Paying off Mortgage or Saving outside of Tax Sheltered Retirement Accounts

[CSdot]

I had an unusually profitable year at work and have enough in the business operating account so that after taxes are paid and SepIRA funded to pay off the Mortgage on our primary residence. We are 48 and 50 and this is our only debt (we pay cash for cars, kids' college funds fully funded, etc.). We have around 7 years left on a 15 year mortgage at 3.125%.

If I don't use the money to pay off the mortgage, the money will likely be invested in an after tax account or set aside for an eventual investment property.

We have over $1M in tax sheltered retirement accounts; building up savings in our after-tax investment accounts; plus enough cash in our 12 month emergency fund, plus some.

I asked my accountant, who I trust and who is a friend outside of our professional relationship. He didn't see any reason to pay off the mtg, but I attribute that more to a philosophical difference in how we approach these things than any economic reason (why pay the bank $5,709.24 to save $2,283.70 (assuming 40% tax rate on $5,709.24 if I itemize).

On the other side of the equation, I suspect there might be a psychological benefit to being 100% debt free. This will free up $2,337.82 per month to help build up savings in our after-tax investment accounts. The monthly mortgage payment is $3,133.22, but $795.40 of that goes to Property Taxes and Insurance so we will still be on the hook for that amount, or still on the hook for $9,544.90 per year.

We pay $5,709.24 for Interest per year, which means a savings of around $40,000 in remaining life of the loan interest payments (7 years x $5,709.24) if we pay the mortgage off this year.

What sayest the collective wisdom of the FIRE group? Keep cheap interest rate mortgage and invest the money, or pay off the mortgage and build up our savings in our after-tax investment accounts with the freed up $2,337.82 per month?

Thanks in advance for your advice.

 

[njhowie]

Paying off the mortgage is a guaranteed return on investment. There's no place at this time where you can put your cash and be guaranteed the return of your mortgage rate - even with tax deduction.

And yes, there is a huge psychological benefit to having it paid off. We did it 10 years ago, and would do it again in a heartbeat.

 

[RobbieB]

The interest will go down as the principal reduces.

 

[frank2009]

I'm in a similar situation and decided to pay it off. I have no need to pay the bank interest. Also where else can one get a guaranteed 3.125% on their money?

 

[RunningBum]

The topic generates a lot of discussion here, but really, it's not a big deal one way or the other, unless paying off the mortgage leaves you with no free cash for emergencies or early retirement, or your business.

3.125% is certainly a better savings than any safe investment you could make. But if you're willing to take on a little more risk, you could probably beat it, but you could also lose money. Would you leave it in the business, and would that help the business be more profitable?

The following part taken from your post is what kind of puzzles me about paying off the mortgage.

On the other side of the equation, I suspect there might be a psychological benefit to being 100% debt free. This will free up $2,337.82 per month to help build up savings in our after-tax investment accounts.

So your goal is to build up your after-tax investment savings, and you're going to do that by taking a large (?) chunk from your after-tax savings? I just don't follow the logic of this, though maybe it will work that way.

If it were me I'd probably pay off the mortgage because safe savings/CD/MM rates are so low, and the stock market seems poised for a downturn.

 

[Retireby45ish]

I also paid mine off this year. You can look up that thread. But ultimately I thought the paying off was equivalent to a 3.75% / (1-tax rate) or something like 5% pre tax return. Where can I get a 5% return now guaranteed? Nowhere. So I went with this. Yes I know that the market historical return is higher but I view this as a part of my fixed income bucket. If I could pay off your mortgage at that rate with extra cash instead of it yielding 2.5% in BND I would invest even more this way (without the risk of you defaulting

Good luck!

 

[mystang52]

The following part taken from your post is what kind of puzzles me about paying off the mortgage.

So your goal is to build up your after-tax investment savings, and you're going to do that by taking a large (?) chunk from your after-tax savings? I just don't follow the logic of this, though maybe it will work that way.

If it were me I'd probably pay off the mortgage because safe savings/CD/MM rates are so low, and the stock market seems poised for a downturn.

