Pay off 4.5% mortgage or keep going 16 years?

[Jimonlimon]

I know, another "should I pay off my mortgage?" thread.

Planning to retire in about a year at age 59. At that time we will have 15 years left of a 30 year, 4.5% fixed-rate mortgage with a balance of about $135,000 and monthly payment of $1013. All money to pay the mortgage installments or full pay off will be from my 401k, subject to Federal and California income tax. I'm figuring this money as at the "top" of my income and therefore subject to my highest tax rates. I'm also assuming both Federal and California tax rates remain the same with brackets indexed for inflation.

I see four options regarding the mortgage:

• Keep paying $1013/month until paid off in 15 years. Tax 31.3% until we start drawing SS in about 8 years then 28%.
• Keep paying $1013/month until starting SS then pay off over one or 2 years. Tax 31.3% until SS then about 29.5%. This is my preferred plan.
• Pay off in 2 years. Tax 31.9%
• Pay off in 1 year. Tax 32.6%

My plan had been to just keep it with the assumption that returns on my 401k will average more than 4.5% and pulling the money out all at once would result in 2-4% higher tax rates.

Obviously there's a "peace of mind" element to paying it off and not worrying about market downturns eroding the 401k value. We have about $1 million in 401k of which about 40% will be used to bridge the gap from retirement to starting Social Security. Pulling money out for the mortgage payoff now obviously reduces the capital but it would also reduce the annual needs by about $17,500 gross (for $12,156 net). My pension and SS combined will more than cover our current spending until our eventual demise. House is currently worth about $950,000 so no worries about loan to value ratios, we don't have mortgage insurance or annoying escrow accounts.

Opinions?

 

[TripleLindy]

I’m not following how you’re coming up with your tax rates, especially after retirement. Regardless, if paying off your mortgage creates a taxable event, I’d wait and do it in chunks over a few years when you can minimize or even avoid taxes. A $135k balance can be knocked out relatively quickly. You could start now by diverting already taxed income to your mortgage.

 

[OldShooter]

These discussions always boil down to the soft stuff/how much happier would the poster be with a paid-off mortgage? Personally, DW and I prefer a paid off mortgage. I also don't like the popular idea of committing to a fixed mortgage cost while hoping that an investment will produce after-tax returns to make the arbitrage profitable. But, again, those are happiness factors not accounting factors. Will RMDs in the last couple of years of your long plan affect your tax rate?

 

[pb4uski]

^^^ Agree, especially where taxable account money is being used to payoff the mortgage. In this case, any withdrawals, for mortgage payments or payoff, would be taxable events.

At a minimum I would wait until retirement. While it is typical for tax situations to change dramatically when one retires (mine did from 28% federal marginal rate to 0% marginal rate) it is unclear if that will be true for the OP.

 

[Jimonlimon]

Some missing information:

No extra money now to pay down the mortgage.
Tax estimates are based on 2023 Federal and California rates and standard deductions. Married filing jointly. Assuming brackets and standard deduction scale with inflation.
Retirement income will be a taxable government pension, taxable 401k distributions, and eventually Social Security.
Social Security will be California tax free and 85% federally taxable.

I’m using $150,000 gross income as the baseline before pulling extra for the mortgage. Tax rates for the mortgage draw are for the amount above $150k. Tax estimate on the baseline $150k is 11.7% federal and 4.0% state.

My pension provides for medical insurance and Medicare including IRMAA.

 

[DJRR]

Do what makes you happy. I don't think $135k mortgage is enough interest to worry about either way. I assume your house in CA is worth multiples of $135k so I don't see much risk. I definitely would not withdraw from an IRA to pay it off while working. If your income drops in retirement then maybe enough to bring you up to the next tax break point if you want to get rid of it over the next few years. If you like segmenting money then maybe move $135k in your IRA to corporate bonds that pay 5% so that you know you can pay it off if you want to.

 

[nwsteve]

Or, a bit less dramatic and still gets your principle down to near zero at retirement is to add to monthly payment an additional amount to be applied to pay down loan principle.
You can do the math but as I recall an additional payment to principle only you can cuts your payoff time by nearly half.

