Pay off house without paying off house

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Topic Author
retireIn2020
Posts: 67
Joined: Sat Jan 04, 2020 6:13 pm

Pay off house without paying off house

Post by retireIn2020 »

So I have this small pension with a monthly payout of $427 per month, or it pays a lump sum of $84,500 which calculates to just over a 6% yield. and I have another much larger pension that I will be taking the lump sum option and rolling into IRA.

Current Mortgage balance is $155,000 with 29 years remaining @ $670 per month.

The plan is to refinance the house with a 3.1% $100,000 30 year mortgage, using $55,000 from the large pension lump payout(with tax it will cost me $66,000) to pay down the new mortgage for a new payment of $427.00 .

Then elect to take the annuity for the small pension of $427 per month which offsets the 30 year payment. Total cost is loss of the small pension lump sum of $84,500 and $66000 from the large lump = $150,500 to payoff a $155,000 Mortgage.

In my mind this pays off my house and locks in a savings of $5000.00 of principle, $83,000 in interest, and, now that I'm retired and will start doing withdrawals, I lowered my IRA savings withdrawal rate from 3.5% to 2.75% eliminating a $670 current house payment.

BTW, I'm 60, just surplused this month from mega corp and was planning to retire EOY.

I think it works out to locking in a $3.5% yield if I'm not mistaken. Also, I'm not chasing yield here, this is meant to be a guarantee since pension annuity is backed by PBGC.

So, shoot some holes in my thought please :).
Retired as of July 2020
babystep
Posts: 265
Joined: Tue Apr 09, 2019 9:44 am

Re: Pay off house without paying off house

Post by babystep »

retireIn2020 wrote: Mon Jul 13, 2020 1:24 am So I have this small pension with a monthly payout of $427 per month, or it pays a lump sum of $84,500 which calculates to just over a 6% yield. and I have another much larger pension that I will be taking the lump sum option and rolling into IRA.

Current Mortgage balance is $155,000 with 29 years remaining @ $670 per month.

The plan is to refinance the house with a 3.1% $100,000 30 year mortgage, using $55,000 from the large pension lump payout(with tax it will cost me $66,000) to pay down the new mortgage for a new payment of $427.00 .

Then elect to take the annuity for the small pension of $427 per month which offsets the 30 year payment. Total cost is loss of the small pension lump sum of $84,500 and $66000 from the large lump = $150,500 to payoff a $155,000 Mortgage.

In my mind this pays off my house and locks in a savings of $5000.00 of principle, $83,000 in interest, and, now that I'm retired and will start doing withdrawals, I lowered my IRA savings withdrawal rate from 3.5% to 2.75% eliminating a $670 current house payment.

BTW, I'm 60, just surplused this month from mega corp and was planning to retire EOY.

I think it works out to locking in a $3.5% yield if I'm not mistaken. Also, I'm not chasing yield here, this is meant to be a guarantee since pension annuity is backed by PBGC.

So, shoot some holes in my thought please :).
You are paying 20% in taxes now to save 3% in interest cost. Have you evaluated the Roth conversions and tax brackets?

Assuming your idea is directionally correct then why not pay-off as much as possible from the larger pension and thereby reduce the IRA withdrawal rate further to maybe only 2.25%?
Topic Author
retireIn2020
Posts: 67
Joined: Sat Jan 04, 2020 6:13 pm

Re: Pay off house without paying off house

Post by retireIn2020 »

why not pay-off as much as possible from the larger pension and thereby reduce the IRA withdrawal rate further to maybe only 2.25%?
I should have mentioned, I did think about taking the small pension as a full lump sum and using it to pay the house off in full, but the taxes get me up into the 32% percent bracket. However, I would reduce my savings withdrawal rate (as you mention) along with future taxes but those will only be in the 12% bracket.

