Paying off a mortgage: Incentivized by new tax law?

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AtlasShrugged?
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Paying off a mortgage: Incentivized by new tax law?

Post by AtlasShrugged? » Tue Jun 12, 2018 8:23 am

Bogleheads....I need some advice on whether to direct money toward paying down a mortgage, or establishing a taxable account. Some background.

I currently max out my 401K and Roth IRA (finally!). Wife has a Roth she contributes to. So we are pretty much maxing out our tax advantaged space. For health reasons, I cannot participate in an HSA. I live in a HCOL (NJ). With the passage of the new tax law, our MFJ deduction is 25,300 (DW is 66). My itemized deductions (from 2017 return) add up to ~20K. It would be a real stretch to get to 25,300 in itemized deductions. I am in the 22% tax bracket.

I am now thinking about next steps. I could purchase rental properties (DW asked me to hold off for a year or two), or open a taxable account, or accelerate payments on the mortgage (4% interest rate). How should I go about evaluating which is the best option? This is what I am struggling with. The mortgage runs to April 2045 if I do nothing (27 years); and I would be 79 years old at payoff.

Is it as simple as just saying, every dollar to the mortgage is a guaranteed 4% (real), and will I do better than 4% (real) in investing the money? Or should I have different criteria to help me evaluate whether the new tax law incentivizes paying off the mortgage over opening a taxable account?
“If you don't know, the thing to do is not to get scared, but to learn.”

SRenaeP
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by SRenaeP » Tue Jun 12, 2018 8:39 am

AtlasShrugged? wrote:
Tue Jun 12, 2018 8:23 am
The mortgage runs to April 2045 if I do nothing (27 years); and I would be 79 years old at payoff.
This alone would incentivize me to accelerate payoff. In your shoes, I would plan to have the mortgage paid off by the time I retire.

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bottlecap
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by bottlecap » Tue Jun 12, 2018 8:52 am

SRenaeP wrote:
Tue Jun 12, 2018 8:39 am
AtlasShrugged? wrote:
Tue Jun 12, 2018 8:23 am
The mortgage runs to April 2045 if I do nothing (27 years); and I would be 79 years old at payoff.
This alone would incentivize me to accelerate payoff. In your shoes, I would plan to have the mortgage paid off by the time I retire.
I agree. I'm not sure why you'd want a mortgage this long.

Personally, I'd probably pay it down/off and take the 4% guaranteed.

JT

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Re: Paying off a mortgage: Incentivized by new tax law?

Post by barnaclebob » Tue Jun 12, 2018 8:54 am

AtlasShrugged? wrote:
Tue Jun 12, 2018 8:23 am
Bogleheads....I need some advice on whether to direct money toward paying down a mortgage, or establishing a taxable account. Some background.

I currently max out my 401K and Roth IRA (finally!). Wife has a Roth she contributes to. So we are pretty much maxing out our tax advantaged space. For health reasons, I cannot participate in an HSA. I live in a HCOL (NJ). With the passage of the new tax law, our MFJ deduction is 25,300 (DW is 66). My itemized deductions (from 2017 return) add up to ~20K. It would be a real stretch to get to 25,300 in itemized deductions. I am in the 22% tax bracket.

I am now thinking about next steps. I could purchase rental properties (DW asked me to hold off for a year or two), or open a taxable account, or accelerate payments on the mortgage (4% interest rate). How should I go about evaluating which is the best option? This is what I am struggling with. The mortgage runs to April 2045 if I do nothing (27 years); and I would be 79 years old at payoff.

Is it as simple as just saying, every dollar to the mortgage is a guaranteed 4% (real), and will I do better than 4% (real) in investing the money? Or should I have different criteria to help me evaluate whether the new tax law incentivizes paying off the mortgage over opening a taxable account?
The old tax laws weren't good enough to incentivize you to not pay it off early anyway. Only the part of your interest that was greater than the standard deduction was a bonus anyway.