The question comes up often, here, and generally there is no one correct answer. FWIW I'm in the pay-it-off camp. But I agree with Running Bum. Paying off mortgage with found, or stashed, money is one thing. But if you need to bolster savings then I would not pay off mortgage.

 

[CSdot]

The topic generates a lot of discussion here, but really, it's not a big deal one way or the other, unless paying off the mortgage leaves you with no free cash for emergencies or early retirement, or your business.

3.125% is certainly a better savings than any safe investment you could make. But if you're willing to take on a little more risk, you could probably beat it, but you could also lose money. Would you leave it in the business, and would that help the business be more profitable?

The following part taken from your post is what kind of puzzles me about paying off the mortgage.

So your goal is to build up your after-tax investment savings, and you're going to do that by taking a large (?) chunk from your after-tax savings? I just don't follow the logic of this, though maybe it will work that way.

If it were me I'd probably pay off the mortgage because safe savings/CD/MM rates are so low, and the stock market seems poised for a downturn.

You might be reading something into the comment. My comment about "after tax savings" just means money I am saving beyond the money I am already putting in tax sheltered accounts like a 401(k), SepIRA, IRA, etc.

I currently pay $2,337.82 per month towards principal and interest on my mortgage. If I pay off my mortgage, then I will not longer be required to pay my bank that $2,337.82 per month. The $2,337.82 per month has to go somewhere. Maybe a bank account? Maybe an investment account? Maybe on hookers and blow? Not really that last one, but don't get too confused about the "after tax" moniker, as I only use it to mean discretionary income I don't already have earmarked for something else.

 

[CSdot]

The question comes up often, here, and generally there is no one correct answer. FWIW I'm in the pay-it-off camp. But I agree with Running Bum. Paying off mortgage with found, or stashed, money is one thing. But if you need to bolster savings then I would not pay off mortgage.

I have several hundred thousand dollars (the 12+ month emergency fund) sitting in a bank account. I also have a good amount of money in accounts beyond the emergency fund. I don't NEED to bolster savings. This is several hundred thousand dollars beyond that money that I am talking about using to pay off the mortgage.

Not sure what the preferred nomenclature is for "money people put away for the future that they have no present use for now" other than the word savings?

Not sure why keeping a mortgage is important for building up additional retirement savings?

 

[RunningBum]

You might be reading something into the comment. My comment about "after tax savings" just means money I am saving beyond the money I am already putting in tax sheltered accounts like a 401(k), SepIRA, IRA, etc.

I currently pay $2,337.82 per month towards principal and interest on my mortgage. If I pay off my mortgage, then I will not longer be required to pay my bank that $2,337.82 per month. The $2,337.82 per month has to go somewhere. Maybe a bank account? Maybe an investment account? Maybe on hookers and blow? Not really that last one, but don't get too confused about the "after tax" moniker, as I only use it to mean discretionary income I don't already have earmarked for something else.

OK, but that money to pay off the mortgage comes from somewhere too. That's all I"m saying. Sometimes the way people say this it's like they have this magical $2300/month extra showing up in savings, without acknowledging that they took a big chunk out to make that happen.

Considering that your next post says you have plenty of other money, it's really whatever you want to do. It just depends on whether you want to take the safe 3% and pay off the mortgage, or take a little risk and invest the money. No wrong or right answer.

 

[RunningBum]

Not sure why keeping a mortgage is important for building up additional retirement savings?

The primary case is someone who has a large pension or 401K/tIRA fund, can't access it yet due to age, but wants to retire now. They are usually better off keeping the mortgage so that they can use their taxable savings to live on until they get their pension or can tap their tax deferred money.

This is not your case.

 

[CSdot]

OK, but that money to pay off the mortgage comes from somewhere too. That's all I"m saying. Sometimes the way people say this it's like they have this magical $2300/month extra showing up in savings, without acknowledging that they took a big chunk out to make that happen.

Considering that your next post says you have plenty of other money, it's really whatever you want to do. It just depends on whether you want to take the safe 3% and pay off the mortgage, or take a little risk and invest the money. No wrong or right answer.