I have not looked at a Roth conversion. When doing Roth conversion, wouldn't that money be taxed as ordinary income as well?
Retired as of July 2020
babystep
Posts: 265
Joined: Tue Apr 09, 2019 9:44 am

Re: Pay off house without paying off house

Post by babystep »

retireIn2020 wrote: Mon Jul 13, 2020 9:09 am
why not pay-off as much as possible from the larger pension and thereby reduce the IRA withdrawal rate further to maybe only 2.25%?
I should have mentioned, I did think about taking the small pension as a full lump sum and using it to pay the house off in full, but the taxes get me up into the 32% percent bracket. However, I would reduce my savings withdrawal rate (as you mention) along with future taxes but those will only be in the 12% bracket.

I have not looked at a Roth conversion. When doing Roth conversion, wouldn't that money be taxed as ordinary income as well?
Yes, it will be taxed as ordinary income. But wouldn't it make sense to not pay the 20% tax rate now vs paying 12% tax over a few years by slowing withdrawing over the years?

You could convert some into Roth if your withdrawal amount is more than what is needed for the mortgage, taxes, and other expenses.
miket29
Posts: 196
Joined: Tue Jun 20, 2017 9:07 pm

Re: Pay off house without paying off house

Post by miket29 »

Not sure I'm following all the numbers here. First off, when your pension delivers $470/mos to you that is going to be taxable as ordinary income. So it won't match the new mortgage, you'll need to pony up the difference. Also unless you have a death benefit for the pension, if you don't live to age 90 then your heirs will have to pay off the mortgage balance.

Furthermore you wrote "I lowered my IRA savings withdrawal rate from 3.5% to 2.75%" but that isn't exactly right. There are required minimum distributions from an IRA that will apply once you reach 72. This starts at 3.65% and goes up every year thereafter. You'll need to take this into account to find your tax rate on that $470, and consider how it impacts your portfolio independent of the mortgage question as the gov't requires you to pay income tax on an increasing share of it each year.

On your current mortage you are paying $8,040/yr. If this is 0.75% of your IRA since you say that is how much less you'll need to withdraw for expenses, that implies an IRA of about $1 million. So you could pay the existing mortgage off from your IRA. Or perhaps pay it off over a few years if that lets you minimize taxes as you take the money out of the IRA.

It comes down to a decision about whether the annual return of the IRA, given how you have it invested between stocks and bonds, is likely to earn more than the 3.1% you pay on the mortgage. And a decision about how you'd feel having to draw down the IRA monthly to pay the mortage even if the stock portion has fallen significantly. Many people, myself included, prefer to reduce their monthly fixed expenses as much as possible in retirement. Discretionary expenses can be minimized as unexpected events occur (the market has a big drop, the house needs a new roof, etc) but fixed expenses chew a hole in the portfolio month in and out.
Last edited by miket29 on Mon Jul 13, 2020 7:11 pm, edited 6 times in total.
Outer Marker
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Joined: Sun Mar 08, 2009 8:01 am

Re: Pay off house without paying off house

Post by Outer Marker »

This all sounds very convoluted and I don't understand the logic at all. If you're retired and plan to stay in the house, I'd try to get rid of the mortgage as quickly as possible to eleminate the ongoing housing demand on your portfolio over a prolonged period of retirement. You can get a 15 year mortgage for around 2.5% on the full current outstanding amount, and use the extra cash on hand to supplement the regular payments.
dandinsac
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Joined: Sat Jul 30, 2016 8:34 am

Re: Pay off house without paying off house

Post by dandinsac »

The kay to doing this is how quickly you end up money ahead. As stated above, paying lots of taxes to save 3.1% on the loan isn’t too good. Assuming you can spread out the withdrawal of $66,000 to multiple years, it’s to your advantage...

