Mortgage Payoff Advice with Appreciated Securities

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
User avatar
jr6857
Posts: 41
Joined: Wed Dec 19, 2007 7:51 pm
Location: SW PA

Mortgage Payoff Advice with Appreciated Securities

Post by jr6857 » Sat Jan 20, 2018 8:17 am

I am considering the payoff of my mortgage with outstanding principle of $300K, using highly appreciated (~90% gain) equity index funds. The key elements of my thinking are based on the new tax law, highly valued equity markets, and the desire to enter retirement in five years mortgage free.

A few key data points – 28 years left on ARM (adjustable rate) mortgage with three more years at 2.875% rate and then a floating rate to a max of 8%. Market value of home ~$520K. Resident of PA.

For 2018 I am in the 22% tax bracket (married, filing jointly) and for the first time will not be able to itemize for 2018 given the higher standard deduction level and limitation on state/property tax deduction. Thus there is no incremental tax benefit from the mortgage interest deduction (e.g. I take the standard deduction with or without the mortgage interest). We are 58/59 years old.

I will owe federal (at 15% cap gains rate) and state tax (~3%) on the appreciated equity index fund securities. Total taxes will be $28K so my plan is to sell $328K in securities to complete the payoff.

Today, the current value of my portfolio is $1.7+M excluding unvested restricted stock. Subsequent to payoff it will decline to $1.4M. My portfolio is 60/40 excluding the unvested restricted stock (currently ~$200K net of income taxes). I intend to rebalance to 60/40 subsequent to sale of equity index funds used in mortgage payoff.

Mortgage P&I of ~$1,300/month is approximately 12% of monthly take home pay so this is not a cash flow issue.

A couple of variations on the theme:
1) Option outlined above
2) Wait until the remaining three years of the ARM period expire to take advantage of the very low interest rate at 2.875% and then complete the pay-off at that time. This will defer the capital gains tax payment with the equity market valuation risk trade-off.
3) Pay-off as much of the principle as possible with monthly cash flow through to retirement and then lump sum payoff at that time. Likely no change in cap gains tax bracket the year of retirement. Market valuation risk trade-off same as in (2).

I’d welcome feedback on my thinking and alternative perspectives.

Wagnerjb
Posts: 7203
Joined: Mon Feb 19, 2007 8:44 pm
Location: Houston, Texas

Re: Mortgage Payoff Advice with Appreciated Securities

Post by Wagnerjb » Sat Jan 20, 2018 8:43 am

jr6857 wrote:
Sat Jan 20, 2018 8:17 am

I will owe federal (at 15% cap gains rate) and state tax (~3%) on the appreciated equity index fund securities. Total taxes will be $28K so my plan is to sell $328K in securities to complete the payoff.
If you are already in the 22% bracket and you add ~$300k in capital gains, I am not sure you will only pay 15% in Federal Tax on your capital gains. You are likely to pay an additional 3.8% if your AGI exceeds $250k, and if your taxable income is around $480K you might pay 20% on some (or all) of your capital gains. Please double check your numbers.

Best wishes.
Andy

lstone19
Posts: 188
Joined: Fri Nov 03, 2017 3:33 pm

Re: Mortgage Payoff Advice with Appreciated Securities

Post by lstone19 » Sat Jan 20, 2018 8:50 am

Wagnerjb wrote:
Sat Jan 20, 2018 8:43 am
jr6857 wrote:
Sat Jan 20, 2018 8:17 am

I will owe federal (at 15% cap gains rate) and state tax (~3%) on the appreciated equity index fund securities. Total taxes will be $28K so my plan is to sell $328K in securities to complete the payoff.
If you are already in the 22% bracket and you add ~$300k in capital gains, I am not sure you will only pay 15% in Federal Tax on your capital gains. You are likely to pay an additional 3.8% if your AGI exceeds $250k, and if your taxable income is around $480K you might pay 20% on some (or all) of your capital gains. Please double check your numbers.

Best wishes.
He said the securities have appreciated 90% which to me means a basis of about $173K and a gain of $155K. So only adding $155K to income, not over $300K. WIthout knowing the rest of income, it’s hard to say where that puts the poster.

