Mortgage or Roth ?

[BooBoo]

Dear Friends,

First I would like to thank you all for all the excellent advice received from this forum, truly amazing. I would like to get your thoughts on a situation that has got me a little perplexed, Where to allocate some funds going forward?

Here is the situation: DW (age 59) already retired no pension and small SS. I (age 55) am planning to retire as soon as my house is sold. I will receive a pension or lump sum from MegaCorp. I have not yet decided but am leaning toward lump sum. Will delay taking SS as long as possible and have adequate savings (never enough but FIRECALC says I am OK) in 401K and IRA’s. The breakdown of saving as follows:

3% Roth
57 % IRA
38 % 401K
2 % after Tax

Mortgage at15 year @ 4.99 %.

Currently in 25 % tax bracket and will most likely be in 15% tax bracket during retirement. (Certainly for next 3 years assuming sale of house)

Plan to use the proceeds from sale of house (tax free) to provide cash living expenses for at least next 3 years. Second home is paid in full and we will move to second home.

Hopefully I have provided enough back ground, here are my questions:

How to allocate new funds this year? I have some “extra cash”.

1) Pay extra on mortgage; a sure 5% looks good. I qualified for mortgage deduction for 2011 but think next year will only make standard deduction. The more I pay down the more cash available and I can fund Roth when house is sold.
2) Fund Roth with extra cash
3) Quit funding 401K (they just eliminated company match) and fund Roth instead or pay down mortgage

My dilemma is that funding the Roth make sense long term. Always have a problem “throwing away” a certain current gain of 5% gain or certain current reduction in taxes at 25 % for a future Roth opportunity.

Plan on converting form IRA to Roth IRA once I am in lower tax bracket and retired as much as makes sense from a tax perspective. I do not plan on using any of the IRA/ROTH/ or 401 K until cash is depleted.

Sorry for being so verbose and thank you in advance for your input. BooBoo

 

[GrayHare]

If you expect being in a lower tax bracket later, and are presently eligible to deduct tIRA contribs, Roth now is usually not a good idea.

If that's not the case, fund the Roth so you can avoid being taxed on the inflation part of its growth, and repay the mortgage later with cheaper, inflated dollars. Even at low inflation rates, such an approach over time puts you far ahead in dollars.

 

[Aeowyn]

Assuming you are right side up on the house, I would available money in Roth first and then 401K. If you are not right side up, then I would set aside some money in case you need to write a check at closing in order to sell your house.

You didn't mention total $ in savings, but if FireCalc says you are OK, I assume its a large enough sum that you are never going to get a significant portion of your tax deferred accounts converted to Roth while staying in the 15% tax bracket.

It looks like most of your savings are in tax deferred accounts (57% IRA + 38% 401K = 85%). In addition if you take a lump sum pension -you will probably roll this into an IRA which will increase the amount you have in tax deferred accounts. If you decide to take a monthly pension payout, this will add a baseline of taxable income every year.

If the tax code stayed the same as it is today, I'm guessing you will probably be in the 25% bracket when RMDs kick in (depending on starting value, how you are invested and your withdrawal rate). But my money is on higher taxes down the road.

Having a portion of your retirement in Roth accounts gives you some flexibility. There are no RMD requirements, you can take large chunks out for major purchases without it kicking your taxes up, if you end of leaving it to your heirs - they can continue to let it grow tax free....

Since you are selling your house (hopefully soon) - I wouldn't pay extra on it now - I'd put all my financial effort on retirement savings and any purchases you need to make for the transition to the new house/life.

 

[Sesq]

Why not re-fi?

Or take out a first lien HELOC to wipe out the mortgage. The advantage of the HELOC is you generally aren't going to get much in the way of closing costs other than maybe an appraisal. The downside is it variable (generally at prime these days, 3.25%), so while the FED has stepped on rates, you never know when that ends. Your short time horizon could be a benefit.

Doing as I say, not as I do, I'd do the Roth first, then mortgage. I am trying to pay off my house in the next two years. But you are further along the road than me, and already have a paid off property.

 

[PaddyMac]

How likely is it that your house will sell? What's plan B if you don't sell the house - do you need cash more than anything else?

Once you are retired, and not earning, you won't be able to fund the Roth.

I always go for the tax deduction. Yes you get a 5% return on paying down the mortgage, but you get a likely 10% reduction in taxes by funding a 401k when you in the marginal tax rate and then paying 15% tax later when you withdraw it.

 

[Animorph]

I think it depends on how long it takes to sell the house and retire. It's early enough in the year that you might be in the 15% tax bracket if that happens fast enough.

Off the top of my head, I'd contribute to the 401k to stay within the 15% tax rate, if practical. Even if that takes a larger contribution. Use your extra cash to pay down principal on the mortgage (make sure you're not just making early normal payments) so that it's making 5% until you sell. When you sell the house, use the cash to convert as much IRA into a Roth as you can, within whatever the lower tax bracket is, for as long as you can.

I'd run the numbers to check all that, and whatever our other suggestions you receive.

 

[EvrClrx311]

Typically Roth is best to invest in earlier in a career when you are paying the least amount of taxes... usually by the time a person is in their 50's they are paying the highest tax rate they will ever see in their lives, so Roth is not very good compared to 401K or IRA. Taking the tax savings now will be worth more in the long run than having the tax savings later...

Mathematically, if you have the same 25% tax rate on the money in and money out sides the Roth and 401K will leave you with the exact same funds in retirement... sometimes I think people see one or the other as inherently better, when really it depends on the situation.

There are other very small differences between 401K and Roth (inheritance and distribution stuff - which usually only matter for the kinds of people with so much money it really doesn't matter)