$66,000 withdrawal (at 16% taxes) = payoff $55,000, saving 3.1%/year = $1705 saved / year => $11,000 cost with 6.4 years simple payback
$62,500 withdrawal (at 12% taxes) = payoff $55,000, saving 3.1%/year = $1705 saved / year => $7,500 cost has a 4.4 year simple payback

My advice would be to first focus 100% on the refinance to see how much you can lower your rate. Ideally it would be a no cost refinance. See the Refinance Mega Thread for more info on this.
Topic Author
retireIn2020
Posts: 67
Joined: Sat Jan 04, 2020 6:13 pm

Re: Pay off house without paying off house

Post by retireIn2020 »

Thank you all for the reply's. Paying off the Mortgage was my 1st thought. Then I looked the tax cost and it didn't work out pulling that large of an amount from the IRA.

I will definitely look at spreading the tax burden out over the next several years and do understand that time is of the essence since things could change and make large withdrawals get ugly.

Also, my credit union has always beet the open market as far as rates and fees go but their 15 year is currently at 2.75%. I'm definitely going to check out the Refinance Mega Thread!
Retired as of July 2020
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Toons
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Location: Hills of Tennessee

Re: Pay off house without paying off house

Post by Toons »

Keep It Simple
Pay Off The House

:mrgreen:
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
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Re: Pay off house without paying off house

Post by Outer Marker »

retireIn2020 wrote: Tue Jul 14, 2020 7:44 pm Also, my credit union has always beet the open market as far as rates and fees go but their 15 year is currently at 2.75%. I'm definitely going to check out the Refinance Mega Thread!
Get a quote from Amerisave. Those guys have been very good to me over the years.

It is frustrating that shopping for a mortgage is not as easy and transparent as it was a few years ago. Now everyone wants personal identifying information to quote you a real rate.
Topic Author
retireIn2020
Posts: 67
Joined: Sat Jan 04, 2020 6:13 pm

Re: Pay off house without paying off house

Post by retireIn2020 »

So I took some time to calculate the tax I would pay if I paid the mortgage off ($155,000) all at once in Jan 2021 vs over 2 years, 3 years, and 4 years. and will put the funds from the large lump into a stable value fund that I have in my 401k that earns 2.5% with no risk.

Option 1) pay it off in full in Jan 2021 the tax bill FED/STATE Tax = $44,448.00 and no more payments.
Total cost with tax = $207,488

Option2) Pay off over 2 years, 2 years Taxes $37,044 + 1 more year of payments = $8,040.
Total cost with tax and house payments = $200,086

Option3) Pay off over 3 years, 3 years Taxes = $34203 + 2 more years of payments = $16080.
Total cost with tax and house payments = $190,883

Option4) Pay off over 4 years, 4 years Taxes = $31482 + 3 more years of payments = $24,120.
Total cost with tax and house payments = $192,602

Looks like Option 3 is the sweet spot, I think my math is fairly close.

BTW, I did the tax math on the original post and the total cost was $186,000, so it would be the lowest cost option, however, tax for 30 years is not guaranteed and likely to go up and end up the highest cost option so it adds RISK. :shock:

Again, thanks for the input and if I'm planning to pay it off in 3 years so no need to refinance.
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Re: Pay off house without paying off house

Post by Outer Marker »

retireIn2020 wrote: Fri Jul 17, 2020 5:53 pm if I'm planning to pay it off in 3 years so no need to refinance.
What is your current interest rate? You can probably refi to a lower rate on a 15 year and take negative points to walk away cash positive at closing. This is basically free money. It’s a few hours work in gathering the papers. When I see a $50 bill on the street, it’s worth my while to bend down to pick it up.
Topic Author
retireIn2020
Posts: 67
Joined: Sat Jan 04, 2020 6:13 pm

Re: Pay off house without paying off house

Post by retireIn2020 »

Heck, I pick up a Nickle :D

Well I guess there are few reasons why I said that.
1st, I was just force retired by mega corp. not sure I want to go and an work just yet.
2nd, can you qualify for a refi with no income? although I have a large 401k and tIRA.
3rd, the interest is approximately $2k or so difference and my thought was fee's would eat allot of that anyway.
negative points to walk away cash positive at closing.
Now that's interesting, I'll have to look into it and possibly qualify with scheduled distributions.

Thanks!
Retired as of July 2020
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