Retirement vs. Liabilities

[mergeberger]

I was having a retirement discussion with my coworker the other day about spending money in the short term to save money in the long term. I believe liabilities like car payments, mortgage, and other bills should be paid off to a manageable minimum to go into retirement. My coworker has a mortgage that he pays very little into the principle, placing that money instead into an IRA. He believes the IRA is a better investment right now. But I say he's only prolonging his liability, which will bite him down the road. What's your thoughts?

 

[honobob]

I was having a retirement discussion with my coworker the other day about spending money in the short term to save money in the long term. I believe liabilities like car payments, mortgage, and other bills should be paid off to a manageable minimum to go into retirement. My coworker has a mortgage that he pays very little into the principle, placing that money instead into an IRA. He believes the IRA is a better investment right now. But I say he's only prolonging his liability, which will bite him down the road. What's your thoughts?

Well obviously the house will appreciate at the same rate no matter how much is owed on it but the IRA will only grow based on the investment into it. Considering the current ability the get low fixed terms on a mort.........waitaminnitwaitaminnit..this is just a tricky way to rehash paying off the mortgage early debate. Drat...foiled again.

 

[rs0460a]

What's your thoughts?

Since you are fairly "new" on this forum (by the number of posts you have), my answer is "it all depends".

I'm retired (at age 59 - planned at age 66). What I did (with much input from my DW ) allowed us (actually me, since my DW is yet to be "emotionally ready" albit "financially ready to retire") to retire ahead of schedule.

A few things we did:

- My DW had the "desire" to be mortgage/note free by the time we retired. We have had four "homes" during our time in marriage. The one we currently own (built in '94) had a 30-year mortgage/note, paid off in 5.5 years. Why? My DW had a strong desire to have a home "debt free" (whatever that is) in retirement. So be it.

While we were putting every last penny into the mortgage/note for 5.5 years from '94 to '99 the market was "on a run". Folks told me that I should be putting money into the market. My DW told me I should be paying off the house.

What happened is that we paid off the mortgage/note in late '99 (guss what happend then ). We put in an amount equal to the mortgage/note payment in the market, resulting in "buying cheap". By 2003 it was amazing what happened to our retirement portfolio (and allowed my ER).

Sometimes you don't know what you should do till "after the fact". That is your decisions are based upon only part of the "equation". You make a decision based upon your "gut decision", but the other half the the equation is yet to be determined/stated. Did your action work for or aganst you?

From my perspective, I would say pay off your debt ASAP. Others (and the market, it the future) could say that I was incorrect.

All you can do is make your own decision (regardless of what is said in this forum) and hopefully you will be OK.

- Ron

 

[jIMOh]

I would prioritize goals like this:

1) invest 15% for retirement from get go. 401k up to match, max out the Roths, then more into 401ks
2) save additional 5% towards short and mid term expenses (keep the liabilities to a minimum). This is new car fund, house repair fund and large health care expense fund
3) pay down mortgage and other liabilities
4) increase size of taxable account

1 needs to be done before 2-3-4. But many others will tell you 3 comes before 2 or 4 comes before 3. Just depends on the situation.

 

[haha]

3) pay down mortgage and other liabilities
Just depends on the situation.

Most posters express concern about inflation. There is no better or lower risk way to hedge against inflation than to get a nice big mortgage at an interest rate that is barely positive in real terms.

I would say never pay off a fixed mortgage as long as we are offered such a sweet deal.

In fact, I would mortgage my nose if I could.

Ha

 

[W2R]

I was having a retirement discussion with my coworker the other day about spending money in the short term to save money in the long term. I believe liabilities like car payments, mortgage, and other bills should be paid off to a manageable minimum to go into retirement. My coworker has a mortgage that he pays very little into the principle, placing that money instead into an IRA. He believes the IRA is a better investment right now. But I say he's only prolonging his liability, which will bite him down the road. What's your thoughts?

