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“FINANCIAL WRITERS always seem to assume everybody’s married.” That’s a complaint I’ve heard more than once—and it came to mind as I reviewed our 2018 tax return.
That tax return reflected the impact of 2017’s tax law, which—among other things—roughly doubled the size of the standard deduction, while capping the itemized deduction for state, local and property taxes at $10,000. One result: Many couples now get little or no tax benefit from either the mortgage interest they pay or the charitable contributions they make. But it’s a different story if you’re single, as I’ll explain in a minute.
To get a handle on what’s going on, let’s start with my wife and me. In 2017, we itemized our deductions, which came to $24,972, comfortably above 2017’s $12,700 standard deduction. But in 2018, we ended up claiming the $24,000 standard deduction, which was above our $22,865 in itemized deductions—and those itemized deductions were even lower, once the $10,000 cap on state, local and property taxes was applied.
Many couples are in a similar situation, and that’s triggered a flurry of financial advice. Experts are now encouraging folks to bunch maybe three years’ worth of charitable contributions into a single calendar year, so the sum is larger, potentially allowing them to itemize their deductions and get a tax break for their generosity. One possible strategy: Dump the big charitable contribution into a donor-advised fund, claim a deduction for that tax year and then slowly disburse the money to your favorite causes.
People have also been rethinking the value of carrying mortgage debt. Suppose you and your spouse pay $12,000 in mortgage interest each year, while also giving $3,000 to charity and claiming the maximum $10,000 deduction for state, local and property taxes. That puts your total itemized deductions at $25,000, above the $24,000 standard deduction.
But that doesn’t mean you’re getting substantial tax savings from all that mortgage interest. In fact, arguably, only $1,000 of your $25,000 in itemized deductions are generating any tax benefit—because you could have claimed the $24,000 standard deduction instead. Indeed, forking over that $12,000 in mortgage interest generated extra tax savings of just $220, assuming you’re in the 22% federal income tax bracket.
The upshot: It may make sense for you and your spouse to pay down your mortgage more quickly, especially if you are conservative investors who wouldn’t otherwise buy stocks. What about the absurd advice to “always take out the largest mortgage possible”? It’s now even more absurd. Before 2017’s tax law, every $1 of mortgage interest might have saved you 25 cents in taxes, meaning you were still out of pocket by 75 cents—not exactly a winning proposition. Now, that $1 of mortgage interest might be costing you the full $1.
It may even make sense to sell bonds and other conservative investments, so you can take out the smallest mortgage possible. Today, a new 30-year fixed-rate mortgage might charge 4.3% in interest—and it’ll likely cost you the full 4.3%, or close to it, either because you claim the standard deduction or because your itemized deductions are barely higher. That 4.3% is more than you’re likely to make on bonds and other conservative investments, especially after paying any taxes owed on the interest you earn.
But remember, we’re talking here about married couples filing a joint tax return. What if you’re single? Please ignore everything you just read.
Imagine the same scenario described above, where you paid $12,000 in mortgage interest, gave $3,000 to charity and claimed the $10,000 maximum deduction for state, local and property taxes. Your $25,000 in itemized deductions would be comfortably above 2018’s $12,000 standard deduction for single individuals—which means your charitable contributions and mortgage interest are indeed generating significant tax savings.
That doesn’t mean you shouldn’t pay down your mortgage. I’m a fan of paying off debt, because it reduces risk in your financial life and offers a guaranteed return, equal to the loan’s interest rate. And I think almost everybody should strive to be debt-free by retirement. But for single individuals, the financial case for paying off their mortgage quickly isn’t nearly as compelling as it is for couples.
“Ah,” you might respond. “But I don’t file my tax return as a single individual or as a couple. Instead, I file as head of household. What about me?”
In 2018, the standard deduction for heads of household was $18,000. If your total itemized deductions are barely above that level, you aren’t getting much tax benefit from your charitable contributions and mortgage interest—and, like married couples, you may want to pay down your mortgage faster than required and bunch multiple years of charitable contributions into a single tax year.
Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include On the Other Hand, Five Crashes and Money Matters. Jonathan’s latest books: From Here to Financial Happiness and How to Think About Money.
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What about people, even single people, without a mortgage? In your example, singles would benefit from itemizing, but barely (taking $10K SALT deduction plus a $3K charitable contribution deduction, vs. $12K std deduction).
Rather than selling bonds, they, like married people, should be considering buying bonds. Specifically muni bonds. Because now that they can’t deduct their state income tax (by hypothesis, they’ve maxed out that deduction), the state/local tax exemption of these bonds becomes even more valuable.
Since many single people may be borderline, they should consider bunching their charitable deductions. Again using your numbers, in 2018 they might choose to double up on contributions and get a $16K deduction, while in 2019 they contribute nothing and take the $12K std deduction. That’s $28K in total deductions over two years, vs. $13K + $13K by making the same contributions every year.
Bunching charitable contributions may indeed make sense for single individuals without mortgage interest to deduct. But I wouldn’t make a blanket recommendation to buy munis. Even long-term munis these days yield just 2 1/2% or so. Most folks, who don’t have debt to pay down, would be better off buying taxable bonds in a retirement account.
There is a variant of the board game ‘Life’ called ‘Redneck Life’. It’s clever and funny, but one thing about it that is very true to life is that you don’t want to get stuck with an expensive house, and you don’t want to spend any more than you have to on cars (even if it’s a classic weinermobile.)
We bought a relatively expensive house many years ago due to a variety of reasons including access to a particular school we knew to have great support for our special needs son – I expect it’s going to take all 30 years to pay it off, especially with college looming for our other son. The other option is to sell it and move to a LCOL area, an option that’s always in our back pocket. I do think going into retirement with the mortgage will be ok in our case because we are roughly on track to transition to retirement with 100% income replacement – but it’s also more risk than I’d like to be carrying, since anything can happen in the ten years or so until we retire, and then sequence of returns risk in the years before and after retirement just exacerbates the uncertainty. I’d much prefer to pay it off first, as you suggest.