For many, buying a home is the biggest asset they will ever own. However, you aren’t able to fully benefit from that asset until you pay off the mortgage; until then, it is technically a liability. The most common length of a mortgage loan is 30 years, but most people either sell their home, refinance their mortgage – or even pay it off before the end of that term.

What are the pros and cons of paying off a mortgage early? Obviously, you no longer have to make monthly payments, so money can be directed elsewhere. It is advisable to pay off your mortgage before you retire when most people live on a lower, fixed income. By having the mortgage paid off, that money can be redirected to other household expenses and/or provide higher discretionary income.

It should be noted that paying off your mortgage doesn’t provide relief from other routine, high-ticket home expenses such as property taxes, homeowners’ insurance, or regular maintenance. However, owning your home outright means it can’t be foreclosed on and taken from you. It also provides a large financial asset from which you can tap the equity or sell for a windfall.

While paying off your mortgage can provide security and peace of mind, you should consider all the factors before going down this path. For example, you may not have enough discretionary income to devote to making extra payments to your mortgage loan principal.

Usually, in the first 10 to 20 years of homeownership, buyers are juggling a multitude of financial obligations – raising a family, building an emergency fund, saving for college, taking annual vacations, and investing for retirement. That doesn’t always leave a lot of money left over for your mortgage.

There are, however, different strategies you can use to pay off a mortgage early:

• Pay an extra amount toward your principal along with your regular payment every month.
• Pay an extra amount each year, such as from a work bonus or other annual windfall.
• If you continue working after retirement age, you may want to allocate the required minimum distributions (RMDs) from a retirement account toward your mortgage.
• Make large payments each year from an inherited IRA transferred from a deceased parent’s retirement account. Non-spouse heirs generally have 10 years to use up these funds. By withdrawing only a portion of the funds each year, the inherited IRA may continue to grow over the full 10-year period.
• Pay off fully or a significant portion of the mortgage using other inherited funds from a deceased parent.

Not only does paying off the mortgage early shorten the life of the loan, but it also can save you tens of thousands of dollars in interest payments.

For some people, paying off a mortgage early may not be their best strategy. After all, if they have locked in a low, fixed interest rate on the loan for the entire term, their excess income may be better deployed to an investment portfolio. Over a 15-, 20- or 30-year period, regular contributions to an investment portfolio can earn even more than the equity built up in a home.

If you’re locked into a high-interest-rate mortgage, you may want to consider refinancing when rates are adjusted downward. This can help you allocate more money toward your principal. However, don’t be quick to refinance to a lower rate if you already have a low rate, as mortgages are structured to pay a higher percentage of interest on the front end of the loan. When possible, it’s best to refinance or pay extra principal in the early years of the loan rather than the later years – because refinancing could cause you to pay more interest in another front-loaded loan for another long term. Also, be aware that some mortgages have an early payoff penalty, generally during the early years of a refinance, so check before you pay it off early.

Another consideration is that mortgage interest is tax deductible, which may be a key tax saver for those in a high tax bracket.

It’s a good idea to pay off any high-interest debt you may owe, such as credit cards, auto, or student loans, before paying down your mortgage early. These debts may be costing you more money than you can save by paying off a low-interest mortgage. Once you’re debt-free, you can redeploy those payments toward your mortgage principal.

The decision to pay off a mortgage early depends on your situation and your priorities. Specifically, if you still need to build an emergency reserve fund, catch up on retirement savings, or pay down high-interest debt, you might be better off allocating money elsewhere. By the same token, if the investment markets are enjoying an upward trend and you have a low-interest mortgage, you may want to just let your money “ride” in the market so you have more available later – perhaps then you can pay off your mortgage before you retire.

The biggest difference between managing taxes throughout your career versus during retirement is that when you are retired, you are responsible for calculating how much you owe and paying it on a timely basis. Retirees normally have several different income sources, and not all automatically withhold taxes from distributions.

