• Question
  • Pay off mortgage with 401k money?

    Asked by a 64 year old woman from Downers Grove, IL on 3/5/2019

    My husband and I currently have $1,000,000 in retirement savings. In 2-3 years when we plan to retire at age 67 we should have $1,200,000 at our current savings rate. We owe a little less than $200,000 on our mortgage (interest rate 3.875) and don't plan on selling our house when we retire (monthly mortgage payment not including taxes $1,300). We have our retirement savings 50% stocks 40% bonds and 10% cash. Our taxable income in 2018 was around $93,000 and will probably go up over $100,000 in the next couple of years. We estimate our monthly expenses during retirement (including mortgage) to be $6,500. If we take out money to pay off our mortgage with retirement funds over the next 2 years, we would go up to 24% tax bracket. When we retire I think our tax bracket would be 12%. Should we pay off the mortgage?

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  • Categories: Paying Off Debt, Retirement Planning

Answers

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  • I don't think that it makes sense to pay off the mortgage while you are still working and saving. As you noted, taking money out of the 401K would push you into a higher marginal tax bracket. Once you retire it will then become more about whether paying off the mortgage will enable you to sleep better at night. Mathematically, paying off the mortgage could work out to be better, or not. When you are in the lower marginal tax bracket during retirement the mortgage interest tax deduction will be of less value to you. In fact, it's possible that won't itemize deductions and the mortgage interest deduction would be moot. Paying off the mortgage would guarantee you a 3.875% return. A balanced portfolio such as the one you laid out should generate a 3.875% return or better over the long-term. However, the stock and bond markets have generated generous returns over the last decade and may underperform historical returns for some period of time going forward.

    I would suggest continuing to maximize your savings while working and then readdress this issue upon retirement.

  • Login to rate this answer:   Answered on 3/5/2019
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  • I would probably not recommend paying it off for two reasons:
    1. Your expected return on your portfolio is higher than the cost of the debt. Over time, a portfolio allocated as you have described has an expected return higher than the 3.875% interest rate on your mortgage.
    2. Why pay taxes at a higher rate if you don't have to? Perhaps there is a way to pay extra on the mortgage without pushing yourself into the higher tax rate? You don't have to pay the mortgage off all at once. Maybe paying a little more would get it paid off sooner, but also allow you to effectively manage your tax rate.

    The only thing that could potentially change the answer is looking at your potential tax rate once you are both over age 70, have Social Security and your RMDs. Your tax rate may be 12% at 67, but if most of your $1M is in tax-deferred accounts the tax rate is likely to be higher once you are both over 70. There may be an opportunity to pull funds out between age 67 and 70 that would allow you to pay off the mortgage over those three years and have the effect of reducing your tax rate later.

  • Login to rate this answer:   Answered on 3/5/2019
**All above answers are provided as general information only. No warranty is made regarding the fitness or accuracy of the information provided in this answer. You should seek advice from a licensed CPA, attorney or CERTIFIED FINANCIAL PLANNER™ as to your unique financial situation.