A False Sense of Saving: The 15 year Mortgage and Retirement Pressure

May 5, 2020

My Dear Reader,

Yesterday we covered the “saving money” aspect of 30 and 15 year mortgages and the concept of home investment. From radio ads to financial talk shows, we often hear that our home is our biggest investment. While we won’t be going into that specific aspect today, many advocates of the 15 year mortgage argue that a 15 year mortgage will “Reduce pressure on your monthly budget in retirement”.  With this in mind, I decided to turn to an interview in my book Smoke and Mirrors to explore the true pressors on retirement income.

In 2015, the total amount of money inside qualified accounts reached $25 trillion. Clearly these plans are attractive and used by many. The people I have worked with seem to think that a qualified plan is the only option to retire on. I assume that what makes these plans so attractive is the ability to defer the taxes due today. This is because tax deferral is sold as a savings. But I wanted a second opinion, so I asked Ken Kendall what he thought about the attractiveness of the qualified plans. His lengthy answer shed a light on just how these plans are sold. 

“The reason [tax deferral is so attractive] is because people are focusing on today. They’re focusing on the tax saving they’re getting today by putting money into a qualified plan. So, there’s no question that if they put$12,000 into their 401(k) or $5,000 into their IRA today they will have a lower tax bill now, and that’s what most people are most concerned about. They’re not trying to calculate the total tax [due] over the course of their lifetime. You’re just looking at the reduction of their current income tax today, and that’s all they’re considering. So that’s why it looks so attractive to contribute to qualified plans. The 401(k) advisors and the financial advisors are not talking about their exit strategy, they’re not talking about what kind of cash flow they’re going to get. They’re not talking about what the income taxes are going to be down the road, and so the focus is just on today, putting money in today, not worry about tomorrow. They say you’re going to be in a lower tax bracket. They say that you’re going to have bigger deductions, and they don’t know that any of that is going to be true, and my experience has been that for the most part that’s not true because when my clients reach retirement age, the vast majority of them are in the highest tax bracket their whole life when they reach retirement. So, the allure of the deduction today far outweighs the potential of getting that tax free money down the road. They’re not thinking about it from any other standpoint, and so that’s why I think people are so enamored with putting money into qualified for tax deduction today.”

We’ve talked about opportunity cost and its relation to taxes, so naturally any reduction in a tax bill should be lauded as a grand accomplishment. The next thing Kendall mentioned was the concept of an exit strategy. ‘Then it hit me that for as long and as much as we’ve discussed these concepts, we’ve never even mentioned an exit strategy. I believe that every plan, especially within the financial field, ought to discuss how we are going to get our money back. We all focus on math, how much ‘we’ll earn, but it all seems like statement wealth. What I mean by this is that $1 million in a 401(k) or mutual fund, as we’ve been over, isn’t ours. That million doesn’t take into account all of the fees, the taxes, and the market volatility that affect how much it is actually worth. While I had Kendall’s ear, however, I thought it would only be fair to ask him about any potential benefits of a qualified plan. 

“There certainly are some benefits, particularly for the average worker and maybe the person who’s not going to make a lot of money. So, some benefits are savings that they might not otherwise do, in terms of saving money for retirement. Because if you can take an undisciplined kind of an average hourly paid worker, and take the money out of his paycheck, that’s going to put money into a savings fund that he would never do on his own. Because the lack of discipline for most people is so strong that they would never, ever put their money away for their own retirement. So there clearly is a benefit of getting people into doing something, rather than doing nothing.” 

This comes back to our mortgage discussion because there are always going to be pressures in retirement.  And by choosing a 30 year mortgage over a 15 year mortgage, it gives retirees more cash to adjust to a changing market. 

To your creation and potential,

Kevin Prendiville