Who is better off?

[Katsmeow]

Imagine 2 retirees. Who is better off financially for retirement?

Couple A has $1,500,000 in retirement accounts and the husband is currently receiving $21,000 a year Social Security. His wife will receive $22,000 in Social Security beginning in 6 years. Couple A plans to spend $81,000 a year of which $14,400 is a recent 30 year mortgage.

Couple B has $1,200,000 in retirement accounts and the husband is currently receiving $21,000 a year Social Security. His wife will receive $22,000 in Social Security beginning in 6 years. Couple B plans to spend $69,000 a year. Couple B has a paid for house.

 

[REWahoo]

Another "pay off the mortgage early" thread?

 

[W2R]

Another "pay off the mortgage early" thread?

I thought it was another LBYM thread. My answer was going to be that I would be better off then EITHER couple, because I couldn't possibly manage to blow that much money every year even if I spent all day every day shopping (and that sounds too much like w*rk! )

 

[Katsmeow]

Another "pay off the mortgage early" thread?

To an extent, but from a different point of view than most. That is, most of the pay off the mortgage early threads deal with the couple who if they didn't pay off the mortgage would invest the mortgage money so the discussion tends to revolve around the difference in investment returns, etc.

I am interested in the couple who pays off the mortgage and can therefore take greater withdrawals from the portfolio for discretionary spending.

That is the couple with the $1.5 million portfolio can take out $60,000 a year and with SS has $81,000 a year but $14,400 goes to the mortgage, leaving $66,600 for everything else.

Couple B has taken $300,000 from the portfolio, paid taxes on it and paid for a house. Couple B's portfolio is $1.2 million but can withdraw $48,000 and with SS has $69,000 so has $2,400 more spending money every year than couple A, but the portfolio is $300k smaller.

W2R -- The actual numbers I used aren't necessarily realistic numbers but simplified to ask the question. For our personal situation the thing that makes it very hard for me to model retirement spending is the variability we will have in the early years if we retire. We would be retiring with teenagers still at home so that complicates stuff.

 

[youbet]

I guess it's a trick question since couple B is scheduled to win the Power Ball Lottery in June, 2012, yielding them a tidy $47.8M after taxes. You sure can't count on that sort of thing when planning for FIRE, but here it is and hopefully they will enjoy a wonderful retirement.

I wonder if Couple B will manage their new found wealth wisely. Or, will they be the subject of yet another bashing thread here on the forum where we can point out at length what dummies they were?

 

[Moemg]

I vote couple B since the male in couple A will have a fatal heart attack and the widow A will be left with a mortgage to cover without the extra from his SS . Plus unbeknownst to widow A husband A invested in a ponzi scheme which will soon be uncovered .

 

[Bestwifeever]

I vote couple A because after Couple B wins the lottery in September 2012, they will have only six months to enjoy their $47.8M before the end of the world but couple A won't ever have to pay off the mortgage.

 

[youbet]

Fatal heart attack? Ponzi scheme? End of the world?

Wow! And I thought Couple Youbet had it tough retiring approximately two years prior to a major recession. I guess that wasn't so bad after all!

 

[Animorph]

If you look only at the 4% SWR, any mortgage >4% will look a little bad. However, the mortgage will end in 30 years, one of those reduced costs as retirement progresses scenarios, if you live long enough to care.

If you also look at the expected or average portfolio value at the "end" of retirement and assume portfolio gains of something better than 4.8% during the 30 year mortgage period then the morgage looks better, at least for your beneficiaries.

 

[Katsmeow]

Sorry about the thread. It was actually a serious question that DH and I have been talking about. I can see it causes hilarity however. Thanks Animorph for the serious response.

 

[JustNtime]

A~B & B~A -- Maybe same couple...

 

[Moemg]

Sorry about the thread. It was actually a serious question that DH and I have been talking about. I can see it causes hilarity however. Thanks Animorph for the serious response.

While my ponzi scheme scenario was a joke the other part was not . My husband and I retired in 1996 ( well I did not really retire I went part time ) . We were set . He had a pension . I had an IRA rolled over from my thirty years in nursing . His SS was just under 20,000 as was mine . We had a lot of savings . In 1998 he had a massive heart attack and died . His SS was history . His pension was halved and my life changed in an instant . So when I see couples planning like there is always going to be two SS and full pension benefits I have to raise a red flag . Besides planning like there will always be two of everything take an honest look at what could happen .So I guess my final answer would be the couple that gets to grow old together would be the winner of who is better off .

 

[Zathras]

Kats, it is largely a matter of personal preference.
The reason there is so much jockularity about it is this is more similar than not to the infamous 'pay of the mortgage early' topic which continues to crop up every few months.

In your case, a lot more detail is needed.
For example, while you wouldn't need to pay the monthly payment if the mortgage is paid off, you would still need to pay insurance and property taxes.
If these add up to the $2400 extra spending money you expect, that benifit may be nothing, or even end up paying more than the extra spending money.

If you don't sell the $300k (or whatever it is) but instead just pay off as schedualed, you avoid the taxes on the sale of the $300k of the portfolio.

