Skip to comments.Does It Make Sense to Decrease Your Retirement Savings to Pay Down Your Mortgage?
Posted on 10/27/2010 1:25:57 PM PDT by Kaslin
Dear Carrie: I'm 60 and will probably retire between age 66 and 70. I currently have $375,000 in IRA/401(k) funds and I'm adding 8 percent of my income annually. My employer matches a portion. I still have a mortgage of over $165,000 at 4.75 percent.
I'm wondering... should I stop my 401(k) contributions and apply that money in extra principal on my mortgage? If I do, I'd pay my house off in about 10 years, making life a lot easier when I retire. But I'd lose the tax advantages as well as the employer match. One idea is to contribute enough to get the match and put the difference toward the mortgage. I'm swimming in possibilities! -- A Reader
Dear Reader: First let me congratulate you on doing some smart thinking in exploring the alternatives for paying off your mortgage. Not having a mortgage in retirement can be a real plus.
But first things first: Under any circumstances, I absolutely agree that you should keep contributing at least enough to your 401(k) to capture the employer match. At your age -- and with possibly 10 years before you retire -- it's crucial to keep saving. In fact, the real crux of the matter is: How close are you to your retirement goal?
Decreasing your retirement savings to pay off your mortgage is a trade-off that takes money from one pocket to put into another. Before you make this decision, I think you should step back and take a more holistic view of your financial situation. Here are some things to consider:
HAVE YOU SAVED ENOUGH FOR RETIREMENT?
Now would be a good time to realistically assess how much money you think you're going to need when you retire. It's a simple formula.
-- First, determine what your annual expenses will be. It's probably safe to assume that you're going to need basically the same amount in retirement as you're living on now.
-- Next, subtract your projected annual Social Security benefit (plus any other source of income you may have, such as rent) from your spending needs.
-- The result is the amount you'll need to withdraw yearly from your retirement savings to cover your expenses.
Now take a hard look at your savings. Will $375,000 -- even assuming a 5 percent annual growth rate for the next six to 10 years -- be enough to give you the type of retirement you want? Industry experts suggest that you withdraw no more than 4 percent of your portfolio in your first year of retirement, adjusted annually for inflation, to comfortably fund a 30-year retirement. Since you plan to retire after age 65, you might increase your first-year withdrawal rate to 5 percent.
So let's say your current nest egg grows to $600,000 by the time you retire. Withdrawing 5 percent would give you an annual income from your portfolio of approximately $30,000. Considering other sources of income, could you live on this? Or do you need to save more? Figuring this out will help you decide how much you can reduce your retirement savings to put toward your mortgage.
WHAT IS YOUR MORTGAGE REALLY COSTING YOU?
This is another important consideration. Mortgage interest is tax-deductible. For instance, if you're in a combined federal/state 30 percent marginal income tax bracket, your loan at 4.75 percent really only costs you a little over 3 percent (assuming full deductibility). Now compare this with what you're averaging on your 401(k) investments. Granted, investing carries risk (as we all know well!) and there's no guarantee that your investments will make a steady return over the next several years, but it could make more sense to keep saving and growing your money now.
On the other hand, paying down your mortgage will reduce your monthly expenses. Once again, it's a trade-off.
WOULD THIS AFFECT YOUR INCOME TAX BRACKET?
You mention losing the 401(k) tax benefit. If you stop or decrease your 401(k) pre-tax contribution, you'll be adding to your taxable income. This could increase your annual income tax bill. Don't forget to factor this in.
WHAT MAKES YOU SLEEP THE BEST?
Crunching the numbers will help you decide what makes the most economic sense. But sometimes it comes down to what gives you the greatest peace of mind. By all means, take steps to pay down your mortgage. Just make sure you don't short-change your retirement savings by diverting too much to your mortgage now.
You might even consider continuing to save at the same rate in your 401(k) and applying any future raises or bonuses to your mortgage. As you say, there are lots of possibilities. I suggest you talk to an adviser to help you make the best choice for both the present and the future.
Does It Make Sense to Decrease Your Retirement Savings to Pay Down Your Mortgage? Maybe ... Maybe Not.
I thought oBAmA was paying out mortgages.
You mean I was supposed to keep paying after Jan. 2009?
With all the talk of the govt federalizing our 401k’s, I would have to seriously consider it.
Of course, the POTUS might answer the question for you, by confiscating your 401K.
Oh Lord this is tough. I say pay off the house due to your age. I mean who knows what is going to be happening with regards to the mortgage deduction by the time you retire. They used to allow deductions for interest on credit cards but took those away....I believe the mortgage deduction is on life support. You still will have a pretty hefty amount in your account for things you may need. Good Luck, but really many people pay off the mortgage and go on to have enough money in retirement.
I agree with you unless their retirement includes taking in borders till the loan is paid off.
Is it AFTER 7 years on the loan they can’t fine you for an early pay off or does that depend on the state?
Get the home paid off, stat!
As a rule of thumb I tell people that if you’re still paying a mortgage past the age of 50, you’re doing it wrong.
Get out of debt and stay out.
I've just been forwarding the bills to 1600 Pennsylvania Avenue, but the bank says they aren't getting the payments. I just don't understand!
If we are entering an inflationary period then he would be better off not paying down the mortgage. Invest the money in ways that are at least inflation neutral and pay the mortgage with cheap dollars later.
Possibly of interest to the Dave Ramsey ping list...........
Conventional wisdom as all the others have said is to pay off your home first. That is always the safe choice, pay off your debt, own your home free and clear, but consider if hyper inflation or even severe normal inflation 10-20% a year comes. The debt you owe on your home is fixed in dollars that will progressively become worth less. If you invest your extra money now in inflation-proof or inflation benefited investments you will be better off in the long run. In a normal economy the longer you wait to pay your house off the more it costs you. In a high inflation economy the longer you wait to pay it off the less it costs you.
I started doing the same thing until 2 years ago when my husband was laid off.
I changed my 401k to 3% which is what my employer matched up to and then took the rest and put that and all extra dollars, bonuses, etc, towards house.
I hate to have any kind of debt.
The question should have been, “Does it make sense to liquidate your IRA, pay the penalty, and pay off your mortgage before the government STEALS the IRA?”
I went the other way when I retired.
Pulled out all my equity and borrowed sub 5% fixed for 30 yrs.
I plan to pay it back with Baraqqi minibucks.
Yes, you'll want to get that done first so the bank can steal your house without complications. :)
Why pay off a mortgage now when you can pay it off in 10-20 years with dollars that will be much cheaper than they are today?
I lived through the Carter years.
I saw what inflation can do.
I believe Turbo Tax Tim, Helicopter Ben, and Baraq are gonna make inflation happen somehow.
So my financial bets are on inflation.
All the theoretical possibilities in the world don’t outweigh securing the value of savings by ridding oneself of debt. Invariably, when people start calculating what-ifs based upon out year assumptions like this, they neglect to include interest not paid as a benefit of debt reduction. A sixty year old is on thin ice as far as continued employment in this economy, so purported future employee match on 401k is tenuous, as is the 401k itself, what with ongoing discussions regarding seizure of pretax accounts such as this.
Cut your overhead and bank the difference for as long as you can. Is there some scenario a broker might cook up to make this sound less than ideal? Sure there is, he or she stands to benefit from churning your accounts. They’re not exactly unbiased observers. The security of having little to no debt in a bizarrely uncertain economic situation far outweighs potential returns right now and for the foreseeable future.
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