Pay down mortgage or stuff retirement accounts?

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save4kollege
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Pay down mortgage or stuff retirement accounts?

Post by save4kollege »

I am trying to determine the most beneficial thing(s) to do for our long-term financial health. I’m also open to exploring/understanding other options I am not aware of. Thanks for your time and help!
1. Pay-off a portion or entire mortgage
2. Pay-off car loan
3. Max-out 401k contributions
4. Max-out Roth IRA backdoor contributions
5. Other?
Emergency funds: $62K
Debt: Mortgage -10 years fixed, $103K @ 3.25%, 65K principle and 6 years remaining, $1100/month; Auto – 4 years, $12K @ 3.1%, 2 ½ years remaining, $309/month
Tax Filing Status: Married Filing Jointly
Tax Rate: 28% Federal, 6.5% State
State of Residence: Illinois
Age: both 54

Taxable
$82K cash (after-tax proceeds available if stock options exercised today)
$58K Facebook (FB)
$62K Vanguard money market

His 401k - $780K at Vanguard in a “balanced fund” comprised 30% VTSMX, 30% VGTSX, 40% VTBIX
His Roth - $60K Vanguard VFIAX S&P 500 Index Admiral
Her Roth - $67K Fidelity FUSVX Fidelity Spartan 500 Index Advtg

New annual Contributions
His 401k: Company targets 12% of salary annual contribution to account, not less than 8% or not to exceed 18%. I can add $18K per year plus $6K catch-up
His Roth: in recent years have performed backdoor contribution of $6500
Her Roth: in recent years have performed backdoor contribution of $6500
DSInvestor
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Re: Pay down mortgage or stuff retirement accounts?

Post by DSInvestor »

You're in a pretty high tax bracket. I suggest that you max out Traditional 401k contributions for 24K, then max out Roth IRA 6.5K each using backdoor if necessary, then consider attacking the car loan and mortgage. The car loan at 3.5% has interest that is non-deductible and is relatively small at 12K. You may be able to pay this off in little time which would free up $309/month in cash flow. Once that's gone, make extra principal payments on the mortgage.
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knpstr
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Re: Pay down mortgage or stuff retirement accounts?

Post by knpstr »

I would pay off the car loan, today! Use $12k from your $62k in savings or from taxable account.
After that I would max out retirement accounts.
If any money available AFTER maxing retirement accounts, I would pay down the mortgage with every extra dollar.

...
Personally, I would likely pay off both the car and house. 12k from savings, the house from taxable. But if you want to keep your taxable account intact, just all extra cash flow goes towards the house.
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Twins Fan
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Re: Pay down mortgage or stuff retirement accounts?

Post by Twins Fan »

"Most beneficial" will kind of come down to a personal preference deal. Are you debt averse?

I would agree with maxing out the 401k, then fill the Roths, then get rid of the car loan (I just don't like car payments), and then pay down the mortgage before anymore taxable investing. But that's mainly going off my preference. Others will be different.

When do you plan to retire? I am one that does not want a mortgage in retirement. But, with only 6 years left on it you may be on track to pay it off right at retirement time just paying on schedule?

Are you comfortable holding the $58k in one stock Facebook? It's not a major part of your portfolio, so it's probably not a big deal either way. Maybe get out of that one while the getting is good though. Something will replace it eventually and it won't be so cool. JMO

Looks like you're doing pretty well though. :beer
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save4kollege
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Re: Pay down mortgage or stuff retirement accounts?

Post by save4kollege »

Thanks for quick replies. I've always had a bias towards funding retirement accounts first, and that seems like the advice given today.
CoAndy
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Re: Pay down mortgage or stuff retirement accounts?

Post by CoAndy »

I would pay off the auto loan today, begin maxing out 401(k), and ROTH and throw all remaining money to the mortgage.
peppers
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Re: Pay down mortgage or stuff retirement accounts?

Post by peppers »

The Illinois state income tax for individuals for 2015 3.75 percent

http://www.revenue.state.il.us/TaxRates/Income.htm
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Watty
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Re: Pay down mortgage or stuff retirement accounts?

Post by Watty »

save4kollege wrote:I am trying to determine the most beneficial thing(s) to do for our long-term financial health. I’m also open to exploring/understanding other options I am not aware of. Thanks for your time and help!
1. Pay-off a portion or entire mortgage
2. Pay-off car loan
3. Max-out 401k contributions
4. Max-out Roth IRA backdoor contributions
5. Other?
6. All the above.

If you pay off the mortgage and car then you have about $1,400 in after tax car and house payments freed up each month. That means that you could increase your 401K contributions by up to about $2,000 a month because of the tax savings. That would also likely then allow you to do the back door Roth.