Alternatively, there is the peace of mind (for some) of having a paid off house.

Really, after seeing many of these discussions I think it comes down to specifics unique to each person and personal preference. I don't think you can get a general answer or even a specific answer without all possible details.

 

[sweetana3]

I totally agree with moemg. The potential issues of one spouse dying or becoming incapacitated and needed advanced care should be part of any financial plan considered.

I know I will have a significantly reduced income stream but have investigated the options and would still have enough to pay bills perhaps in the same house or a different location.

Perhaps this is just too much info for an interent forum to consider. It is also amazing to me how many women, in particular, are not aware of their income after the death of a spouse.

 

[poorman148]

While my ponzi scheme scenario was a joke the other part was not . My husband and I retired in 1996 ( well I did not really retire I went part time ) . We were set . He had a pension . I had an IRA rolled over from my thirty years in nursing . His SS was just under 20,000 as was mine . We had a lot of savings . In 1998 he had a massive heart attack and died . His SS was history . His pension was halved and my life changed in an instant . So when I see couples planning like there is always going to be two SS and full pension benefits I have to raise a red flag . Besides planning like there will always be two of everything take an honest look at what could happen .So I guess my final answer would be the couple that gets to grow old together would be the winner of who is better off .

Moemg,

I am so sorry to hear what happened to you. I hope the last 11 years have been better to you than that year. I also hope you have a wonderful Thanksgiving, full of sunshine.

Rich

 

[Katsmeow]

Good points. I am very much aware of the issues of one spouse dying. This is one reason DH is taking the pension as a lump sum. Under his company's rules if he died before retiring I would be entitled to his full benefit. If he took the benefit as a non-COLA pension he could leave a 100% survivorship to me (for reduced benefit). His company is very solvent but you never know what will happened so I looked at what would happen if the pension was taken over by the PBGC. His pension would exceed the max that PBGC pays so he would take an immediate paycut. Also if he were to die the PBGC would not pay me 100% of his pension (which is what I would get from the company). PBGC would pay me 50% of his PBGC benefit which would be roughly 1/3 of his company pension. For these reasons we have decided to go for the lump sum (A little over $900k if he retired tomorrow but about 10% higher in a year).

When DH dies he has the option to convert his life insurance to an individual policy and it would be enough to replace his social security income. I do not have a similar option if I retire however. However, I have run numbers if one of us dies and the other would have enough.

Something I just found out -- can't believe I didn't know this because it makes a huge difference -- is that if DH retires a year from now our teeneage 2 children under age 18 will get benefits in a very significant amount. It is significantly enough that it probably makes it very easy for DH to retire in a year and resolves most of the questions we had about retiring with adolescents. (That SS income is not reflectied in the Couple A and B scenarios since it wasn't relevant to the specific question).

The $1.5 million in the couple A example is that lump sum in a year plus 401(k) and taxable savings. Most of it is in the 401(k). We will be selling our house and could either buy a downsized house with a mortgage or take some money out of the 401(k), pay the taxes and pay cash for the house. (There are some variables other than those but not really relevant to this thread).

Zathras -- We would have to pay insurance and property taxes whether there is a mortgage or not. The taxes and insurance aren't going vary based upon whether we have a mortgage or not.

I do realize this is a variation of the pay the mortgage question but it seemed a somewhat different variation of it that I didn't see discussed in the other threads in that I'm not really as focused on the investment returns issue which is where most of the other threads went.

 

[traineeinvestor]

I took this as being a borrow to invest question. If the borrowed amount provides a return greater than the interest cost on the mortgage (after tax in both cases), then in theory it is beneficial to take the mortage and invest the money. However, as it is a P+I mortgage, principal is being paid as well as interest which adversely affects cash flow.

There is also the question of the couple's age. Given the statements regarding SS, they have reached ages where they should have a high proportion of their portfolios in bonds. It is unlikely that bonds could be found which would show an after tax return higher than the cost of the mortgage (high yield or junk bonds excepted).

It is questionable whether either couple will need to draw down the principal of their portfolio to meet living expenses at least before the second SS payment starts - this will depend on investment returns. It is likely that they will not need to draw down principal after then. Draw down requirements will depend on investment returns and, over time, inflation. Even if no draw down is required in the early years, this could change in the future.

Given their higher spending requirements, couple A is more vulnerable to adverse returns (in particular in the early years of retirement) and inflation (in the later years).

Couple A has higher income. If the rules on SS change, they are more vulnerable to an income based test than couple B.

Lastly, couple B still has the possibility of taking a reverse mortgage later in life should the need arise. Couple A no longer has this possibility.

For the above reasons, I would say that couple B's retirement is more secure.

 

[youbet]

Sorry about the thread. It was actually a serious question that DH and I have been talking about. I can see it causes hilarity however. Thanks Animorph for the serious response.

It's humorous only in the fact that there are undefined variables in play which will most likely turn out to be more significant than whether the $300k is tied up in the house resulting in a lower portfolio value and lower expenses. Or, whether the $300k is still in the portfolio resulting in a higher portfolio value, higher investment income and higher expenses due to the mortgage payment.

