Advice for Widow re: Mortgage/Taxes/IRA

[SoReadyToRetire]

Hi. My widowed sister, age 60, has $120K left to pay on her mortgage.

Luckily, many years ago she bought stock in a company a friend started, inside of an IRA. That stock split, grew, split, grew, etc--and now she has enough to pay off her mortgage in that account.

I'm a huge advocate of paying off a mortgage asap--esp. when you're alone. So I'm encouraging her to sell all that stock and take the money out to pay off her house. It'll be a huge relief to her not to have that mortgage payment.

HOWEVER, here's the question--since the stock is inside an IRA, when she sells it and take the money out, will it be taxed as regular income? That's what I'm assuming. So the means she'll ALSO need to have the money for a tax bill on $120K at the end of this year--correct?

She makes $40K/year (still working--not FIREd). So I'm thinking figure out her personal tax rate, and add that amount to the amount needed to pay off the house, and she'll be all set--right? (Meaning don't sell the stock quite yet--got to wait for it to go up enough to pay the taxes too.)

Thoughts? Thanks.

 

[Teacher Terry]

If she doesn’t have other substantial savings I wouldn’t pay off the mortgage.

 

[Scrapr]

Money coming out of an IRA is ordinary (regular) income. One of the disadvantages of holding a fast growing stock in a tax deferred account. You lose the Cap gains.....but you still have a bunch of $$$

I would just pay as agreed

 

[harley]

Yes, she'll have to pay taxes on the withdrawal from the IRA. That would likely push her into a higher tax bracket, too.

Personally I wouldn't pay off the mortgage. One option would be to slowly sell the stock within the IRA, and withdraw enough each year to make the mortgage payment. That would give her the relief from the payment without having to make a major tax payment. Or, if she thought the investment wasn't a good one long term she could sell the whole thing, but again just withdraw enough each year to make the mortgage payments. Again, the same financial relief as paying it off, but without the tax hit and with the flexibility to change her mind later.

 

[REWahoo]

^ What harley said.

I'm a big fan of ridding myself of debt, even delayed retiring for a year in order to pay off my mortgage early. However, I wouldn't be willing to take the large tax hit this would require to be mortgage free, especially if it would totally wipe out my nest egg as in this case.

 

[Hermit]

There are many ways to approach moving money from a tax deferred account. I am a fan of coming up with a few reasonable approaches and then doing the math to determine which approach nets your friend the most money. Your approach is one way and it would eliminate interest expense on the mortgage. Other approaches will minimize taxes or maximize returns or some combination of the above. Your friend could go to a financial planner for help, but there is a good chance that planner would be interested in making money on your friend's money. She could also bring her financial information to this forum and get lots of ideas and solutions for a complete financial plan that would be worth what she paid for it and likely a lot more.

 

[Mdlerth]

Stand by with the smelling salts

HOWEVER, here's the question--since the stock is inside an IRA, when she sells it and take the money out, will it be taxed as regular income? That's what I'm assuming. So the means she'll ALSO need to have the money for a tax bill on $120K at the end of this year--correct?

You are correct. Sis would have to withdraw enough to pay off the note PLUS cover the tax on the withdrawal. She probably has no idea how much going from grossing 40k to >160k will tack on. Trust me, it's gonna be sticker shock.

If she doesn’t have other substantial savings I wouldn’t pay off the mortgage.

+1 Being free of the mortgage may be a relief, but raiding the retirement chest to do it is not the wisest strategy.

 

[RunningBum]

I'm a huge advocate of paying off a mortgage asap--esp. when you're alone. So I'm encouraging her to sell all that stock and take the money out to pay off her house. It'll be a huge relief to her not to have that mortgage payment.

Is she the one saying it'd be a huge relief, or are you projecting that on her based on you're being a huge advocate of paying off the mortgage? She should feel just as good having the means to pay off the mortgage.

I would definitely advise spreading out the IRA withdrawals over time to level out the tax bill rather than take a huge hit one year.

How about taking out just enough each year to make the 12 monthly mortgage payments, perhaps plus the extra income tax that will be due. So if she has a $1000 monthly mortgage, take out $12,000 for the mortgage and maybe an extra $2000 for the taxes. This way she gets the relief from the mortgage payment, without that huge tax bill.

If she still has the stock in the single company, I would diversify. Too much risk of her stash disappearing if it's heavy in one company.

 

[pb4uski]

Hi. My widowed sister, age 60, has $120K left to pay on her mortgage.

Luckily, many years ago she bought stock in a company a friend started, inside of an IRA. That stock split, grew, split, grew, etc--and now she has enough to pay off her mortgage in that account.

I'm a huge advocate of paying off a mortgage asap--esp. when you're alone. So I'm encouraging her to sell all that stock and take the money out to pay off her house. It'll be a huge relief to her not to have that mortgage payment.

HOWEVER, here's the question--since the stock is inside an IRA, when she sells it and take the money out, will it be taxed as regular income? That's what I'm assuming. So the means she'll ALSO need to have the money for a tax bill on $120K at the end of this year--correct?

She makes $40K/year (still working--not FIREd). So I'm thinking figure out her personal tax rate, and add that amount to the amount needed to pay off the house, and she'll be all set--right? (Meaning don't sell the stock quite yet--got to wait for it to go up enough to pay the taxes too.)

Thoughts? Thanks.