User avatar
tfb
Posts: 7980
Joined: Mon Feb 19, 2007 5:46 pm
Contact:

Re: Mortgage Payoff Advice with Appreciated Securities

Post by tfb » Sat Jan 20, 2018 10:21 am

jr6857 wrote:
Sat Jan 20, 2018 8:17 am
A couple of variations on the theme:
1) Option outlined above
2) Wait until the remaining three years of the ARM period expire to take advantage of the very low interest rate at 2.875% and then complete the pay-off at that time. This will defer the capital gains tax payment with the equity market valuation risk trade-off.
3) Pay-off as much of the principle as possible with monthly cash flow through to retirement and then lump sum payoff at that time. Likely no change in cap gains tax bracket the year of retirement. Market valuation risk trade-off same as in (2).

I’d welcome feedback on my thinking and alternative perspectives.
The equity market valuation risk can be taken care of by rebalancing in tax deferred accounts without triggering capital gains. If you have bonds in taxable accounts you can sell those and pay down the mortgage. Assuming that's not sufficient, then use ongoing cash flow from income to pay it off.
Harry Sit, taking a break from the forums.

KlangFool
Posts: 10700
Joined: Sat Oct 11, 2008 12:35 pm

Re: Mortgage Payoff Advice with Appreciated Securities

Post by KlangFool » Sat Jan 20, 2018 10:27 am

OP,

1) What is your current annual expense?

2) Is 1.4 million equal to 25 times your current annual expense?

KlangFool

User avatar
jr6857
Posts: 41
Joined: Wed Dec 19, 2007 7:51 pm
Location: SW PA

Re: Mortgage Payoff Advice with Appreciated Securities

Post by jr6857 » Sat Jan 20, 2018 3:13 pm

Thank you for the replies.

The gain on sale is approximately $150K (cost basis is ~$175K) so the capital gains rate will be 15%. [The 15% rate for capital gains applies for total taxable income below $480K for married filing jointly.] I do have approximately $35K in taxable bonds with limited gain which probably should be sold first and will slightly reduce the tax drag. I will re-balance using tax deferred assets so there will be no additional tax issues associated with rebalancing.

As far as KlangFool's question related to 25x expenses, my expectation is to retire at approximately $2.5M (minimum) based on additional investments and additional restricted and upcoming performance based stock. This assumes a realistic 5% return on the underlying portfolio and no price growth in company stock. The restricted and performance based stock does have single company risk and unfortunately I am now required to hold a multiple of salary in stock until retirement. I also have three small pensions that will total approximately $30K per year (non-COLA). This portfolio value plus pensions plus SS would easily exceed 25x including a very large cushion for travel and other non-essentials.

In an almost worst case scenario of short term retirement, the restricted stock would vest and I'd still have the house value where we could easily downsize and pull some cash out of the house. However, I would say that we would not be at 25x of a desired spending level but would easily be at 25x of a comfortable level of expenses.
Last edited by jr6857 on Sat Jan 20, 2018 3:19 pm, edited 1 time in total.

CppCoder
Posts: 846
Joined: Sat Jan 23, 2016 9:16 pm

Re: Mortgage Payoff Advice with Appreciated Securities

Post by CppCoder » Sat Jan 20, 2018 3:17 pm

Without doing detailed calculations, I'd probably keep it until at least the ARM resets and then evaluate at that point. You've got a pretty good rate for the next three years.

KlangFool
Posts: 10700
Joined: Sat Oct 11, 2008 12:35 pm

Re: Mortgage Payoff Advice with Appreciated Securities

Post by KlangFool » Sat Jan 20, 2018 3:25 pm

jr6857 wrote:
Sat Jan 20, 2018 3:13 pm
Thank you for the replies.

The gain on sale is approximately $150K (cost basis is ~$175K) so the capital gains rate will be 15%. [The 15% rate for capital gains applies for total taxable income below $480K for married filing jointly.] I do have approximately $35K in taxable bonds with limited gain which probably should be sold first and will slightly reduce the tax drag. I will re-balance using tax deferred assets so there will be no additional tax issues associated with rebalancing.

