Does It Make Sense to Decrease Your Retirement Savings to Pay Down Your Mortgage?

Townhall.com ^ | October 27, 2010 | Carrie Schwab Pomerantz

[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.

[Logic n' Reason]

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.

NOW you tell me!!!!!

I'm 72...still working....have a huge mortgage....and the little tin god says he needs me to contribute to his campaign funds.

What's a body to do??????????????

[No Truce With Kings]

Since there is an employer match involved, I’d say the answer is no. At least up to the employer match.

If this guy is putting 8% of his income into an IRA and the employer is matching that, ending his contributions gives him what is effectively an 8% pay cut. He goes from earning 108% of his base pay to his base pay. He would be better off continuing the IRA contributions and using the employer match to pay down his principal when he retires.

If OTOH he is putting more than 8% of his salary into the IRA, it would probably make sense to cut his IRA contributions to 8% and applying the difference to the mortgage. For example, if he is putting 12% of salary into the IRA, reduce the contribution to 8% and apply the take-home of the other 4% to the mortgage.

[tbw2]

That only works if:

1. You still have an income.

2. The stock market is still allowed to make a profit

[muawiyah]

If you're still paying a mortgage it's probably pretty much the same as "rent" once you deal with taxes, et al.

As the most recent real estate crash demonstrated there ain't nobody nowhere no how who can escape those crashes.

Think of your house as a place to live.

[cmwy]

This is a no brainer. Where in this market can one buy a no risk investment paying 4.75%. The answer is no where. Unless there is some high payoff penalty paying off the mortgage is like buying a no risk investment that yields 4.75% a deal that can be found nowhere. Don't get confused by the tax deduction as it means nothing. Take your after tax return of 3.15%(assuming 30% bracket) which is your mortgage payment and save it don't spend it. Keep putting into 401k to get the employer match.Do it this year as taxes will probaly be higher next year

[posterchild]

1. You still have an income.

Even if you don't have an income at that point you will have the 401K savings to live on rather than having all of it prepaid on the house debt.

2. The stock market is still allowed to make a profit

There are a lot of bad things that could happen either way. If we look at that doomsday scenario we could just as easily look at his property taxes becoming unbearable causing him to lose his paid off house and have no money in the IRA.

[Prokopton]

Debt is for poor people, not folks with $$!

The wealthiest people I know, and a few are really wealthy, also have the most debt. It's not hard for them to manage it, but the debt is still there.

[dfwgator]

Debt isn’t measured in terms of absolute dollars, it’s the debt/assets ratio that matters. Rich people will have debt, it makes sense, since it frees up other assets that can have a better return than the cost of the debt.

[shove_it]

Going into retirement with a mortgage is a bad idea. People need to pay off their mortgage before they retire.

After retiring nine years ago, my ARM has adjusted down to 3.25%. That's practically free money. Why would I take money from my investments, which are beating the market, to pay off my mortgage? Many mortgages are based on the Libor which is at 0.76538 as of last Friday.

[hinckley buzzard]

This decision should be deferred until the future fate of taxes becomes more clear. And, there are the menacing sounds coming from the "deficit reduction" cabal which will issue a report sometime before year's end.

[HonestConservative]

Did it.

I am glad.

Of course our morgtage was already paid down to under 20 grand, but it was nice to be rid of it!!!!!!!

[Attention Surplus Disorder]

LOL. How much is postage to the present, or do you have automatic debit?

[DrC]

“Where in this market can one buy a no risk investment paying 4.75%. “

Well, for every dollar of 401(k) savings that is matched by the employer, the rate of return is 100%! So as others have noted, it absolutely makes no sense to divert any contributions that would otherwise have gotten an employer match (even if the match is only 25%).

[DrC]

“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.”

For those who failed to take your sensible advice (such as the individual raising this question), I don’t understand the following logic:

“It’s probably safe to assume that you’re going to need basically the same amount in retirement as you’re living on now.”

