Interesting Outcomes from FIRECalc Hypotheticals

[nico08]

I have been investigating different scenarios in FIRECalc in preparation for my FIRE.

I found some outcomes rather interesting. I kept all other variables constant, and altered only two- one variable was whether my mortgage was paid off as today (with the corresponding decrease in my net worth) and the other variable was whether a cost of living adjustment (COLA) was part of the state government pension that I will receive about 17 years from now. This COLA is presently the subject of a legal appeal, the outcome of which is uncertain.

The following shows the additional amount of net worth I would need to have in order to FIRE with a 95 percent likelihood of success:

Additional amount needed
$17,673
Mortgage paid off and with COLA attached to pension

$91,312
With mortgage paid off and no COLA attached to pension

$77,208
Carrying mortgage payments into early retirement and COLA attached to pension

$147,538
Carrying mortgage payments into early retirement and no COLA attached to pension

Now, I have no control over whether a COLA will be included in the pension (although of course I want it to attach), but I can control whether I pay my mortgage sooner rather than later. Are these numbers suggesting to me, that if my goal is to FIRE sooner rather than later, that it is in my interest to pay the mortgage now (I have a good interest rate, if that makes any difference)?

[Animorph]

Quote:

Originally Posted by nico08 I have been investigating different scenarios in FIRECalc in preparation for my FIRE. I found some outcomes rather interesting. I kept all other variables constant, and altered only two- one variable was whether my mortgage was paid off as today (with the corresponding decrease in my net worth) and the other variable was whether a cost of living adjustment (COLA) was part of the state government pension that I will receive about 17 years from now. This COLA is presently the subject of a legal appeal, the outcome of which is uncertain. The following shows the additional amount of net worth I would need to have in order to FIRE with a 95 percent likelihood of success: Additional amount needed $17,673 Mortgage paid off and with COLA attached to pension $91,312 With mortgage paid off and no COLA attached to pension $77,208 Carrying mortgage payments into early retirement and COLA attached to pension $147,538 Carrying mortgage payments into early retirement and no COLA attached to pension Now, I have no control over whether a COLA will be included in the pension (although of course I want it to attach), but I can control whether I pay my mortgage sooner rather than later. Are these numbers suggesting to me, that if my goal is to FIRE sooner rather than later, that it is in my interest to pay the mortgage now (I have a good interest rate, if that makes any difference)?

I don't think it would suggest an early mortgage payoff if you have a low interest rate. I would check those numbers. You did subtract the mortgage payoff from the portfolio? The mortgage payments were non-COLA and extended only until the final balance was $0?

[ggbutcher]

Given you don't have control of the presence of the COLA, for planning the conservative approach would be to use the worst outcome, no COLA. You have a certain amount of control over retiring your mortgage, so you can use that to mitigate the uncertainty.

You probably already realize this, but the dominant dynamic about a mortgage over its long life is how much total you pay to 'rent' the money, and I'd guess FIRECalc is considering how much interest expense in total you'll avoid by paying it off sooner, making that money available for funding retirement income. I haven't played with FIRECalc yet, but your numbers would suggest such consideration.

Observation: If they're fighting over the COLA now, they're probably worried about being able to support it long-term, so it may not just be a legal issue.

[nico08]

Hi ggbutcher:

Yes, that is a good point you make about the long-term viability of the COLA, because I have to wait for it to start for about 17 years, a long time from my point of view. I resent the governor who initiated this action, because it is essentially a breach of contract, but that is a whole other issue. The COLA was part of the pension during the time that I accepted employment, and I worked for 10 years until I vested into the pension. To me, to take it away from those who already vested into it, is an act of bad faith.

[nico08]

Hello Animorph:

Yes I did subtract the mortgage payoff from the portfolio value.

[Animorph]

Tried it for myself:

Default settings except "Investigate" 95% success rate with $30k spending per year.

Mortgage: new, 30 year fixed, $300k loan, 4.5% rate, $1520.06/month payment

Without the mortgage, plain $30k per year spending (inflation adjusted):
FIRECalc says required portfolio is $754,716.
Add in $300k to payoff the mortgage for a total of: $1,054,716, the average ending portfolio is $1,375,547.
So you have a new mortgage and $1M, you pay off the mortgage balance leaving you $755k and live off that at $30k per year.

With the mortgage, $30k per year inflation adjusted plus $18,240.72/year mortgage payments for the first 30 years with no inflation adjustment:
(FIRECalc inputs: Spending = 48,240.72, Off chart spending reduction = 18,240.72 starting in 2044, no inflation)
FIRECalc says required portfolio is $1,213,601, the average ending portfolio is $2,211,912.


So yes, it is saying that in the failing scenarios market gains over the 30 years of the loan are lower than 4.5%, and paying off the debt early is safer. The cost is that for an "average" scenario you are giving up something like $800k in the ending portfolio value. Unfortunately we do not have a median portfolio value, so I'm just accepting the average as the median here.

[nico08]

Hello Animorph:

Since I do not have any heirs or dependents, I guess it makes sense for me to take the "safer" alternative and try to get that mortgage off my back, because I don't have much of an incentive in creating the "possibility" of a higher ending portfolio value. Does that sound right to you?

[Animorph]

Quote:

Originally Posted by nico08 Hello Animorph: Since I do not have any heirs or dependents, I guess it makes sense for me to take the "safer" alternative and try to get that mortgage off my back, because I don't have much of an incentive in creating the "possibility" of a higher ending portfolio value. Does that sound right to you?