Under "other" also save up money in a taxable account so that you can have a few years when you retire where you are in the 15% federal tax bracket. This will allow you to sell the FB stock and not pay the federal capital gains taxes.
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save4kollege
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Re: Pay down mortgage or stuff retirement accounts?

Post by save4kollege »

Thanks Watty, CoAndy and Twins Fan -- if things work as currently planned I would retire in 6 yrs which is when mortgage would be paid in full. Based on current feedback there doesn't seen to be a clear direction - equal number of pay mortgage vs. stuff retirement accounts. Seems like I would come out ahead by feeding the retirement accounts over paying mortgage. Of course, this is a bet I would be placing that the retirement accounts would earn more than the 3.25 percent I'm paying on that loan.
Twins Fan
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Re: Pay down mortgage or stuff retirement accounts?

Post by Twins Fan »

Yep, there is no one answer fits all for these situation. You will get answers from both sides of the fence. You're in a good spot and wouldn't really be wrong no matter which way you go.

Which would be optimal? Well, we will know in about 10 years. :happy
larmewar
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Re: Pay down mortgage or stuff retirement accounts?

Post by larmewar »

I would look at itemized deductions before deciding. If itemized deductions excluding mortgage interest are less than the standard deduction, you aren't benefiting tax wise and the balance is tipped toward paying off the mortgage.

Lar
SleepKing
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Re: Pay down mortgage or stuff retirement accounts?

Post by SleepKing »

larmewar wrote:I would look at itemized deductions before deciding. If itemized deductions excluding mortgage interest are less than the standard deduction, you aren't benefiting tax wise and the balance is tipped toward paying off the mortgage.

Lar
+1. I'd probably just knock out the car loan with cash, since it just seems annoying :wink:
bdpb
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Re: Pay down mortgage or stuff retirement accounts?

Post by bdpb »

Noticed your username. Are you saving for or have savings set aside for kids' college funding?

If so, use the IL 529 Bright Start Direct plan. It's low cost and gives an IL state tax break up to 20k per year on a joint return.

Where did you ever come up with the 6.5% IL state tax number? It's currently 3.75% and was recently 5%. Do you work in another state?
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grabiner
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Re: Pay down mortgage or stuff retirement accounts?

Post by grabiner »

save4kollege wrote:Debt: Mortgage -10 years fixed, $103K @ 3.25%, 65K principle and 6 years remaining, $1100/month; Auto – 4 years, $12K @ 3.1%, 2 ½ years remaining, $309/month
Tax Rate: 28% Federal, 6.5% State

Taxable
$82K cash (after-tax proceeds available if stock options exercised today)
$62K Vanguard money market
You shouldn't have the car loan at 3.1% if you can afford to pay cash; it's clear to pay that off.

You get just a 2.19% return after tax on paying down the mortgage. But you can pay the whole thing off right now, which means that your payment has a duration of just three years, and 2.19% after-tax is a great rate on a three-year investment.
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save4kollege
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Re: Pay down mortgage or stuff retirement accounts?

Post by save4kollege »

to "bdpb" ....

It was a bad guess on my part about IL tax rate, glad to hear it is much lower. Yes, I am an IL resident.

As for 529, I am fortunate that college funding is taken care of, one son graduates next year and another in two years. We started saving very early for both and each will only need to borrow about $25K to fill the gap.
CelebrateLife
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Re: Pay down mortgage or stuff retirement accounts?

Post by CelebrateLife »

I am a fan of NO DEBT! First, use your emergency fund to immediately get rid of your car debt. This car debt does not benefit you in any way, shape, or form. Decide on a comfortable percentage of your income to contribute to IRA funds, concurrently attacking your mortgage debt. Slowly but surely each month I would contribute extra dollars to the mortgage, perhaps aiming to pay off that debt in fewer years than the 6 remaining. Think of all the extra money you will have when you no longer have that monthly payment!!! No matter what happens in our future economy, you will be able to sleep peacefully each night by being debt-free, and that feeling is priceless. Whatever you decide, however, you are doing exceptionally well.
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Re: Pay down mortgage or stuff retirement accounts?

Post by abuss368 »

Hi save4kollege,

You appear to be doing very well on the journey to financial freedom. A few things I would point out or consider:

1) Taxable - Facebook stock - This is a large concentration and risk that may or may not be rewarded. I would consider selling and investing in the Vanguard Total Stock or Vanguard Total International Stock Index Funds.

2) Vehicle Loan - This loan is almost complete and has a very low rate. Increase the payments if you can or just finish the term. I would not use an asset to payoff. Let your assets continue to grow.

3) Mortgage - Once the vehicle loan is paid off, increase the payment to the mortgage if possible.

Please stop back with any additional questions or concerns.

Best.
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jimb_fromATL
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Re: Pay down mortgage or stuff retirement accounts?

