Q. I’m single, recently retired at age 65 and have approximately $450,000 in my IRA. My Social Security and a small pension total $2,000/month, and I can meet all my expenses with this amount of money except for my mortgage. I only have seven years until it is paid off, but with my other expenses, I can’t make the monthly payment without tapping into my IRA. My mortgage interest rate is 6.5 percent, and now that I’m retired, I’ve been told that it will be extremely difficult to refinance. I should have refinanced while still working, but I traveled a lot and thought I’d do so once in retirement when I had more time. My question is this: Should I continue to take $1,500/month out of my IRA for the next seven years for my mortgage payment, or should I just take the money from my IRA and pay off my mortgage? If I take out a lump sum, then I wouldn’t have to draw from my IRA until my required distribution age, and I’d avoid the 6.5 percent interest expense for the next seven years.
A. I would not take a lump sum from your IRA. Based on your $1,500/month payment amount with 84 months remaining and an interest rate of 6.5 percent, your current principal balance is around $101,000. If you are a single tax filer, you would need to take at least $128,000 from your IRA to pay off your mortgage and pay the taxes owed on the distribution. The taxes owed will be more than the approximately $25,000 of interest you will pay on your mortgage over a 7-year period.
This may seem like a close call – pay $28,000 in taxes now, eliminate your mortgage and save $25,000 in interest payments – but time value of money needs to be taken into account. If you leave the $128,000 in the IRA and take out $1,583/month, federal taxes owed will be around $750/year. The $1,583 will provide you with enough additional cash flow to cover your mortgage principal and interest and your tax owed on the withdrawal. If you earn a 5 percent rate of return on your IRA investments, its value will be more than $22,000 greater than if you took the lump sum now, paid taxes and paid off your mortgage.
Depending on your other income, a large withdrawal from your IRA could cause you to pay a higher premium amount for Medicare Part B and Medicare prescription drug coverage. These plans pay for doctor services, outpatient care, prescription drugs and other medical services. The government used to pay a major portion of the costs for these plans, but as part of the health reform law, if you have higher income in any one year, the law requires an adjustment to your monthly Medicare Part B and Medicare prescription drug coverage premiums. The IRS tax return from two years ago is used to determine if you will pay a higher premium.
For 2014, if you file married filing jointly and your modified adjusted gross income (MAGI) in 2012 was greater than $170,000 – or if you use a different filing status and MAGI is greater than $85,000 – you will pay higher premiums. The additional amount you will owe above the base premium ($104.90/month for Part B and $00.00 for prescription drug coverage in 2014) is based on your MAGI, and an additional charge can range from $46.90 to $230.80 per month for Part B and $12.10 to $69.30 for prescription drug coverage. The MAGI threshold was adjusted for inflation but is now frozen until after year 2019. If you increase your MAGI by taking a $128,000 distribution from your IRA, you will see your Medicare Part B & D premiums rise in 2016.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624