I like to play the odds more than play it safe. And it depends on what makes you feel safe. A larger portfolio later in retirement may give you options for long term care or new medical procedures, and is the more likely outcome.

I'm keeping our 3.25% mortgage just refinanced in 2012. But I do have kids that can have what's left when we're done with it. You have to balance your risks to your taste.

[nico08]

Hi Animorph:

Good points. Someone suggested that since the mortgage is fairly new, and the mortgage interest deduction is relatively high, and since I currently have a decent income, that I stick with the mortgage for now. Then, when I FIRE, my taxable income will be lower, so I can consider selling investments, pay lower capital gain taxes at that time, and at that point pay the mortgage off. That sounds like it makes sense. Oh, and of course, keeping the mortgage active gives me more access to equity if I need it.

[Animorph]

Quote:

Originally Posted by nico08 Hi Animorph: Good points. Someone suggested that since the mortgage is fairly new, and the mortgage interest deduction is relatively high, and since I currently have a decent income, that I stick with the mortgage for now. Then, when I FIRE, my taxable income will be lower, so I can consider selling investments, pay lower capital gain taxes at that time, and at that point pay the mortgage off. That sounds like it makes sense. Oh, and of course, keeping the mortgage active gives me more access to equity if I need it.

That works, and is quite reasonable, except in those worst case scenarios where the market crashes early on. Then you're kind of stuck waiting for a recovery before you can sell to pay off the mortgage.

[TimSF]

I too have been contemplating whether or not to pay off a mortgage in early retirement. I am 51 and have an outstanding mortgage of $180k, with an interest rate of 3.375% (15 years). I have more than enough in my cash balance to pay it off. I have decided to hold on to it for awhile and reconsider later. One factor is that that mortgage interest tax deduction may be useful in 2014 to keep my MAGI below the ACA cliff level. Right now, I look to be hovering near the cliff. The extra $6000 in mortgage interest I will be able to deduct might make the difference.

[Accidental Retiree]

Quote:

Originally Posted by TimSF I too have been contemplating whether or not to pay off a mortgage in early retirement. I am 51 and have an outstanding mortgage of $180k, with an interest rate of 3.375% (15 years). I have more than enough in my cash balance to pay it off. I have decided to hold on to it for awhile and reconsider later. One factor is that that mortgage interest tax deduction may be useful in 2014 to keep my MAGI below the ACA cliff level. Right now, I look to be hovering near the cliff. The extra $6000 in mortgage interest I will be able to deduct might make the difference.

Someone will correct me if I am mistaken, but I don't believe the mortgage interest deduction will help keep you below the ACA cliff level.

The mortgage interest deduction will not reduce your Adjusted Gross Income (as would an HSA contribution or a tIRA contribution); it will only reduce your taxable income.

[TimSF]

aw shoot.

[ERD50]

Two points:

1) For FIRECalc, you should factor in only the interest payment on the mortgage. The principal payments are not 'spent' they are only transferred from one Net Worth entry (your current funds) to another NW entry (your home equity). Interest payments decrease over time, so this isn't trivial, but you could enter averages for each decade.

2) FIRECalc runs may not be that helpful anyhow (something I learned from others here). You are probably getting lower than historical average rates on the mortgage. But a historical failure period may have occurred during a period of high interest rates /inflation, when those interest rates were not available. So it becomes a false scenario.

What to do? Assuming adequate liquidity, I think you just have to make a guess - do you have reasonable expectations that the long term rates on your portfolio will exceed a low mortgage interest rate? If not, you probably have bigger problems.

-ERD50

[ggbutcher]

I've always in principle favored expediting mortgage and other loan retirement. Interest paid over the life of a loan can add up, and not having that monthly payment is one less line in the budget. For mortgages, it is usually the biggest line item. It makes watching your (hopefully growing) hypothetical property value in Zillow so much more satisfying...

[donheff]

The mortgage payoff issue is complicated. Often people are calculating how much additional portfolio they need to generate the mortgage payment amount using a 4% yardstick or something like that. But, in many cases the mortgage payment is fairly large because it is based on a mortgage that is nearing the payoff. When approaching payoff it is also generating very small tax deductions. In such a case if the payoff amount is refinanced into a new 30 year mortgage at current low rates, the payment could drop substantially while the deduction increases substantially. Then, the portfolio amount needed to generate the payment will be lower. Since the whole concept involves an assumption that you can earn more from investing the payoff than you are paying for the mortgage why not leverage it better?

[Animorph]

Quote:

Originally Posted by ERD50 1) For FIRECalc, you should factor in only the interest payment on the mortgage. The principal payments are not 'spent' they are only transferred from one Net Worth entry (your current funds) to another NW entry (your home equity). Interest payments decrease over time, so this isn't trivial, but you could enter averages for each decade.

From a net worth point of view, or if someone were going to sell the house and count that as retirement income, that's OK. But for a house you will keep though retirement that principal is outside the retirement financial plan. As far as FIRECalc is concerned principal payments are an expense, paid early or paid as a mortgage.

[ERD50]

Quote:

Originally Posted by Animorph From a net worth point of view, or if someone were going to sell the house and count that as retirement income, that's OK. But for a house you will keep though retirement that principal is outside the retirement financial plan. As far as FIRECalc is concerned principal payments are an expense, paid early or paid as a mortgage.

That's a good point. I guess it would probably only really matter if you hit one of the bad cycles, and were running out of funds. And in that case you might be looking at pulling equity out of the house, and then it would be important.

But a good point to consider.

-ERD50