I paid off my 6.375% mortgage in four years, between 2002-2006. I might have earned a little more in the market, or not. I owe nothing to anybody, and have no loans or credit card debt, so I feel confident going into ER next year. That appeals to me, but others would rather invest. What I think is important is to pick a goal that will help your retirement goals, and work towards it with all the energy and drive you have. Either way, you will be WAY ahead of the average person. Wavering between goals is really not helpful.

 

[Sarah in SC]

The mortgage/no mortgage debate is a hot one here, mergeberger (what a moniker!).
I will say that the emotional value of paying off a mortgage is a big deal for those of us that have done it. I cannot speak for those that keep a large mortgage, it was primarily a comfort level decision for us.

 

[Nords]

http://www.early-retirement.org/forums/f47/should-i-pay-off-mortgage-invest-money-30644.html

 

[Meadbh]

For a home, which is a lifestyle choice, most people would be more comfortable without a mortgage going into ER. However, if the mortgage is for a revenue producing property, other things being equal, that's an investment.

 

[ats5g]

Thoughts about paying more on mortgage vs. investing, in no particular order:

The mortgage is basically a negative callable LT nominal bond. You're borrowing money at a fixed rate of interest [hopefully fairly low], which you can pay back when you please.

As jIMOH said, I'd at least do the following before paying off the mortgage:

1) get any company match on 401k/403b
2) max out deductible savings plans [401k/403b, deductible IRA] and Roth IRA

Even if you only invest the money in bonds, you'll still probably come out ahead, especially if you can deduct the mortgage interest.

As far as what to do next [taxable acct or pay down mortgage], don't forget that the paying down the mortgage is much safer/less risky return than say investing in stocks. So, it roughly equivalent to buying say GNMA bonds or other mortgage backed securities. For me, I'd get a higher after tax return by paying down the mortgage than investing in those bonds in a taxable account.

When you don't pay down the mortgage, and instead invest the money, it's just like taking a loan [i.e. mortgage] out on the house and investing it. Both have the same result. As long as you realize this is what you're doing, then I'm usually fine with whatever people do.

- Alec

 

[Frugality_of_Apathy]

Thoughts about paying more on mortgage vs. investing, in no particular order:

The mortgage is basically a negative callable LT nominal bond. You're borrowing money at a fixed rate of interest [hopefully fairly low], which you can pay back when you please.

As jIMOH said, I'd at least do the following before paying off the mortgage:

1) get any company match on 401k/403b
2) max out deductible savings plans [401k/403b, deductible IRA] and Roth IRA

Even if you only invest the money in bonds, you'll still probably come out ahead, especially if you can deduct the mortgage interest.

As far as what to do next [taxable acct or pay down mortgage], don't forget that the paying down the mortgage is much safer/less risky return than say investing in stocks. So, it roughly equivalent to buying say GNMA bonds or other mortgage backed securities. For me, I'd get a higher after tax return by paying down the mortgage than investing in those bonds in a taxable account.

When you don't pay down the mortgage, and instead invest the money, it's just like taking a loan [i.e. mortgage] out on the house and investing it. Both have the same result. As long as you realize this is what you're doing, then I'm usually fine with whatever people do.

- Alec

I always wonder about the big 401K push that goes on in these forums. Isn't an account you cannot touch until regular people retire and cannot really control antithetical to retiring early?

I think of it this way. If I pay off a $150,000 house in 4 years, move out and get a mortgage on another house than that $150,000 will increase in value( historically at least following inflation, plus I will have the rental income ~$12,000/year. If inflation is 3%(hah!) and I'm getting 8% from rent I'm making a guaranteed 11% minus repairs and the like. Anything the value of the house does beyond inflation would just be a bonus.
I think that kind of secure return is pretty incredible.

 

[Crichton]

I always wonder about the big 401K push that goes on in these forums. Isn't an account you cannot touch until regular people retire and cannot really control antithetical to retiring early?