First thought.... don't give up your day job because you don't have a great future as a financial advisor.

Of course it will be taxed as regular income (assuming her contributions were deductible which is the typical case).

What is the mortgage interest rate? If it is 3-4% then terrible advice.

It seems to me that you are pushing her in a direction that you like because you don't like mortgages and in the process are giving her bad advice. She'll pay about 8% in federal income taxes on her $40k of earnings and then 22%/$27k on the $120k IRA withdrawal... plus she'll need to withdraw more to pay the taxes.... very bad idea.

How soon before she retires and what does she expect her sources of income and marginal tax rate to be in retirement?

 

[pb4uski]

.... If she still has the stock in the single company, I would diversify. Too much risk of her stash disappearing if it's heavy in one company.

+1, especially at 60 years old... not much runway to recover if the stock goes poof.

 

[cathy63]

When did she become a widow? If she lost her spouse in 2019, then she can file taxes as MFJ for this year. That gives her access to the higher standard deduction and tax brackets for married couples, so this is an opportunity to withdraw from the IRA or convert it to a Roth IRA while paying lower tax rates.

I do agree that you haven't given us enough information to justify paying off the mortgage early. How much does she have in savings besides the IRA? What is the interest rate on the mortgage and how long before it would be paid off under the existing terms?

 

[Katiek]

Is this all (or most) of the money she has saved for retirement? If so, I wouldn't spend it all at once (especially since income tax would need to be paid right away). It is nice to have no mortgage and that adds a level of security, but there could be other emergencies that come along as well.


However, if this investment is all she has for retirement, then I would second what some people have said about diversifying a bit more or at least taking some of the gains off the table by selling stock within the IRA.

 

[CRLLS]

One should not make a decision like this without a total picture of her financial picture/plan. Does she plan on retiring at 62 or 70? What will her monthly SS be like? What other sources of income will she have? what will her monthly income be at that time? Is there an inheritance in her future? And the list go on.....

One should not base a big decision like this considering only one aspect like eliminating a mortgage payment. If you cannot help her build a plan, then a professional should be sought out IMO.

 

[SoReadyToRetire]

Lots to think about

Wow--thank you for all the responses. Lots to consider here. I'm glad I asked this question.

This IRA is *not* all she has saved for the future. She has at least one other IRA with a similar balance, plus a 401k at her current job. I'll get more info on those totals when I get home tonight and post an update here. (If memory serves, though, I think she has about $100K in the other IRA and $60 in her current 401k.)

She was widowed nearly 10 years ago, so has had to struggle. Lost her husband just 4 years after they married and had just bought a house (they paid $199K for it). She happened to be between jobs when he died, so she had to hurry up and find one. I'm extremely proud of her for how she has handled everything since that awful time.

Here's what gets me: She's still at the point of paying twice as much in interest per month as principal. In other words, out of a $730/month payment, principal is $257 and interest is $472! So I thought if she paid it off early, she'd save a ton in interest, plus she could put that $730/month that she'd no longer be paying out into some much-needed maintenance on the house, to keep its value up. (It's worth about $300K now.)

Interest rate on her mortgage is 4.75%.

 

[RunningBum]

My suggestion holds. Don't be dismayed by that interest. If she keeps it invested instead, she could probably make more than that.

4.75% is a little high. You might look at having her refinance it if she can qualify. If she can't, maybe make double payments out of her IRA to speed up the payoff without a huge one time tax hit in a larger bracket.

I'm kind of guessing here because I still don't have the whole picture, but I suggest you do a sample tax prep for her with the one time IRA distribution, and see how big the tax bill will be. Compare that to withdrawing $10K or $20K over the years.

It sounds like she did bounce back from her loss well. Don't steer her wrong now. Listen to what people here are saying. Note that nobody is agreeing with your strategy. There's a reason for that. It's not a good idea.

If you and her are really determined to get the mortgage paid off, at least do it over a few years, not a single year.

 

[Sunset]

OP - Perhaps your sister could refinance her home to a lower interest rate ?

 

[kaneohe]

...........................................
If she still has the stock in the single company, I would diversify. Too much risk of her stash disappearing if it's heavy in one company.

+10........just in case you missed the first two recommendations that you do this.

 

[OldShooter]

... If she still has the stock in the single company, I would diversify. Too much risk of her stash disappearing if it's heavy in one company.

+1000

For professional money managers anything above 10-15% in a single asset is considered to be an imprudent concentration (and can get them sued if the position goes south.)

In some cases with appreciated stock, a concentration is necessary to avoid taxes. But in this case the gain will be tax sheltered, so the excess position should be liquidated as fast as possible even if she might be pulling the money in the near future.

 

[Bamaman]

My question is what is the future of the company stock. Increasing in price? Stable in price? Is this a closed corporation?

If it's a closed corporation or one that's got a stable price, she could cash it in and rollover the proceeds into an IRA Rollover account that's diversified. If the future of the stock (and company) is really good, sit on the stock.

 

[OldShooter]

... If the future of the stock (and company) is really good, sit on the stock.

With respect, this is really bad advice. Nobody can foresee the future of the company stock. Nobody.

Bill Bernstein's observation on diversification:

“Do you think that by choosing a portfolio of only a few stocks that you hope will score big, you are maximizing your chances of becoming wealthy? Indeed you are, but you are also maximizing the chances of a retirement of cat food cuisine.”
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