The two most important tax benefits contained in the tax code can be very interrelated.  What are these two important tax benefits?

1. The first is the ability to deduct the taxes and interest of a home mortgage.  This benefit allows you to lower the effective cost of your mortgage payment typically by 20% or more, depending upon your tax bracket.  When you combine this with the fact that the vast majority of the rest of your mortgage payment is comprised of principal, which lowers your mortgage balance, this is why home ownership is such a great bargain as compared to renting.

2. The second is the ability to fund retirement plans, the contributions to which reduces your taxable income. Whether you contribute to an IRA, 401K, SEP or other plan, the fact that you can put thousands of dollars away each year, and at the same time lower your tax burden, is a major tax and retirement benefit.  Many of those who are employed also enjoy a second benefit of employer sponsored contributions to these plans.

The next question is, how are these two benefits related?   On the home side, there is tremendous equity in homes in America.  For example, Zillow has reported that approximately 30% of the homes in America have no mortgage at all.  Many more have more than 30% equity in their homes, with the Federal Reserve reporting that total national home-equity topped $15 trillion in 2019.

On the other side of the coin, the Bureau of Labor Statistics show that just over 50% of Americans participate in a retirement plan at work.   With this statistic, it is not surprising that a recent Retirement Confidence Survey of the Employee Benefit Research Institute (EBRI) shows that retirement confidence among Americans is at near all-time lows, with only 18 percent reporting they are “very confident” that they’ll have enough money to retire comfortably and 37 percent reporting that they’re “somewhat confident.”

Basically, when you look at these two sets of statistics side-by-side, you can see why there is a relationship and more importantly an opportunity. There are hundreds of thousands of Americans who have substantial equity in their homes but under-funded retirement plans. This means that they are not taking full advantage of all the tax benefits available to them, as well as not preparing for retirement.

The solution is to remove equity from the home to fund the plan, via a “cash-out” refinance or a second mortgage.  With interest rates low and the possibility of the payments being tax deductible (consult with your tax advisor to know for sure), removing equity from the home will increase your payments only marginally.   The payment may not go up at all if you are lowering your rate on your present loan as well.  When using the money to fund a retirement plan, the cost will be offset by the tax benefit of retirement contributions.

In the long run, borrowing at a low “tax deductible” rate and investing the money could be beneficial even without the retirement tax deduction. Non-retirement money could be reinvested in stocks, bonds or even through purchasing additional real estate such as rental properties.  If the returns exceed the minimal financing costs, you come out ahead without the benefit of retirement tax savings.

Should you make this move? We would advise you to get with a financial advisor who works with a mortgage consultant so that you get the best advice possible. If you coordinate with one without the other, you may not receive the best plan maximized to achieve your long term financial goals.