Here is a calculator to help work out the proper amount https://www.americanfinancing.net/mortgage-calculators/extra-payments

 

[albireo13]

I would avoid withdrawals from your nest egg until you are both retired and your taxable income drops. Don't forget that your mortgage interest is deductible so, the effective rate you are paying is a touch lower than 4.5%.

If you pay it off now, with a lump taken from your 401k, there is the opportunity cost of lost growth on the $135K over multiple future decades!

I kind of like the idea of carrying the loan and accelerating the paydown with extra payments towards the principle. It sounds like you will be able to live off of SS and pensions. Maybe run your budget and figure out how much extra per month you can throw at the mortgage and see how much that pulls in the life of the loan.

 

[Jimonlimon]

I would avoid withdrawals from your nest egg until you are both retired and your taxable income drops. Don't forget that your mortgage interest is deductible so, the effective rate you are paying is a touch lower than 4.5%….

Our taxable income will increase when re retire since it’s all taxable (pension and 401k)and we plan to travel and make some deferred purchases like a new car, new HVAC, etc. The marginal rate won’t drop until we start claiming SS— hence my preferred method of waiting until then to start making extra payments.

With the current tax rules we won’t likely itemize deductions after the first year of retirement so our $6000 In interest won’t be deductible. If the 2017 tax changes were to expire after 2025 that would change the calculation so I’ll pay attention. (It might be better to pull money from 401k to the top of the 24% bracket vs. waiting and paying 25 to 28%.)

Regarding the potential gains from keeping the money invested: I think at 4.5% it’s almost borderline. If I put the required amount into a very safe investment it probably wouldn’t exceed 4.5%. If I keep it in index funds it will probably do quite well but it might go the other way.

 

[COcheesehead]

4.5% is an odd rate. If it were under 3%, I would say keep it - for all the reasons folks bring up: time value of money, possible tax benefits, easy return arbitrage even in quality fixed income yielding over that, liquidity, but at 4.5% it’s a wash.

 

[Andre1969]

In my opinion, it all boils down to just how much you hate having that $1,013/mo payment hanging over your head. If it were me, I'd just leave it alone, and let it run its course. To me, $1,013/mo doesn't seem like all that much to worry about either way, but then I'm coming from the perspective of a ~$1941/mo (plus taxes/insurance) mortgage.

Personally, I don't like having a mortgage payment. I'm sure nobody does. Every time my mortgage payment comes around, and I start getting annoyed by it, I just think of the math, and remind myself that it's best to just let it run its course.

But, in the end, I think it just depends on how much the peace of mind of being mortgage free means to you.

As for the interest rate, I agree, that 4.5% is around borderline, where I can actually understand some temptation to pay it down early or even off. Mine is only at 2.875%, so as much as I really don't like having a mortgage payment, it just makes sense, to me, to keep it. FWIW, before I refinanced, I was at 4.75%, and at the time didn't feel any need to pay it down. But I was also early enough in the mortgage that paying it down early wouldn't have affected things much, short term at least. Now if I was towards the later part of that mortgage, I might feel differently.

 

[freedomatlast]

With a $135,000 balance and an interest rate of 4.5%, it's not going to make an earthshattering financial difference which of the four options in the original post you choose.

 

[CRLLS]

Personally, I was one to keep the mortgage. I rationalized it as the right thing to do because it was less than what I was earning on our investments. Even when rate dropped below 3%, I kept the 4.6% mortgage rate. I tried to drop to lower rates at the time, but the outstanding balance was ~90,000 and nobody was giving the low rates for that small a loan. Then one day about 3 years ago I said WTH, just pay it off to simplify our financial life, which we did. Either way was not a financial slam dunk. I can say I neither am happier now, or regret it. It just is what it is.

To quote Risky Business, "There's one thing I have learned in all my years, at some you just gotta sat WTF. Make your move".

 

[albireo13]

It seems like it is a wash, going either way. If the mortgage payment fits within your budget, and you are comfortable paying it, I would say let it run its course. When it finally gets paid off, it will be like you are getting a sudden pay raise ... a nice surprise!!

You can always change your mind down the road, anytime, and pay it off.