Post by jimb_fromATL »

save4kollege wrote:Thanks Watty, CoAndy and Twins Fan -- if things work as currently planned I would retire in 6 yrs which is when mortgage would be paid in full. Based on current feedback there doesn't seen to be a clear direction - equal number of pay mortgage vs. stuff retirement accounts. Seems like I would come out ahead by feeding the retirement accounts over paying mortgage. Of course, this is a bet I would be placing that the retirement accounts would earn more than the 3.25 percent I'm paying on that loan.
Considering your tax bracket(s) you don't have to earn much at all in the retirement accounts to come out better by investing instead of paying off the debts.

According to their own site, Illinois does not tax withdrawals from retirement accounts like 401(ks) and IRAs. So if you contribute to your 401(k) you get to defer the state income tax and invest it for yourself, then will never pay tax on the withdrawals.

Plus, unless you have huge pensions or other income after retirement, the money you don't pay in federal taxes now but invest for yourself in the 401(k) will most likely grow to considerably more than you'll have to pay in taxes on the withdrawals later.

Also bear in mind that with no state income tax and no FICA tax and no contributions to retirement, you won't need to withdraw nearly as much money from retirement funds to have the same net income as you have now anyway. So chances are you won't pay any of your federal tax in the 28% federal bracket later.

Your numbers don't quite match up perfectly for the mortgage, but here's an example that's close enough to illustrate why you should contribute the max to the 401(k) IF you want to put your money to its best use ( instead of just feeling good about paying off debt regardless of the long-term loss of taxes and compound interest earnings).
  • A mortgage debt of 65,000 at 3.2% would be paid off in 64 months (5.37 years) with a payment of $1100 per month for P&I. The total interest would be $5,826.

    If you did not contribute the $2000 per month to the 401(k) plan and paid a total of 31.75% state and federal income taxes, that would be $635 per month that does nothing for you from now on. It does not pay down debt, pay bills, buy necessities, or earn compound interest for the rest of your life either.

    The extra after-tax $1365 would pay the debt off in 27.4 months and save $3,338 in interest.

    That may sound good at first glance, but notice that during that 27.4 months you've paid an extra $17,385 in taxes that you could have invested for yourself in order to save that $3,338 in interest.

    If you contributed $2000 per month to the 401(k) for 5.4 years earning a conservative average of 7.% it would grow to $155,749.

    If you start contributing the $2K after delaying 27 months while paying of the debt faster you would have a total of $82,348 at the end of 5.4 years. That is a loss of about $73,401 by that time.

    At a conservative 4% earnings during retirement the $73,401 could have paid you another $245 per month in interest earnings without even touching the principal. If you lived another 30 years it would result in a lifetime loss of $161,482 in retirement income in exchange for saving $3338 on the short-term debt.

    Assuming you resume the $2000 contributions as soon as the debt is paid off, then at the same earnings it would grow to $40,747 at retirement.

    Most people do NOT do this, and you would not get to defer taxes, but if you had the self-discipline to reinvest the freed-up $1100 per month payments for the remaining 37. months of the original loan, then at the same 7% it woud grow to $45,291 by retirement. You'd then have a total of $127,640 in savings for retirement. But you're still short by $28,109 at retirement time in exchange for saving the $3,338 interest on the debt.

    And that's still only part of your long-term loss. At 4% earnings after retirement that could pay you $94 per month in interest if you never touched the principal. So if you lived 30 more years you would still lose the $28,109 you won't have plus the $33,731 interest it won't earn in the next 30 years for a potential total loss of $61,841 of income during your life in exchange for saving the $3,338 interest on the debt.
The long term consequences for losing the tax deferral and just a couple of years of time for earning compound interest would be proportional for delaying the 401(k) contributions to pay off other debts, too. There's just nothing to gain by paying the state taxes now if you can defer them and never pay them later; or to pay fed taxes in your highest bracket now when you're not likely to pay that much on your retirement withdrawals later.

jimb
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Re: Pay down mortgage or stuff retirement accounts?

Post by ControlContentment »

There is no wrong answer. Paying debt and saving are two sides of the same coin.
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Watty
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Re: Pay down mortgage or stuff retirement accounts?

Post by Watty »

jimb_fromATL wrote:Considering your tax bracket(s) you don't have to earn much at all in the retirement accounts to come out better by investing instead of paying off the debts.
The OP has significant taxable accounts so a better comparison would be trying to invest money in the taxable account and being able to get a higher return. They are both 54 so if they invest with an asset allocation of anywhere near the old saying of "your age in bonds" then getting a higher return after taxes could be harder than it might sound if they invest 54% of the money in low interest rate bonds.

I would assume that the retirement accounts would be maxed out in any situation so the tax advantages are pretty much a given whatever they choose.