Got it. I collected on a big matter at work and will take home an extra $300,000 - $400,000 this year. After my CPA tells me what the tax hit is on earning the extra money, I will use that money to pay off the mortgage.

 

[CSdot]

The primary case is someone who has a large pension or 401K/tIRA fund, can't access it yet due to age, but wants to retire now. They are usually better off keeping the mortgage so that they can use their taxable savings to live on until they get their pension or can tap their tax deferred money.

This is not your case.

Now I see where you are coming from. Good insight.

 

[troutnut1]

(why pay the bank $5,709.24 to save $2,283.70 (assuming 40% tax rate on $5,709.24 if I itemize).

“If I itemize” stands out to me as being a very important part of the equation.

My wife and I are in a similar position and no way could we come up with enough deductions to justify itemization vs standard deductions. So that amount of home mortgage interest would be meaningless to us. In our mind not having to pay market interest is the same as earning it without it being taxable.

The 40% used in your example would only be true IF you have enough deductions to make itemizing worthwhile, and IF you end up in a 40% tax bracket. I find most people cannot fit in this unless they have HUGE mortgages or some other special circumstance.

We love having a paid off home in spite of all the other possibilities. It’s hard to put a number on that, but my wife would be very hard to convince otherwise having been paid off for 28 years.

Your mileage may vary.

 

[CSdot]

“If I itemize” stands out to me as being a very important part of the equation.

My wife and I are in a similar position and no way could we come up with enough deductions to justify itemization vs standard deductions. So that amount of home mortgage interest would be meaningless to us. In our mind not having to pay market interest is the same as earning it without it being taxable.

The 40% used in your example would only be true IF you have enough deductions to make itemizing worthwhile, and IF you end up in a 40% tax bracket. I find most people cannot fit in this unless they have HUGE mortgages or some other special circumstance.

We love having a paid off home in spite of all the other possibilities. It’s hard to put a number on that, but my wife would be very hard to convince otherwise having been paid off for 28 years.

Your mileage may vary.

Some of what I have been reading lately suggested that very few people still itemize after the standard deduction was doubled in the Trump Tax cut last year. Hence my use of “If I itemize” in my post. Obviously if we use the standard deduction, then there is zero tax benefit to the mortgage interest deduction to us.

I don't think the top 37% tax rate fully kicks in until $622,000 filing jointly. With SALT and restricted deductibility, it would be over 37%, but only for amounts over the thresholds.

 

[mrfeh]

My suggestion would depend on how much you have in taxable accounts today, and when you want to retire.

Back when we had a mortgage and extra monies, some would go toward the mortgage and some would be invested. It doesn't have to be either/or.

 

[pb4uski]

From a pure numbers perspective, the financial decision depends on whether if you keep the mortgage that the monies retained will earn more than 3.125%. It is hard to tell without knowing more about what investments are in the 'investment account" that the money might be invested in and it sounds like you don't have a good idea of what that would be.

If the money kept rather than paying the mortgage would end up in a bank account, then there is little doubt that it would be better to pay the mortgage in that it is unlikely that CDs and the like will earn 3.125% over the next 7 years. I paid off my 3.375% mortgage last December with online savings account money that at the time was earning 1.7%... but is now down to 0.6%.. so it was a good decision. Unlike others, I don't get any sense of euphoria from having the mortgage paid off... in part because it was on autopay and I hardly noticed it.

OTOH, if the money that would be used to pay the mortgage would otherwise be invested in a diversified portfolio then, at least from a pure financial perspective, it is likely that a diversified portfolio would exceed 3.125% over the next 7 years.

Since you seem to have ample emergency funds, if it were me I think I would pay it off and then use the cash flow that is freed up to invest going forward.

P.S. You might want to consider getting more from that emergency fund by investing in short term CDs or online savings accounts.... or if you are comfortable with a bit more risk something like Dominion Energy Reliability Investment Notes (currently paying up to 1.7%) or Toyota Motor Credit IncomeDriver Notes (currently paying 2%).