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munemaker
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by munemaker » Tue Jun 12, 2018 8:56 am

Personally I don't invest in the stock market with borrowed money. I would pay off the loan now and invest later.

Nate79
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by Nate79 » Tue Jun 12, 2018 11:07 am

What is the right decision depends on the accuracy of your crystal ball - do you believe the guaranteed return of your mortgage rate (which is an after tax rate) will be higher or lower than the return you will get by investing in whatever else you decide to invest in. That alternative investment may have a higher risk profile and also would need to evaluate on an after tax basis. In your case you may also want to think about whether you want to carry a mortgage so long into retirement and rely on asset drawdown to pay the mortgage vs a lower withdrawal rate and no mortgage. The other issue to think about is that if you are having to pay the mortgage in retirement then what does that do to your tax bracket vs no mortgage - you need less income if no mortgage. You may also find less SS being taxed due to lower taxable income needed.

Personally for us holding a mortgage during accumulation phase with interest rate below 4% is ok but once it is paid off I will try my best to not have a mortgage ever again. And I do not want a mortgage in retirement.

TravelforFun
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by TravelforFun » Tue Jun 12, 2018 11:28 am

To me the new tax laws have very little effect on my decision. The question is if you had a paid-for home, would you borrow on it and use the money to invest in the market. I would not.

TravelforFun

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Re: Paying off a mortgage: Incentivized by new tax law?

Post by Grt2bOutdoors » Tue Jun 12, 2018 11:33 am

If you have sufficient liquidity in hand, job is relatively stable, I would focus on paying off your home mortgage.
If you reside in NJ, you don't deduct mortgage interest on state tax return and your property tax deduction is capped at $10K.
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poker27
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by poker27 » Tue Jun 12, 2018 11:37 am

It is more appealing for me to pay down my mortgage since I will hardly itemize this year, but have not begun to do so. If you are unsure what to do, i would split it 50/50. I would doubt that paying off a 4% mortgage is the best financial decision long term, but its a safe one. I will continue to put my extra loot into a taxable, but may switch it up at some point.

magicrat
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by magicrat » Tue Jun 12, 2018 11:40 am

AtlasShrugged? wrote:
Tue Jun 12, 2018 8:23 am

Is it as simple as just saying, every dollar to the mortgage is a guaranteed 4% (real), and will I do better than 4% (real) in investing the money? Or should I have different criteria to help me evaluate whether the new tax law incentivizes paying off the mortgage over opening a taxable account?
Note that it is 4% nominal, not real.

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Re: Paying off a mortgage: Incentivized by new tax law?

Post by Jack FFR1846 » Tue Jun 12, 2018 11:42 am

4%? I would absolutely pay down that mortgage.
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PhilosophyAndrew
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by PhilosophyAndrew » Tue Jun 12, 2018 11:45 am

Paying off your mortgage is not a guaranteed 4% real return — the return is nominal, and will become less significant wirh inflation.

Andy.

Admiral
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by Admiral » Tue Jun 12, 2018 11:47 am

You do realize that NJ is one of a few high-tax states (along with NY and CT) that have said they are allowing tax payers to deduct their state taxes as a charitable contribution, and thus continue to itemize and get the full (uncapped) deduction? Google it if not.

The IRS has (thus far) indicated that this is not going to fly, but it's likely going to play out in the courts. I would wait a bit.

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Re: Paying off a mortgage: Incentivized by new tax law?

Post by Admiral » Tue Jun 12, 2018 11:57 am

TravelforFun wrote:
Tue Jun 12, 2018 11:28 am
To me the new tax laws have very little effect on my decision. The question is if you had a paid-for home, would you borrow on it and use the money to invest in the market. I would not.

TravelforFun
This is too facile. What if my company is going to match my investment 100% (as many companies will) when I invest in my retirement plan? Should I pay more on my mortgage, or put my money into retirement? You're still "borrowing on your home" (as you put it) by directing the dollars you COULD be paying toward a mortgage into an investment. Yes, the investment may fluctuate, but you've just doubled your money regardless. Most of us would not think twice about this choice.