The IRS has a rule, 72(t), that lets you make substantially equal withdrawals from an IRA. If you keep this up for at least 5 years or until past the point where you are 59.5 (whichever comes first), you are not assessed any penalties.

So essentially: You retire, you roll your 401k into an IRA, and you begin making consistent withdrawals from the IRA and the money is yours again, without penalty.

 

[ats5g]

I think of it this way. If I pay off a $150,000 house in 4 years, move out and get a mortgage on another house than that $150,000 will increase in value( historically at least following inflation, plus I will have the rental income ~$12,000/year. If inflation is 3%(hah!) and I'm getting 8% from rent I'm making a guaranteed 11% minus repairs and the like. Anything the value of the house does beyond inflation would just be a bonus.
I think that kind of secure return is pretty incredible.

I'd compare the after tax, after expenses return to the return you can get inside the IRAs/401(k).

For example, the return on the rental will probably be rental income plus property appreciation. So, you've got $12,000 minus income taxes first, then minus property taxes, then minus insurance, then minus repairs [and I'm probably forgettin a few]. And of course, don't forget to take away the interest you're paying on the mortgage. I'm not sure if the interest on the mortgage is tax deductible or not.

So, you're likely not going to be earning 9-11% return after taxes and expenses. Compare this to having the $150,000 in an IRA/401(k), which if you're in the 25% tax bracket is equivalent to $200,000 in the IRA/401(k). And all the return in the IRA/401(k) is tax deferred, while only the property appreciation [if any] is tax deferred. And, IIRC, if/when you sell the rental property you'll have to pay cap gains taxes if it appreciated.

Now the rental income could most likely increase every year, or every couple of years, so it'd be inflation adjusted. But then I can get 20 + 30 yr TIPS with real yields of 2.20% tax deferred in an IRA.

- Alec

 

[Frugality_of_Apathy]

The IRS has a rule, 72(t), that lets you make substantially equal withdrawals from an IRA. If you keep this up for at least 5 years or until past the point where you are 59.5 (whichever comes first), you are not assessed any penalties.

So essentially: You retire, you roll your 401k into an IRA, and you begin making consistent withdrawals from the IRA and the money is yours again, without penalty.

Ah, that makes alot more sense.
Though I don't know that I trust a rule like that to hang around forever. I can envision someone seeing this rule as "allowing tax cheats to shortchange the economy" and changing it if a bear market sets in.

 

[DblDoc]

Ah, that makes alot more sense.
Though I don't know that I trust a rule like that to hang around forever. I can envision someone seeing this rule as "allowing tax cheats to shortchange the economy" and changing it if a bear market sets in.

There is no penalty - you still have to pay taxes on the withdrawal. No loophole here...

DD

 

[JesseBernard]

I had this same debate over a timeshare I had that I considered an unneeded liability. After trying to sell it with no success, I actually had a title transfer done through Timeshare Relief. It cost me $3500, and I’m out of the timeshare entirely. That means no more bills, no liability. I was paying about that amount each year for the timeshare, and trying to sell it would likely have taken longer than a year. With anything you’re paying off, be it student loans or mortgages, paying them off ASAP is always better.

 

[haha]

I had this same debate over a timeshare I had that I considered an unneeded liability. After trying to sell it with no success, I actually had a title transfer done through Timeshare Relief. It cost me $3500, and I’m out of the timeshare entirely. That means no more bills, no liability. I was paying about that amount each year for the timeshare, and trying to sell it would likely have taken longer than a year. With anything you’re paying off, be it student loans or mortgages, paying them off ASAP is always better.

The thing you got rid of is an accounting asset that is actually an economic liability, like a horse standing around eating alfalfa that you have to buy. OTOH, a student loan or low rate mortgage is a liability in the pure accounting sense, but may be a very valuable asset if you are a good asset allocator. There are some quite complete analyses of this from the earlier years of this board. Some of these might be in the "Best of the Board" section.

