Insider Jeff Fleming

Taxing Times

With the April 15 income tax deadline rapidly approaching, Jeff Fleming tackles two tax-related issues: Whether it makes sense to keep a mortgage for tax purposes, and the pitfalls of forming a corporation for use as a tax shelter.

Dear Jeff:
We are retired, and owe about $20,000 on our mortgage. We'd love to pay it off and only have to pay taxes on the house, but have always heard that it's best to have a mortgage for tax purposes. We've been paying $500 extra a month to reduce it faster, but wonder if we should even be doing that. What do you think? Joyce

Jeff Says:
Taxes seem to drive us to do funny things. In your case, you have heard that you should have a mortgage because it is better for tax purposes. It is true that you can deduct the mortgage interest that you pay each year if you itemize your deductions on a Schedule A. But, the reality is that it still costs you money.

For the sake of simplicity, suppose that you paid $1,000 in mortgage interest last year and that your effective tax rate was 20 percent. This means that you had to spend $1,000 to save $200 in taxes. Does this make any sense to you? I caution you not to let taxes be the driving force behind all of your financial decisions.

I'll switch gears now and tell you that there are some really good reasons why you could consider investing the $20,000 rather than paying off your mortgage. The interest rate on your mortgage may be very low or you may have paid enough on the principal to significantly reduce the amount of interest that you are actually paying. If so, you could invest in a properly designed portfolio that would allow you to earn more than the lost interest payments and would give your retirement savings quite a boost. Of course, I have assumed that you would be willing to invest the money in a well-balanced portfolio rather than keep it in savings. Otherwise, your current course of action is probably appropriate.

One final thought. Your emotions play a role in this decision as well. If you are intolerant of debt, or you would just "love" to pay off your mortgage because there is something emotionally gratifying about it, then by all means ... DO IT! There is no way for me to measure them, but the emotions of my clients do have a value that must be taken into consideration when determining whether or not something makes financial sense.

More Advice: Corporation a Tax Shelter?