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Does It Make Sense to Decrease Your Retirement Savings to Pay Down Your Mortgage?
Townhall.com ^ | October 27, 2010 | Carrie Schwab Pomerantz

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.


TOPICS: Business/Economy; Editorial
KEYWORDS: 401k; personalfinance; retirement; savings
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To: RegulatorCountry

LOLOL - this thread needed a comedy break.


61 posted on 10/27/2010 4:45:41 PM PDT by GnuHere
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To: bert

I have very little worry about my debts in the coming era of inflation. What I (and anyone else who gets it) need to worry about is keeping my income ahead of the inflation curve. If you are retired and on a fixed income you are in a for a world of hurt.


62 posted on 10/27/2010 4:54:41 PM PDT by azcap (Who is John Galt ? www.conservativeshirts.com)
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To: DrC
Everyone should remember that at age 71 you have to take out what the government determines based on your life expencency....(and for some reason they need to know the age of your oldest child) neither myself or my financial guy know why this is necessary.

I have to take out double what I have taken out for the prior years....puts me in a higher tax bracket so I will probably be paying more income taxes which I haven't had to pay outside of what I tell my guy to deduct from my IRA.

63 posted on 10/27/2010 5:01:10 PM PDT by goat granny
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To: Kaslin

Paying off a mortgage early is a terrible financial choice.

I base this on the following:
1) All variable interest debts (Credit cards, heloc, etc) must be paid off first. Because:
2) Inflation is set to get off an running in a big way, meaning..
3) fixed interest loans will be bargains in a new economic reality, because new loans will have high interest rates and variable interest instruments will run up with inflation.

Hopefully, the mortgage interest deduction will still offer you added incentive by knocking down your tax exposure, effectively lowering your fixed interest rate even further.

And hopefully, your 401k investments are better suited to match inflation and increase your nest egg than equity in a fixed asset with questionable liquidity; your home.


64 posted on 10/27/2010 5:26:55 PM PDT by sbMKE
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To: Kaslin

We paid off our house and have nothing else saved.

Was that correct? Probably not, but we have a lot of confidence that we will survive the future. We lost practically all our retirement in stock market failure after we had paid off house.

We are in our middle and late 60’s and will probably be left on social security retirement, but at least our home (condo) will be paid for.

It feels good whether it was correct or not.


65 posted on 10/27/2010 5:49:36 PM PDT by arjay (2010 Old blood out. New blood in.)
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To: A CA Guy
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?

If I'm reading your question directly, it's not the state, it's the lender that imposes any early prepayment penalties.

We paid off both our homes years early, and have never ever come close to regretting it - "tax deductions" and whatever contrary advice be damned.

There is absolutely no better feeling, unless you're a 16 year old boy getting boinked by a hot teacher, than getting the 'note paid' letter on your home.

66 posted on 10/27/2010 5:56:40 PM PDT by ErnBatavia (It's not the Obama Administration....it's the "Obama Regime".)
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To: ErnBatavia

Each to his own.
I could pay mine off tomorrow but am pleased as could be that they will loan me money below 5% fixed for 30 yrs and let me deduct the interest.


67 posted on 10/27/2010 6:04:07 PM PDT by nascarnation
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To: DrC
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?

No, medical expenses will likely eat that up.

68 posted on 10/28/2010 5:17:01 AM PDT by EVO X
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To: Kaslin

I thought it made sense to me to do it at this point in time, since 0b0z0 and the Dems have designs on 401(k) and IRA plans. However, once 0b0z0 and the Dems get thrown out of power, I shall resume saving and making regular mortgage payments.


69 posted on 10/28/2010 5:20:45 AM PDT by Tolerance Sucks Rocks (Muslims are not the problem, the rest of the world is! /s)
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To: goat granny

“and for some reason they need to know the age of your oldest child) neither myself or my financial guy know why this is necessary.”

I think it’s because once you die, the IRA reverts to your designated beneficiary(ies) and IRS uses age of oldest child to figure out drawdown rate even if you’ve named multiple children.
http://www.estateattorney.com/irabenef.htm

Obviously, they could get this info after you died, but maybe they want it declared in advance to avoid any shenanigans.


70 posted on 10/28/2010 9:21:47 AM PDT by DrC
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To: ErnBatavia
You are right, and debt free is great in this Depression.

I think there is a law that despite the loan's contract as to fees for early pay off, I think there is a law that after 7 years they can not add a fine for paying off early.

I heard something like that. I'm not sure, so I put it out there. I'm like 90% sure on that one though.

You want to see people lose homes though, if taxes go on homes based on market values a lot of people would have to give up their homes. It would be like having an additional $500 a month each month to the state for no good reason.
$500 when you get older or retire or if you big pay days were in times when people got paid less is a lot of money a month.
In CA when they remove prop 13, all hell will break loose IMO.

71 posted on 10/28/2010 10:37:13 AM PDT by A CA Guy ( God Bless America, God bless and keep safe our fighting men and women.)
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To: Hoosier Catholic Momma; CottonBall; TenthAmendmentChampion; Chickensoup; JDoutrider; ...

Baby steps 4, 5 and 6 discussion. Thanks Day10 for the heads up.

Dave Ramsey Fan Ping List.

If you would like to be added to the “Live like no one else, so that you can LIVE like no one else” list, feel free to Freepmail me.


72 posted on 10/28/2010 11:23:59 AM PDT by CSM (Keeper of the "Dave Ramsey Fan" ping list. FReepmail me if you want your beeber stuned.)
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To: nascarnation

“I could pay mine off tomorrow but am pleased as could be that they will loan me money below 5% fixed for 30 yrs and let me deduct the interest.”

Keep in mind that in essence this would mean that you are sending the bank $10K to avoid sending the gov $3K. (yes, the numbers are examples only.)


73 posted on 10/28/2010 11:37:00 AM PDT by CSM (Keeper of the "Dave Ramsey Fan" ping list. FReepmail me if you want your beeber stuned.)
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To: CSM

Don’t forget I have the use of the borrowed money (the principal that I took out). Based on my 40 yr investing record (thank you Lou Rukeyser) I sleep well at night.


74 posted on 10/28/2010 1:25:44 PM PDT by nascarnation
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To: CSM

You ruin the conversation when you come in with actual indisputable logic.


75 posted on 10/28/2010 3:41:22 PM PDT by B4Ranch (Conflict is inevitable; Combat is an option. Train for the fight.)
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To: DrC

>>or do repair costs in retirement magically rise to equal the amount previously paid to the mortgage lender?<<

Looking back I have to say they do because now you have time to all those little things that you contemplated years ago such as putting in the brick fireplace, extending the deck, correcting the irrigation flaws. You know those little things that you could get by without doing when you were working.


76 posted on 10/28/2010 3:46:34 PM PDT by B4Ranch (Conflict is inevitable; Combat is an option. Train for the fight.)
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