Everything has a cost. Conservative investments miss out on earnings. Mortgagees pay interest. Retirement plan participants pay taxes on distributions. It is important to weigh these costs relative to each other when making financial decisions like paying off a mortgage.
Q: I am 59 years old. Currently my retirement pension is $ 6,500 dollars net a month, with a cost of living raise, for the rest of my life. I am working now and earning $ 4,100 net a month. I have 11 years to pay off my mortgage at $ 1,800 a month. I refinanced my mortgage to 3% in 2012. Should I take money out of my tax sheltered annuity, to help pay off my mortgage?
A: Stan, I have been advising retirees for over a quarter of a century and have yet to have any of them tell me, “Darn it. I wish I still had a mortgage”. I share that just to make the point that this is not purely a financial issue.
Mathematically, if you earn more on your money than you pay in interest, your net worth is better off by not paying down the mortgage.
At first blush earning enough may seem easy. Your after-tax cost of borrowing may be a bit less than 3% if you itemize deductions on your tax return but even if its 3%. Historically, the odds of beating that over 11 years with a decent portfolio are good. Now if you intend to keep the funds in cash, you are not likely going to earn enough.
The more difficult issue though is taxes. You didn’t mention a spouse so with an income of $ 127,200 you are probably in the 28% tax bracket. “Tax sheltered annuity” can be a lot of things but it is a common name for a 403(b) plan. When the cash comes from a retirement plan like that, for every $ 1,000 you want to put toward the mortgage balance, you need to withdraw $ 1,388. If you took out enough to get you in the 33% bracket (over $ 191,650 in total taxable income for a single), the withdrawal to net $ 1,000 is $ 1,493.
An $ 1,800 payment for 11 years at 3% implies a mortgage balance of about $ 202,000. An immediate payoff would save you over $ 35,000 in interest. An immediate and full payoff would cost a lot more in taxes than $ 35,000.
If the annuity is the only source of cash, a better strategy would be to withdraw maybe only a little each year and only take out larger amounts when you have a lower income year or after you retire. Your pension payments will make it very challenging to get below a 25% bracket but you can make sure the withdrawals aren’t any more costly than that.
Dan Moisand’s comments are for informational purposes only and are not a substitute for personalized advice. Consult your advisor about what is best for you. Some questions are edited for brevity.
Dan Moisand is a principal at Moisand Fitzgerald Tamayo, LLC in Melbourne and Orlando, Fla. He is a past national president of the Financial Planning Association (FPA), and has served three years on the CFP Board of Practice Standards crafting the standards to which all U.S. CFP’s must adhere and was chairman of the CFP Board’s Discipline and Ethics commission.