I don't think there is going to be a very significant financial difference between either scenario and you should do whichever makes you feel most comfortable. Many here point to the subjective "comfort" of living in a paid-for house. Others point to some potential financial advantages of carrying a mortgage. Again, IMHO, there will likely not be a huge difference financially going with or without a mortgage.

For myself, given today's low mortgage interest rates and my perception of future inflation possibilities, I'd probably take a mortgage. But it very well may not work out that way and you should do what makes you comfortable.

 

[Katsmeow]

Good points traineeinvestor. I had not thought of the reverse mortgage point which is a good one.

I picked the spending number in the scenario based upon 4% not really the exact spending requirements. For the real life couple our spending requirements are higher in the next few years (teenagers at home and to educate) then go down markedly.

The question is my mind in part is who has more flexibility. On the surface perhaps Couple A has more flexibility since they have a larger portfolio and can perhaps survive more volatility. Couple B seems more vulnerable to volatility (I did run Firecalc on both scenarios and both were at 100%).

On the other hand, I think about which decision is more reversible. If couple A becomes uncomfortable with the mortgage they can take money out of retirement funds and pay the mortgage. If couple B needs more money and are not yet old enough or not ready to take a reverse mortgage they have less flexibility. If both are retired they probably can't go get a mortgage.

 

[Katsmeow]

I don't think there is going to be a very significant financial difference between either scenario and you should do whichever makes you feel most comfortable. Many here point to the subjective "comfort" of living in a paid-for house. Others point to some potential advantages of carrying a mortgage. Again, IMHO, there will likely not be a huge difference financially going with or without a mortgage.

I didn't see one either but always wonder if I've missed something so like to get other perspectives. In actuality, what I am seriously thinking about doing is taking the mortgage initially. We would probably buy the house in a year when we have significant earned income and are in the 33% tax bracket. If we took the money out to pay cash for the house the taxes would be significant. I might be inclined to retire, take out "extra" money over a few years to pay off the house and so that it is taxed at a lower rate. But, still not sure.

 

[Zathras]

Zathras -- We would have to pay insurance and property taxes whether there is a mortgage or not. The taxes and insurance aren't going vary based upon whether we have a mortgage or not.

The only reason I mention this is that many people think that they will not have any of the payments once the mortgage is paid off.
But if they have an escrow that pays the insurance and property taxes, this will not be the case.
No offense intended if you were well aware of this, or if there is no escrow and you always paid those out of pocket.

For the most flexibility, you may want to see if you can get a home equity line of credit rather than a mortgage. This way you don't have to liquidate a large part of your portfolio, yet can pay off the debt as quickly or slowly (within reason).
I would not recommend this for everyone, it really depends on how quickly you could pay off the debt if you wanted to. All sorts of factors need to be considered (pay of part of the house, and home equity for the rest, etc). But purely on looking for the most flexible option, that is about as flexible as you can get.

 

[Animorph]

A mortgage for home purchase might be better than a later home equity loan. You can deduct purchase interest for a mortgage up to $1M, but once that is paid off you can only deduct for interest amounts for up to $100k in principle. You might be able to deduct additional interest if you use the loan to invest. I'm not sure how the reverse mortgage would be treated. Depending on your borrowed amounts, taxes may limit you a bit.

I don't mind refinancing once in a while to lower my rate and maintain most of the original home purchase loan balance. I'm keeping my mortage because I think I can invest the balance and make more than the borrowing costs. However, that's also a higher risk strategy given the chance of market losses and getting stuck with a large debt. Having no debt is safer and more conservative, but also doesn't have the upside of investment gains.

 

[traineeinvestor]

On the other hand, I think about which decision is more reversible. If couple A becomes uncomfortable with the mortgage they can take money out of retirement funds and pay the mortgage.

I would personally be uncomfortable with this approach - the time when I would most likely want to get rid of the mortgage on emotional grounds would be when the markets have given my retirement portfolio a beating (like last year) - the very worst time to be taking money out of a portfolio.

The more I think about it, the more inclined I would be to go with option B. If I wanted to speculate, I would wait until the markets had taken a beating and then borrow whatever I was comfortable with to invest in equities then. In effect, I would time the markets.

 

[youbet]

I didn't see one either but always wonder if I've missed something so like to get other perspectives. In actuality, what I am seriously thinking about doing is taking the mortgage initially. We would probably buy the house in a year when we have significant earned income and are in the 33% tax bracket. If we took the money out to pay cash for the house the taxes would be significant. I might be inclined to retire, take out "extra" money over a few years to pay off the house and so that it is taxed at a lower rate. But, still not sure.

I agree that if the source of funds to purchase the house outright is a 401k or IRA, thus resulting in taxes on the full amount at your marginal rate, I'd probably mortgage and, depending how things go, pre-pay over the next several years based on tax efficiency. My previous comments were made not considering taxes.

 

[Bikerchick]

Getting a mortgage with the idea of taking out "extra" money over a few years to pay it off gives you a lot of flexibility. Owning a home outright provides a very secure feeling, and it's amazing how little one needs to spend when there's no mortgage.