Retiring with a mortgage or other debt: what to weigh before and after the last paycheque

How debt changes a retirement budget

In your working years, mortgage payments come from a salary. In retirement, they come from CPP, OAS, pensions and withdrawals, and most of those are taxable. If your marginal rate is 30%, every $700 of after-tax payment needs about $1,000 of taxable withdrawal.

Debt also adds a fixed cost to a budget that otherwise has some flexibility. In a year when markets fall, a retiree without debt can trim travel or delay a purchase. Required payments can't be trimmed, which can mean selling investments at a low point. Our retirement budget guide has more on separating fixed and flexible costs.

Not all debt is the same

The case for paying off a debt depends on its interest rate, whether the rate is fixed or variable, and when it renews. A few broad categories are worth separating.

It also helps to separate debt you chose from debt that crept in. A mortgage on a home you intend to keep is a planned cost with a fixed end date, while a revolving balance on a line of credit or a card often signals that spending and income don't yet line up. The first can often be scheduled into a retirement budget; the second is usually a reason to revisit the retirement budget before deciding how to pay it down.

• High-interest consumer debt, such as credit card balances: the interest cost is usually far higher than any reasonable return assumption, so it tends to be the first target.
• A mortgage at a fixed rate: payments are predictable until renewal, but the renewal rate is unknown and lenders will assess the application on retirement income.
• A secured line of credit or home equity line of credit: flexible, but usually variable-rate and callable, and interest-only payments can leave the balance unchanged for years.
• Car loans and other instalment debt: shorter terms, which may end naturally in the early retirement years.

A worked example: Tom and Gail's mortgage

Suppose Tom and Gail are both 63, live in Ontario and are retiring this year. Together they have $520,000 in RRSPs and $90,000 in TFSAs. Their CPP estimates at 65 are $1,100 and $700 a month. They also have $150,000 left on their mortgage, and they're wondering whether to clear it right away from Tom's RRSP.

Leaving the mortgage aside, the calculator estimates their savings, CPP and OAS could support about $60,100 a year of after-tax household spending to 95, assuming 5% returns in retirement and 2% inflation. Mortgage payments would come out of that amount while the mortgage lasts.

The tax cost of a lump-sum payoff

RRSP withdrawals are taxable in the year you take them. Suppose Tom's other income this year is $30,000, on which the calculator estimates about $2,756 of Ontario and federal tax. If he withdraws $150,000 from his RRSP in the same year, his income becomes $180,000 and his estimated tax jumps to about $54,367, with a marginal rate of about 45%.

That's an extra $51,611 of tax, so the withdrawal would leave only about $98,389 after tax, not enough to clear a $150,000 mortgage. To pay it off fully in one year he'd need to withdraw considerably more, at that same high marginal rate.

Spreading the withdrawals instead

Now suppose Tom withdraws $30,000 a year for five years instead, also totalling $150,000, and uses it toward the mortgage. Each year his income is $60,000, and the calculator estimates his tax at about $8,817, or about $6,061 more than on $30,000 alone.

Over five years, the extra tax totals about $30,307, rather than about $51,611 in a single year. The mortgage takes longer to clear, so they pay some interest in the meantime, and the comparison also depends on what the RRSP money earns while it waits. But the tax difference alone is substantial.

If Gail also has RRSP savings, splitting the withdrawals between them could lower the tax further, because each spouse has their own brackets. And once Tom is 65, any withdrawals that come out of a RRIF can qualify for pension income splitting.

What paying off debt does to the rest of the plan

Clearing debt from savings shrinks the portfolio but removes a fixed cost. In Tom and Gail's case, if roughly $190,000 left their RRSPs to cover the mortgage and the tax on it, the calculator estimates the remaining savings could support about $52,800 a year of household spending to 95, instead of about $60,100. Without mortgage payments, though, more of that spending is truly discretionary.

OAS adds another consideration from 65. A large one-year withdrawal can push net income above the 2026 OAS recovery threshold of $95,323, triggering a 15% recovery tax on the excess. Tom, at 63, isn't receiving OAS yet, but a retiree over 65 doing the same thing could see part of that year's OAS recovered. The OAS clawback guide explains the rules.

TFSA money and non-registered savings can also be used to reduce debt without adding taxable income. TFSA withdrawals don't affect OAS or GIS, and the room returns the following calendar year.

Planning ahead and alternatives

Because lenders assess retirement income when you apply for or renew credit, some people arrange a line of credit or plan a renewal while they're still employed, and confirm the terms in writing. Others look at downsizing to free up equity; our guide to downsizing and home equity covers that, including reverse mortgages.

Debts don't disappear at death; they're generally paid from the estate before anything passes to heirs. Estate planning basics covers how that works.

The retirement tax estimator can compare a lump-sum and a spread-out withdrawal for your own income, and the retirement plan tool shows how your savings hold up with or without the payoff. If debt feels unmanageable, a non-profit credit counselling service is one place people look for help.