Retirement Income Sources

Having multiple sources of income during retirement is a good strategy, as it helps protect you from market declines, tax legislation changes, and potential defaults or cutbacks in pensions or entitlement programs. However, be aware that the more income sources you have, the more effort it takes to determine how much you owe in taxes for the year.

As a general rule, retirement income is taxed as either ordinary income or long-term capital gains. Ordinary income includes:

• Employer wages
• Taxable interest payments
• Ordinary dividends
• Short-term capital gains (on assets held a year or less)
• Taxable withdrawals from retirement accounts
• Taxable Social Security benefits
• Withdrawals from health savings accounts (HSAs) for nonqualified expenses
• Annuity payouts
• Rental income
• Pension payouts

Income subject to long-term capital gains is taxed at 0 percent, 15 percent, or 20 percent, depending on your total taxable income. This type of income is generated from:

• Profits from the sale of a business (assuming you started and sold the business over more than 1 year)
• Real estate (excluding rental income)
• Securities
• Most other investments held for over a year
• Qualified dividends

Additional Investment Tax

Single taxpayers may be subject to an additional 3.8 percent net investment income tax (NIIT) on income generated from invested assets – if their modified adjusted gross income (MAGI) is $200,000 or more ($250,000 or more if a married couple filing jointly). Examples of investment assets include interest, dividends, long- and short-term capital gains, rental income, royalty income, and nonqualified annuities.

Automate Tax Withholding

One way to make tax planning easier in retirement is to have taxes automatically withheld whenever you take income distributions. Much like having payroll taxes withheld from your paycheck, when you file year-end taxes, you reconcile the amount owed by either paying more or receiving a refund.

There are certain income sources on which taxes are automatically withheld, but be aware that a fixed percentage (e.g., 10 percent) may not be the appropriate amount for all taxpayers. The fixed percentage withheld may vary by investment type, and in many cases, the account holder can change the default withholding. The following shows how taxes are handled for different retirement income sources.

• 401(k), 403(b), and other qualified workplace retirement plans – Basic distributions are typically subject to 20 percent withholding. However, required minimum distributions (RMDs) are subject to a 10 percent withholding. Note that if the plan balance is high enough for the RMD to place the taxpayer in a higher tax bracket, a 10 percent withholding may be too low. Set up or change the withholding percentage by submitting Form W-4R to the plan administrator.
• IRA (Traditional, SEP, and SIMPLE) – Unless the retiree specifies otherwise, non-Roth IRAs typically withhold 10 percent of distributions. Set up or change the withholding percentage by submitting Form W-4R to the custodian.
• Annuity – Annuities are taxed as ordinary income, thus subject to a tax rate based on the total amount of income the retiree receives throughout the year. Note that a non-qualified annuity is usually comprised of already taxed income plus earnings. When a retiree starts receiving distributions, only the earnings portion is taxed. Set up or change the withholding percentage by submitting Form W-4P to the issuer.
• Pension – Pensions are taxed as ordinary income, thus subject to the total amount of taxable income received throughout the year. Set up or change the withholding percentage by submitting Form W-4P to the payer.
• Social Security – If Social Security benefits and all other income totals less than $25,000 per year, the beneficiary generally does not have to pay income taxes. However, if a retiree earns a higher amount through a combination of income sources, including tax-exempt income, up to 85 percent of Social Security benefits may be taxable. In this scenario, the retiree can request that the government withhold a fixed percentage (7 percent, 10 percent, 12 percent, or 22 percent) from his Social Security paychecks. Set up or change the withholding percentage by submitting Form W-4V to the local SSA office.
• Taxable bank or brokerage accounts – These accounts may give you the option to have a percentage of taxes (10 percent or choose your own percentage) withheld from investments with realized capital gains, dividends, or other asset-based income. Retirees who withdraw regular income or periodic high distributions may want to elect a percentage of taxes withheld to reduce their tax liability at the end of the year. You can make this election at the time you set up your withdrawal.

Develop a Tax Payment Plan

One of the best ways to enjoy retirement is to automate your tax payment plan. You can do this by actively selecting a withholding percentage for each income source you own and varying it based on the amount and frequency you tend to draw down each year.

