are lower, and purchase a home for the same price as their home in New York (with a $250,000 down payment and a 15-year mortgage), they will have an additional $3,300 to spend each year during their lifetime. 

• However, they can triple their additional discretionary income each year in Florida to more than $9,000 by simply “downsizing” to a $250,000 home and purchasing it outright. 

When considering a move for their senior years, whether to another state or another home in the same state, retirees should look at the pros and cons of carrying a mortgage. While paying down higher-interest debt, such as credit cards, should take first priority, those who have only mortgage debt should think carefully before taking on another mortgage or extending their existing one.

Pam Villarreal is a Nation Center for Policy Analysis Senior Fellow and an expert on retirement, Social Security, economic growth, and tax issues.Villarreal has written studies and analyses on specific topics such as the danger of 401(k) borrowing, Social Security disability, the expiration of tax cuts, and the future of Social Security and Medicare. She authored and co-authored numerous publications on diverse topics such as medical malpractice reform, Medicaid reform, the estate tax, smart growth policies, monetary policy, and teacher pay. She also has written “The Coming Tax Tsunami” and “Would you Benefit from a Roth IRA,” among other reports. Villarreal’s work on the NCPA’s 401(k) borrowing calculator and the negative consequences to borrowing from a 401(k) has been recognized by media throughout the country. Villarreal has bachelor’s and master’s degrees in Applied Economics from the University of Texas at Dallas. In 2011, the first of some 78 million baby boomers began retirement. By the year 2031, the last year of the boomer generation will reach their full retirement age (67). Many will consider moving to a less costly, low-tax state in an effort to reduce their living expenses. However, more than half of those on the verge of retirement – 55 to 64 year olds – are still carrying mortgage debt, and some households will carry it into retirement for many years to come. How will this affect their lifetime wealth?

Using the NCPA’s State Tax Calculator, I compared the tax burden from state to state, as measured by the amount of lifetime spendable income after taxes and housing or rental expense. Our calculator accounts for federal and state income taxes, median property taxes, and state and local average sales taxes for each state. But regardless of where retirees choose to spend their golden years, mortgage debt could significantly reduce lifetime wealth.

Consider the example of a 64-year-old individual living in New Jersey, with one of the highest tax burdens, who plans on moving to Texas (a state with one of the lowest tax burdens) and retiring at age 65. He currently earns $75,000 a year, and has a home valued in New Jersey at $300,000 with $50,000 left on his mortgage.

If he moves to Texas, purchases a home for $300,000 and assumes a $50,000 mortgage for 20 years, his monthly payments will be low ($642 a month at a 5 percent fixed rate) but he will gain only $242 a year in annual discretionary income for the rest of his life. Assuming he lives to age 100, his lifetime loss will total $12,026. 

If he instead purchases a $250,000 home and pays it in full at the time of purchase (using the proceeds from his previous home), he will gain an additional $5,405 in annual discretionary income, resulting in an additional accumulation in lifetime wealth of $239,226! 

There are two factors at play here. First, despite Texas’ overall low tax burden, the state’s median property tax rate is about the same as New Jersey. Even though property taxes and interest payments are both tax deductible, they are not enough to reduce his federal tax burden and increase his wealth. However, purchasing a slightly less expensive home and paying it in full, as in the second example, increases his wealth by reducing property taxes and interest payments.

Does more housing mean more wealth? Consider a couple earning $200,000 a year considering a move from New York to the lower tax state of Florida. One spouse, who is 64, will retire in a year. They own a $400,000 home in New York with a $169,000 mortgage balance left to pay over 15 years.

If they move to Florida, where tax rates are lower, and purchase a home for the same price as their home in New York (with a $250,000 down payment and a 15-year mortgage), they will have an additional $3,300 to spend each year during their lifetime. 

However, they can triple their additional discretionary income each year in Florida to more than $9,000 by simply “downsizing” to a $250,000 home and purchasing it outright. 

When considering a move for their senior years, whether to another state or another home in the same state, retirees should look at the pros and cons of carrying a mortgage. While paying down higher-interest debt, such as credit cards, should take first priority, those who have only mortgage debt should think carefully before taking on another mortgage or extending their existing one.

Pam Villarreal is a Nation Center for Policy Analysis Senior Fellow and an expert on retirement, Social Security, economic growth, and tax issues.Villarreal has written studies and analyses on specific topics such as the danger of 401(k) borrowing, Social Security disability, the expiration of tax cuts, and the future of Social Security and Medicare. She authored and co-authored numerous publications on diverse topics such as medical malpractice reform, Medicaid reform, the estate tax, smart growth policies, monetary policy, and teacher pay. She also has written “The Coming Tax Tsunami” and “Would you Benefit from a Roth IRA,” among other reports. Villarreal’s work on the NCPA’s 401(k) borrowing calculator and the negative consequences to borrowing from a 401(k) has been recognized by media throughout the country. Villarreal has bachelor’s and master’s degrees in Applied Economics from the University of Texas at Dallas.