You may be sure you are right, but if you are open-minded I recommend a look at these earlier threads.

Ha

 

[cute fuzzy bunny]

Most posters express concern about inflation. There is no better or lower risk way to hedge against inflation than to get a nice big mortgage at an interest rate that is barely positive in real terms.

Except that inflationary pressure exerts equally on your investments and the loan.

Its a nice hedge if you're still earning a living through wage adjusted earnings or have an inflation indexed pension. For an early retiree living off their holdings, there is no inflation hedge.

In fact, I would mortgage my nose if I could.

Good news, Ha! I'll give you a loan on your nose! How much were you looking for and when can my nasal appraisers come by to have a look around?

Also, it'd be great if you could present me with a list of comparable area noses.

 

[haha]

Except that inflationary pressure exerts equally on your investments and the loan.

Its a nice hedge if you're still earning a living through wage adjusted earnings or have an inflation indexed pension. For an early retiree living off their holdings, there is no inflation hedge.



Good news, Ha! I'll give you a loan on your nose! How much were you looking for and when can my nasal appraisers come by to have a look around?

Also, it'd be great if you could present me with a list of comparable area noses.

On the nose loan, my people will contact your people. I appreciate your interest in this impressive collateral. As to comps, let me just say that Jimmie Durante had me beaten, but I could temporarily stop my nose hair trimming regimen which might bring me even.

On the point that inflation will attack the loan, I don't understand what you mean. If you mean the proceeds would be invested in something of similar risk and duration, then one would be only spinning wheels. The money has to be invested in higher returning assets than the interest rate on the loan, or a time risk has to be taken while you accept some negative cash flow while you find a suitable asset.

Ha

 

[Dawg52]

The thing you got rid of is an accounting asset that is actually an economic liability, like a horse standing around eating alfalfa that you have to buy. OTOH, a student loan or low rate mortgage is a liability in the pure accounting sense, but may be a very valuable asset if you are a good asset allocator.

Ha

Very true. When I was in college, I took out a National Direct Student Loan and the interest rate was just 3%, payable over 10 years. Now with cd rates near or at double digits and pass book savings around 5% during that period, why would I consider paying off such a loan early? Of course those were unusual times but it does show that it is not always prudent to retire a loan early, unlike retiring early.

 

[ats5g]

Except that inflationary pressure exerts equally on your investments and the loan.

Eh, not if you're investing in TIPS. I'd gladly put LT TIPS into a deductible IRA or Roth vs paying down the mortgage. And then pray for inflation.

I'd also gladly put money into a 529 [most likely the guaranteed tuition type] than pay down the mortgage. That is until the gov't takes away the tax free earnings on the 529.

 

[cute fuzzy bunny]

Funny, I originally typed "and the loan, unless you invest in TIPS or another safe CPI indexed investment" and then erased the last bit because it muddied the water and didnt produce a happy result. We're just terribly unlikely to have 10-15 years worth of super high inflation and if that doesnt materialize, you'll be eating it on the ~2% real payout.

A frequent error is to crow about inflation eating away at the value of the loaned dollars without taking into consideration that the same inflation is eating the invested principal at the same rate.

You cant get the thing to work unless you take the mortgage money and put it in equities, stay in the house a good long time, keep a big emergency stash, and break out the brass balls and stay in your asset allocation no matter what.

Seems to me to be a lot of aggravation to net a percent or two on a couple of hundred grand.

 

[clifp]

My rule is pretty simple. If your mortgage is below 4.5% keep it. If it is above 6.5% pay it off, if it is between those two numbers do whatever makes you feel best.

 

[cute fuzzy bunny]

I think the difficulty is that the vast majority of people have something in the 5-6% range.

 

[unclemick]

My rule is rent.

It seems I never follow my rule - with a paid up mortgage pre Katrina and a 5.75% 30 yr post Katrina.

But at least I have a rule.

heh heh heh - Don't read books! Pssst - Wellesley, etc. etc.