Another option is to pay estimated quarterly taxes (due Jan. 15, April 15, June 15, and Sept. 15 every year). This is how most independent business owners and contractors self-pay their taxes in order to avoid an underpayment penalty. This strategy works best if you receive unexpected income throughout the year, earn self-employment income, or receive rental or taxable investment income.

The good news is that after your first full year of retirement, you will have set the bar for how much you owe in taxes – referred to as your safe harbor. Thereafter, you’re not subject to an underpayment penalty as long as you pay at least:

• 90 percent of the prior year’s full tax bill or
• 100 percent of the prior year’s full tax bill (if AGI is $150,000 or less;$75,000 or less if married filing separately), or
• 110 percent of the prior year’s full tax bill (if AGI is more than $150,000; more than $75,000 for individuals or married couples filing separately)

Remember that in addition to creating a retirement income plan, it’s important to develop a tax payment plan as well. This will help make tax season go a whole lot easier.

In one year’s time, the U.S. inflation rate dropped by more than half, from 8.2 percent in September 2022 to 3.7 percent in September of 2023.

If there is a downside to lower inflation, it’s a lower cost of living adjustment (COLA). This year, the inflation rate plummeted from 6.4 percent in January to the current 3.7 percent. While food prices, both grocery and dining out, continue to increase. Between February 2020 and September 2023, grocery store prices rose 25%. That was slightly above the 23% increase in menu prices during the same period. But a number of consumer goods prices had decreased by midsummer, such as:

• Gasoline (-26.5%)
• Airline fares (-18.9%)
• Car and truck rentals (-12.4%)
• Major appliances (-10.7%)
• Televisions (-9.9%)

The Problem with Inflation Data

Inflation data can be misleading for a number of reasons. First, while inflation statistics are quoted annually, these are compounded figures. The annual inflation figures for the past three years are as follows:

• January 2022: 5.9%
• January 2023: 8.7%
• January 2024: 3.2%

If you add each year’s annual inflation, it comes to 17.8 percent; however, compounded prices rose by 18.8 percent over the three-year period. Now, imagine the compounding effect of inflation over many more years.

Second, when you hear that there is a decrease in inflation, it is not that prices are lowering; instead, it’s that prices are increasing but at a slower rate. For prices to drop, we would need actual deflation and not just lower inflation.

Finally, you need to remember that whether it is from a Social Security COLA increase or a raise at your job, an increase in income equal to inflation does not keep up with the actual cost of inflation. This is because of taxes. If you get a raise equal to inflation, you take home that amount less taxes, so your wages or Social Security is really not keeping up with inflation.

Take all three of these factors together, and that’s why inflation feels much worse at the grocery store than it appears on paper.

Social Security Benefits

The fluctuating inflation rate doesn’t just impact the prices of consumer goods, it also affects income. Specifically, Social Security benefits are adjusted each year based on changes in the cost of living.

More than 71 million Americans currently receive Social Security and Supplemental Security Income (SSI) benefits. One in four households of people age 65 and older depend on their Social Security check for at least 90 percent of their family income. Therefore, it is very important that COLA adjustments keep up with inflation.

Given that the inflation rate fluctuated between 7.1 percent and 9.1 percent last year, Social Security benefits increased by 8.7 percent in 2023. However, since inflation has dropped significantly in 2023, Social Security benefits will increase by only 3.2 percent in 2024.

To find out how much individual Social Security paychecks will increase, beneficiaries can check the Message Center of their my Social Security account. In early December, recipients will receive notification of their increased payment by mail.

How the Increase is Determined

Be aware that if there is no year-to-year increase in inflation, there is no cost-of-living adjustment for Social Security income. While inflation rates vary, it is pretty uncommon not to have some sort of increase.

Effective January 2024, the average monthly Social Security benefit for a retired worker is $1,907; for a married couple, the combined average is $3,033. The maximum amount of earnings subject to the Social Security tax is scheduled to increase from $160,200 in 2023 to $168,600 in 2024.

