Paying off mortgage with an SPIA


Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Feb 20, 2006
Washington, DC
An off hand remark by the new lady on the health forum caused me to ponder this question. I have tentatively decided to pay off my mortgage on my second home when DW retires in a year or two. I have $270K in safe fixed investments to cover the pay off. I am choosing to do this because I want to reduce expenses to drive my SWR percentage rate down well below 4%. You don't need to tell me all the reasons not to pay off my mortgage since we have already covered that several times (but feel free to slam in anyway if you can't restrain yourself ;)).

Anyway, I ran the numbers against Vanguard's annuity quoter to see how a $270K 26 year fixed annuity with cancellation option would perform. It would deliver $1497.45/mth. My current mortgage (principal and interest only) is $1,065. Vanguard says that 57.9% of the annuity is "excluded." I assume that means 42.1% of the annuity is taxable income.

This sounds like an attractive option. In the early years, the tax deduction on the mortgage interest would more than make up for the tax on the annuity. In the meantime, the annuity would pay the mortgage and the insurance and property tax I would have to pay on my own if I paid the mortgage off in cash. The fact that the insurance and property tax would continue to rise is irrelevant since that will happen if I pay the loan off anyway.

Am I missing anything here? Has anyone evaluated such an approach and, if so, does it make sense to take out a shorter annuity covering years were the mortgage tax deduction is high and reserve the remainder for a future buy-out?

Brewer - what insurance companies should I consider if I get serious about this? Should I include Vanguard in the mix?
What do you mean "cancellation option?" What you really want is an annuity "period certain" which pays out for a specified time period regardless of whether you live or die.

This seems like an idea worth considering, so let's explore the possible gotchas:

- Insurance company goes bust. Always a possibility, but possible to mitigate by sticking with superior credits.
- Tax code changes to make this idea less attractive.
- You keel over and the mortgage becomes due immediately. This is a real consideration for your survivors, although if they would have sufficient assets to pay off the mortgage without a big strain, it might not matter that much.
- You move. Pretty much stuck with the SPIA in that case.

What you are realy talking about doing is defeasing the loan. If an insurance company can do it economically, you might be able to, too. So in addition to buying an annuity, you should look into buying a package of bonds (ladder) that would mature in time to pay the mortgage off year by year.

Start with insurers rated a minimum of Aa3 by Moody's for Insurance Financial Strength. Bigger is better. Mutual is better than stock. I will be happy to opine on specific companies. But hit the usual suspects first: USAA, TIAA-CREF, Prudential, MetLife, MassMutual, Northwestern Mutual, Pacific Life, ING. See what quotes you can get directly or on the web, although some companies may requie you to go through a middleman.

I believe VG sells AIG products. I would not buy anything from them, personally.

"A provision that voids a bond or loan when the borrower sets aside cash or bonds sufficient enough to service the borrower's debt. The borrower sets aside cash to pay off the bonds, therefore the outstanding debt and cash offset each other on the balance sheet and don't need to be recorded."
Brewer, I think what donheff has considered is an immediate annuity with a 26 year guarantee period, so he or she would continue to recieve payments beyond the 26 years if still alive.

One potential problem with this is that if you die or want to sell the house then you or your estate will have to figure out some way to unwind the arbitrage between the loan and the annuity.

I'm also curious how you got a $270k 26 year loan with a payment of only $1,065 per month. That's an interest rate of about 1.65%. Are you sure you aren't just looking at the interest portion of your payment? You clearly should hang onto that rate if you can.
Forget the whole topic. I was mixing mortgages up. The weekend house in question actually has a $170k mortgage vs the $270K that was the mortgage on my primary residence until I closed it out recently. That $270K amount was rattling around in my head.

When I run the correct $170K amount through the calculator I get $942/mth -- not enough to fully cover the mortgage of $1065. With the continued tax deduction in the initial years it might still work out but it isn't a great deal.

Lets go back to sleep on this one -- sorry for the distraction.
I had a sneaking suspicion something was funny.

Even so, I think paying off the mortgage in your situation makes a lot of sense.
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