If nothing else to max out their retirment accounts they could sell some of the FB stock and pay 15% capital gains tax, but use that money to live on so they could get the 33% tax break. They would have to do this through payroll deductions but they could do something like sell $12K in FB stock and use $1,000 of that each month to live on but also increase their 401K contributions by $1,000 a month.
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jimb_fromATL
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Re: Pay down mortgage or stuff retirement accounts?

Post by jimb_fromATL »

Watty wrote:
jimb_fromATL wrote:Considering your tax bracket(s) you don't have to earn much at all in the retirement accounts to come out better by investing instead of paying off the debts.
The OP has significant taxable accounts so a better comparison would be trying to invest money in the taxable account and being able to get a higher return. They are both 54 so if they invest with an asset allocation of anywhere near the old saying of "your age in bonds" then getting a higher return after taxes could be harder than it might sound if they invest 54% of the money in low interest rate bonds.

I would assume that the retirement accounts would be maxed out in any situation so the tax advantages are pretty much a given whatever they choose.

If nothing else to max out their retirment accounts they could sell some of the FB stock and pay 15% capital gains tax, but use that money to live on so they could get the 33% tax break. They would have to do this through payroll deductions but they could do something like sell $12K in FB stock and use $1,000 of that each month to live on but also increase their 401K contributions by $1,000 a month.
I think we're saying essentially the same thing in different ways. But the OP asked about paying off the mortgage and sez they are not contributing the $18K plus 6K catch-up to one 401(k).
save4kollege wrote: "...
1. Pay-off a portion or entire mortgage
2. Pay-off car loan
3. Max-out 401k contributions..."

"... I can add $18K per year plus $6K catch-up..."
So my illustration shows why I think maxing the 401(k) should be done before paying any extra on the debts.

They appear to have significant money to spare since the have the after-tax accounts and have done backdoor IRAs. So I fail to see any advantage in investing in after-tax accounts when there are still any tax deferral opportunities not being used.

No way I can see how paying 31.75% tax now could possibly be better than deferring it and investing the money now and paying less tax after retirement.

As for paying off the mortgage, while it would be bad to do it in lieu of maxing the 401(k) I would probably do it with the existing after-tax money ... especially if while the market is still relatively high and provided it's not their emergency funds.

In their case, six years until retirement is not a long enough time for recovering from a really bad market crash. So if the cyclic history of the market is any indicator at all, this may well be a time when taking the gain now and dollar-cost-averaging by reinvesting the freed-up payments could end up give a better return (or reduce the potential for a future loss) in the after-tax account(s).

jimb
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save4kollege
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Re: Pay down mortgage or stuff retirement accounts?

Post by save4kollege »

abuss368 wrote:Hi save4kollege,

You appear to be doing very well on the journey to financial freedom. A few things I would point out or consider:

1) Taxable - Facebook stock - This is a large concentration and risk that may or may not be rewarded. I would consider selling and investing in the Vanguard Total Stock or Vanguard Total International Stock Index Funds.

2) Vehicle Loan - This loan is almost complete and has a very low rate. Increase the payments if you can or just finish the term. I would not use an asset to payoff. Let your assets continue to grow.

3) Mortgage - Once the vehicle loan is paid off, increase the payment to the mortgage if possible.

Please stop back with any additional questions or concerns.

Best.
Thanks for feedback on FB of which there seems to be similar sentiment. For the time being I'm comfortable hanging on to it. I purchased shortly after the IPO when it was close to it's historical low, so this is a good story know matter when I cash it in for a broad index fund as you suggested.
SGM
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Re: Pay down mortgage or stuff retirement accounts?

Post by SGM »

I would pay off the car loan and the mortgage. It is a safe return whereas investments in the stock market fluctuate. Once the loans are paid off I would invest that much more in stocks and bonds. That is what I did and never regretted it. Although I had very little in bonds until close to retirement. Now that I am retired I am increasing my allocation to bonds a little as I am a little more risk averse.
Big Dog
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Re: Pay down mortgage or stuff retirement accounts?

Post by Big Dog »

not a fan of consumer debt, so I'd pay off the car loan immediately. And then max out 401k. At a 28% bracket, not sure if Roth is the way to go. The mortgage will take care of itself in due time.
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Re: Pay down mortgage or stuff retirement accounts?

Post by joebh »

save4kollege wrote:Thanks for feedback on FB of which there seems to be similar sentiment. For the time being I'm comfortable hanging on to it. I purchased shortly after the IPO when it was close to it's historical low, so this is a good story know matter when I cash it in for a broad index fund as you suggested.
The fact that it has been a good story, doesn't mean going forward it will continue to be one.
You should only hold a stock if you believe it will go up in value - without regard to what it has done do far. Otherwise, you should cash it in.
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