Health Savings Accounts

Starting in 2024, the annual contribution limit for an HSA linked to a high-deductible healthcare plan will be $4,150 for individual coverage; $8,300 for a family plan.

2025: Catch-up Contribution

Starting in 2025, people ages 60 to 63 will be able to significantly increase catch-up contributions to certain employer-sponsored retirement plans. The limit will increase to $10,000 – or 50 percent more than the regular catch-up amount – whichever is greater.

2026: Catch-up Contribution Twist

Starting in 2026, catch-up contributions made by people earning more than $145,000 will have to be contributed to an after-tax Roth account. Note that the Roth account requirement applies only to workers whose wages are subject to FICA taxes, so it does not apply to partners, the self-employed, or state and local government employees.

As of this writing, the IRS has not yet released changes to contribution limits for qualified retirement plans in 2024.

 

You can work and still receive Social Security benefits, but how much you receive depends on a number of factors.

First, if you do plan to continue working after becoming eligible to receive benefits, you might consider delaying filing for benefits for as long as possible. That’s because the earlier you begin drawing benefits, the lower the amount you will receive. In fact, your monthly payout will be permanently reduced from what you’ll receive if you wait until full retirement age (FRA).

Your FRA depends on the year you were born (note that for people born on Jan. 1 of any year, they should refer to the previous year):

• Born 1943-1954: full retirement age is 66
• Born in 1955: 66 plus two months
• Born in 1956: 66 plus four months
• Born in 1957: 66 plus six months
• Born in 1958: 66 plus eight months
• Born in 1959: 66 plus 10 months
• Born in 1960 or later: 67

Benefit Reduction Due to Work

If you are working and begin drawing benefits before your full retirement age, your payout could be further reduced if you earn more than the prescribed income limit. In 2023, the annual earnings limit is $21,240. In this scenario, Social Security will deduct $1 from your benefits for each $2 in excess of the limit.

Benefit Reduction in Your FRA Year

The benefit reduction amount and the earned income limit both change the year you reach FRA. In 2023, the earned income limit is $56,520. In this year only, the reduction is adjusted to $1 for every $3 in excess of $56,520, but only up until the month you reach FRA. After that, there will no longer be a reduction due to work income.

In the first full month after your FRA, Social Security will begin paying out your total eligible amount (which depends on the age you started drawing benefits) for any whole month after FRA, regardless of how much more you earn that year (and every year thereafter). In other words, from that point on, you will receive the full amount you were eligible for at the age you began drawing benefits.

You might wonder if you will ever receive the money that was held back due to your excess income. The answer is yes. Starting the following January, after you turn full retirement age, your Social Security benefit will increase to reflect those previously lost benefits.

Work Advantages

If working while drawing Social Security seems like a bad idea, consider that you could benefit from a couple of advantages. First, the automatic benefit reductions that occur while you’re working will help reduce your income tax liability for those years. Second, your work income could increase your permanent Social Security payout if any or all of those years before FRA are among your 35 highest-earning years. As you continue to pay FICA taxes on your work income, the benefit is recalculated every year. This is a way to increase your lifetime benefit if you begin drawing Social Security early.

Work Until Age 70

The most strategic way to earn the highest possible lifetime benefit from Social Security is to keep working and delay drawing Social Security benefits until age 70. This is because during the years between your official FRA and the month you turn 70, you can earn additional credits that reward you for delaying. This will permanently bump up your payout.

If You Go Back to Work

Also, be aware that if you’ve already started drawing Social Security benefits but wish you hadn’t, you can cancel your application as long as you do so in the first 12 months. Note that you are required to pay back all of the money you received from Social Security, including any spousal benefit that was based on your earnings record and all Medicare premiums that were deducted from your benefits. However, doing so could reset your benefit to a higher amount when you reapply later – if your subsequent annual income counts among your highest 35 years of earnings.

If you have already reached your full retirement age (but have not yet turned age 70), you no longer have the option cancel your application. However, you can have your Social Security benefit suspended, which might reduce your tax bill while you continue working.