There are other problems with this analogy (like borrowing against a wholly-owned asset versus a leveraged asset, which is not the same thing) but I am not a fan of this description of the choice.

KlangFool
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by KlangFool » Tue Jun 12, 2018 12:14 pm

AtlasShrugged? wrote:
Tue Jun 12, 2018 8:23 am

Is it as simple as just saying, every dollar to the mortgage is a guaranteed 4% (real), and will I do better than 4% (real) in investing the money? Or should I have different criteria to help me evaluate whether the new tax law incentivizes paying off the mortgage over opening a taxable account?
AtlasShrugged,

1) This is simply wrong. Your mortgage is not 4% (real). If it is, the interest rate should be around 7% now.

<<will I do better than 4% (real) in investing the money?>>

2) Ditto.

3) There is a bigger picture question here too. What is your overall portfolio size excluding the house? Are you putting too much of your money into the house basket by prepaying the mortgage?

<<The mortgage runs to April 2045 if I do nothing (27 years); and I would be 79 years old at payoff.>>

4) This is irrelevant. If your portfolio is 10 million and your mortgage is only 100K, why should this matters?

KlangFool

Nate79
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by Nate79 » Tue Jun 12, 2018 12:23 pm

PhilosophyAndrew wrote:
Tue Jun 12, 2018 11:45 am
Paying off your mortgage is not a guaranteed 4% real return — the return is nominal, and will become less significant wirh inflation.

Andy.
Yes, the mortgage rate is a 4% nominal AFTER TAX return and should be compared to an equivalent nominal after tax return for whatever investment one chooses.

As an example, Vanguards Lifestrategy Conservative Growth fund (VSCGX, a 40/60 fund) has had an average annual return of 4.85% over the last 10 years according to Vanguard. This is a before tax return and doesn't include annual tax drag on dividends, ST and LT capital gains.

VTSAX: 9.32% 10 year return (before tax) --> after tax would be ~7.9% (15% LT capital gains)
VBTLX total bond market: 3.66% 10 year return (before tax) --> after tax would be ~2.7% (24% income tax rate)

This excludes tax drag and is just quick and dirty calc. Point being that 4% after tax rate is actually pretty darn good compared to the alternatives. You can take much more risk and get an extra 3.9% or so (VTSAX). If you are able the manage to get capital gains tax rate to zero then it starts to look much better.

So excess after tax return of a much higher risk stock fund would be only an excess return of 3.9%. In essence you are taking on stock risk for bond return.

PhilosophyAndrew
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by PhilosophyAndrew » Tue Jun 12, 2018 12:46 pm

Yes, I agree. If I were in OP’s shoes, I would work to pay off the mortgage.

There are also nice psychological benefits of having a paid off house!

Andy.

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AtlasShrugged?
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Re: Paying off a mortgage: Incentivized by new tax law?

Post by AtlasShrugged? » Wed Jun 13, 2018 5:25 am

You do realize that NJ is one of a few high-tax states (along with NY and CT) that have said they are allowing tax payers to deduct their state taxes as a charitable contribution, and thus continue to itemize and get the full (uncapped) deduction?
Admiral...Yeah, I read that. We'll see. I am not holding my breath. My deductions would probably not get me to 25,300 even if they did that. Which is why I am asking about this.
Paying off your mortgage is not a guaranteed 4% real return — the return is nominal, and will become less significant wirh inflation.
There are also nice psychological benefits of having a paid off house!
Andy...Thank you. This helps. So it is 4% guaranteed return - 2.5% inflation = 1.5% real. That is a helpful way to look at it. The comparison is now 1.5% real (bond like return) versus whatever return Mr. Market gives (which through my life has been higher than 1.5% real). DW is big on paying off house. And in truth, I would forego a certain amount of return for that psychological benefit. Our mortgage is our only debt we have.

Other: I am asking 'how' to evaluate the question. One assumption - it is nominal, not real returns - which changes things considerably.
“If you don't know, the thing to do is not to get scared, but to learn.”

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