If someone currently is spending 25-30% of their annual income on housing payments and they pay off their mortgage the very day they retire, won’t their retirement expenses be about 20-25% lower? The only on-going expense once the house is paid off are taxes and insurance, or do repair costs in retirement magically rise to equal the amount previously paid to the mortgage lender?

[668 - Neighbor of the Beast]

Aside from the fact that some people (such as I) find a mortgage psychologically intolerable...
You might want to think about the relative security and vulnerability of retirement fund and house.
Which one is easier to steal? Which one do more predators want? Which one goes easily from this column to that column in the account books?
The answer is clear. The predators who would take anything from you that they could, really don’t want your house. It’s a liability. It takes a lengthy court process to acquire, it has to be insured and maintained at least minimally, and the predator has to work within certain regulations as to how long he can hang onto your repo’ed house before he can dump it for a fraction of its market value. It racks up taxes that he (and/or his shareholders) have to pay. In this market, it might sit there racking up rats and other code violations too.
Your retirement fund has none of these shortcomings, aside from a few regulations not so deeply carved into law as your legal rights w/r/t a mortgage on your primary residence.
In short, if someone’s going to rob you, they’re more likely to steal your cash than your German Shepherd. It’s just easier.
Therefore use the money while you still have it, because they’ll be coming for that first; and while it is no picnic for them to repo your house...they will eventually have to if you no longer have a retirement fund with which to pay your mortgage.

Better yet (though you didn’t ask), sell the house, get a much smaller cheaper place for full cash, in an area with low taxes. Go to realtor.com and shop around. There are still lots of places in America where a wonderful house in the country can be had for way less than $100k.

With the money you save, invest in precious metal: such as lead.
:)

[ridesthemiles]

TAKE YOUR money out of your 401 (k) before NObama seizes it. Pay the taxes. You are over 60, so you have no penalties.

Do it now. IMO, NObama will go after the retirement accounts between Nov 2 & Dec 31. It is too much of a lure for his cheating heart to ignore. He thinks that $$$ you have saved is money that you STOLE from his ‘homies’.

Whether you keep YOUR money in a safe at your house or you pay down your mortgage is up to you. Don’t put it into any kind of bank account. Too easy to trace.

There is toooo much talk of dropping the mortgage interest deduction on your tax return in the very near future. Maybe as soon as 2011 or even 2010 in a retroactive manner.

I suggest you get the 401 money into your own hands——NOW!!! There will be no warning by NObama. It will be electronically taken over a weekend. That is what Argentina did in June of 2009-—over $68 BILLION worth.

Then sit down with your tax preparer & do a couple/3 different ‘test returns’.
Do one with still having the mortgage & being able to deduct the interest.

Do one with still having the mortgage & NOT being able to deduct the interest.

Do a monthly budget where you no longer have a mortgage payment.

Look at it from all possible directions you can & then decide what to ‘pay down’.

Getting YOUR $$$$ into YOUR hands is the first priority.

I am NOT kidding about NObama taking it all.

[bert]

You are the only poster so far that understands the issue.

In many locations, house values will rise. The inflation of the house value and the devaluation of the dollar will both earn you money. The devaluations touted in the press are not universal

As a further incentive, if you invest properly, you should take the amount required to pay the mortgage and earn a higher return that 4.75% and the rate of inflation.

It requires work and attention but is the way to go if you are financially literate.

[ridesthemiles]

In many states, you cannot be tagged for an early pay off.

[sportutegrl]

Paying off a mortgage early is absolutely the best investment you can make, unless, of course, you plan to let Obama take over the payments for you.

It's still better than letting Obama take your 401K from you.

[Iron Munro]

In today’s economy no single answer fits everyone.

If you are in a high income tax bracket and paying 10% to 20% or more on income but only paying 6% on a mortgage you may come out ahead by itemizing deductions and protecting some income with a mortgage deduction.

Crunch your own numbers or have your accountant run a few scenarios for you.