A widow or widower is eligible for a survivor’s benefit from Social Security even if they never worked – as long as the deceased spouse qualified for benefits based on his or her own income record. Also, note that surviving spouses must have been married to their most current spouse for at least the nine months prior to their passing or for 10 years if the couple was divorced.

When Can You Claim?

A widow/er may apply for benefits once she turns age 60, age 50 if she qualifies as disabled or if she is responsible for the care of a child under age 16 (or a mentally or physically disabled child aged 16 or older). However, if the widow/er applies for a surviving spouse’s benefit starting at age 60/50, that benefit will be permanently reduced from the maximum amount available if she were to wait until her own full retirement age.

What Is Full Retirement Age for the Widow/er?

For anyone born from 1945 to 1955, their full retirement age (FRA) is 66. If born between 1955 and 1959, FRA increases by two months each year from age 66 to 67. FRA is age 67 for anyone born in 1960 or later.

How Much Can You Get?

First and foremost, all Social Security beneficiaries receive the highest benefit for which they qualify. Therefore, if a surviving spouse would receive a higher benefit from her own record of earnings than that of the deceased spouse, then that’s the amount she will receive.

If the deceased was receiving Social Security disability benefits when he passed, the survivor benefit is based on the deceased’s disability benefit.

Normally, the spousal benefit equals half the benefit of the higher-earning spouse. However, the surviving spouse’s benefit equals 100 percent of what the deceased worker would have received, including any delayed retirement credits he earned by postponing benefits to age 70.

The minimum surviving spouse benefit at age 60 is 71.5 percent of the available amount. This represents a permanent loss of 28.5 percent of the benefit available at FRA. The widow/er benefit is reduced for each month shy of his or her own FRA, so the closer they get to FRA before applying, the higher the benefit. The amount freezes once they begin drawing benefits, although it will increase incrementally based on cost-of-living adjustments.

The maximum benefit a widow/er may receive is 100 percent of what the deceased spouse would receive if he was still alive. However, that amount may already be reduced. For example, if the deceased began drawing benefits at age 62 instead of waiting until FRA, then that is the maximum benefit the widow/er is eligible for. If she begins drawing early before her own FRA, that benefit will be reduced further.

Ideally, the deceased will not have started receiving Social Security before his death. In this scenario, even if he died in his 50s, his maximum benefit is what he would have received at FRA. Now it’s up to the widow/er to time her survivor benefit – she can wait until her own FRA or take a permanently reduced benefit.

Delay Strategy

One strategy a widow/er may want to consider is to begin her own benefit at age 62, even if it is less than what she would draw as a survivor. Then, she can delay drawing the survivor benefit until it grows higher – ideally, the highest benefit at her FRA.

If the widow/er does not have her own benefit from earnings or can’t live on that amount alone, she may want to withdraw income from other sources, such as retirement savings or an annuity. While that may reduce her overall net worth, it’s important to remember that the Social Security benefit continues for life, so it may be worthwhile to get the highest benefit possible. Other accounts, such as an IRA or 401(k), will stop paying out income once they are depleted.

If the widow/er has a stronger earnings record, another option is to begin drawing the survivor’s benefit early and delay taking her own benefit until FRA or age 70, to receive a higher benefit for life based on her own record. Once she applies for her own benefit, the payout will increase to a higher amount.

Seek Professional Advice

Knowing when to begin drawing a widow/ers benefit can be challenging. The best option is usually based on factors such as other income resources and even the widow’s health. If in poor health and not expected to live many years, it may be wise to begin the survivor’s benefit as soon as possible. Otherwise, it’s probably better to wait and get a higher payout for as long as she lives.

Another thing to keep in mind is that if the widow/er doesn’t know the deceased spouse’s FRA benefit at the time of death, she is not likely to find out until age 60. The Social Security shuts down the deceased’s account at death and won’t reveal the benefit until the widow/er is of qualifying age to begin receiving it. It’s always a good idea for both spouses to check (and share with each other) their accrued benefits each year so that they have accurate numbers to plan with in case one spouse passes away.