Personal Finance

Money Matters: Paying off mortgage before retirement not always best decision

Q. I can’t stand my job and the only thing keeping me going is my plan to get out of here sooner than later. I plan to retire in five years at age 58. I may find some other type of work but I want to be able to retire based on no income from a salary. I have run some numbers and I think I can do this if I pay off my mortgage before I retire. My current mortgage balance is $75,000 and my interest rate is 3.75 percent. I figure a little more than $600/month added to my mortgage payment will be needed to pay off my mortgage in five years versus ten and reducing my 401(k) contributions by this amount will still allow me to get the company match. I figure the interest saved on the mortgage will make up for any lost savings in my 401(k). I know most financial advisers suggest you retire without a mortgage so I think you’ll agree with my plan to reduce my monthly 401(k) contributions by an amount to allow me to make larger mortgage payments but wanted your input. Your thoughts would be appreciated.

A. Sorry you are so miserable in your job; I think I’d feel the same way if I were still working at the utility company. I’m not aware that most financial advisers focus on paying off your mortgage prior to retirement. I agree that it is a “feel good” decision to pay off your mortgage early but I don’t think it is always the best financial decision. Eliminating debt while you are still working is a good financial goal but other existing debts and investment options may lead to the conclusion that accelerating your mortgage payment is not a wise idea.

Assuming you are in the 25 percent federal tax bracket and are able to deduct your mortgage interest, the effective interest rate you are paying is less than 2.82 percent. If you have any other debts that carry a higher interest rate, those should be paid off before you consider accelerating your mortgage payments.

Again, assuming the 25 percent federal tax bracket, the $600/month you are contributing to your 401(k) is saving $150/month or $1,800/year in taxes. To put it another way, if you reduce your monthly contributions by $600 your cash flow will only increase by $450 due to the increased tax bite on your earnings. You’ll have to pay taxes when you take distributions from your 401(k) but you will have deferred the tax and you may be in a lower tax bracket when taking distributions.

Hopefully, you will get a higher return on your 401(k) investments than the interest rate on your mortgage. You only have five years to take advantage of investing pre-tax while having earned income; you should take full advantage of this retirement savings opportunity. Since you plan to retire after age 55, as long as you leave your 401(k) with your employer, withdrawals will not be subject to a 10 percent early withdrawal penalty. If you were to roll the 401(k) to an IRA, withdrawals prior to age 59 1/2 would be subject to the penalty unless limited exceptions were met.

If you have any consumer debt with an interest rate of over 3 percent, any extra cash flow should be directed to paying this off.

I know you’ve run the numbers, but since you are so close to retirement it may be a good idea to hire a financial planner to review your analysis to make sure you haven’t missed anything before you turn in your notice at work.