As far as KlangFool's question related to 25x expenses, my expectation is to retire at approximately $2.5M (minimum) based on additional investments and additional restricted and upcoming performance based stock. This assumes a realistic 5% return on the underlying portfolio and no price growth in company stock. The restricted and performance based stock does have single company risk and unfortunately I am now required to hold a multiple of salary in stock until retirement. I also have three small pensions that will total approximately $30K per year (non-COLA). This portfolio value plus pensions plus SS would easily exceed 25x including a very large cushion for travel and other non-essentials.

In an almost worst case scenario of short term retirement, the restricted stock would vest and I'd still have the house value where we could easily downsize and pull some cash out of the house. However, I would say that we would not be at 25x of a desired spending level but would easily be at 25x of a comfortable level of expenses.
jr6857,

1) What is the price of the house? 500K? 1 Million?

2) Would you tie up too much of your money with the house if you pay off the house?

<< In an almost worst case scenario of short term retirement, the restricted stock would vest and I'd still have the house value where we could easily downsize and pull some cash out of the house. >>

3) In the worst case, the restricted stock worth nothing. The house price drop by half. You are laid off and the stock market drop by half.

KlangFool

itstoomuch
Posts: 5343
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

Re: Mortgage Payoff Advice with Appreciated Securities

Post by itstoomuch » Sat Jan 20, 2018 3:30 pm

JMO,
I'd would look at the broader picture...an overall exit strategy for retirement in 5 years. A lot can happen in just 1 year.
Your concept sounds like a good "option", could be others. My wife would have no objections if we would do this, if in your position.
YMMV
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

User avatar
jr6857
Posts: 41
Joined: Wed Dec 19, 2007 7:51 pm
Location: SW PA

Re: Mortgage Payoff Advice with Appreciated Securities

Post by jr6857 » Sat Jan 20, 2018 3:41 pm

KlangFool - house value is $500K. I indicated "almost" worst case scenario which assumes no dramatic change in the overall economic environment. There are all kinds of really bad things (black swans, etc) that could happen and I understand that but at the end of the day we can't plan for them.

itstoomuch - thank you for your input. Definitely agree that this is only one option of many. As noted by an earlier poster, hanging on for another three years until the ARM resets can be argued is a very attractive option in that I continue to take advantage of a very favorable mortgage rate (2.875%) until it re-sets. As I noted, the downside risk is that the market is a much less favorable position at that time (which of course no one knows).

At the end of the day, decisions like this are always easy to evaluate in hind sight.

Wagnerjb
Posts: 7203
Joined: Mon Feb 19, 2007 8:44 pm
Location: Houston, Texas

Re: Mortgage Payoff Advice with Appreciated Securities

Post by Wagnerjb » Sat Jan 20, 2018 4:10 pm

jr6857 wrote:
Sat Jan 20, 2018 3:13 pm
The gain on sale is approximately $150K (cost basis is ~$175K) so the capital gains rate will be 15%. [The 15% rate for capital gains applies for total taxable income below $480K for married filing jointly.]
The 18.8% rate kicks in when your AGI gets to $250k. I don't know the base income that you have, but adding $150K in capital gains to an income already in the 22% bracket is probably going to cost you 18.8%....at least on part of the gain. I would run some numbers to be certain.

(You may still want to move forward with your plan, but it is best to know the tax costs precisely).

Best wishes.
Andy

big bang
Posts: 30
Joined: Mon Jul 25, 2016 8:33 pm

Re: Mortgage Payoff Advice with Appreciated Securities

Post by big bang » Sat Jan 20, 2018 4:13 pm

I will suggest to refinance the mortgage with a fixed interest rate to an amount of monthly payment and mortgage level that you feel comfortable with.
For example reduce the mortgage amount to $200K with 15 years mortgage. Your interest rate will be higher but you will get the benefit that it's fixed. Your monthly payments will stay close to what you are paying now. When you feel that you have it in your budget you can make extra monthly payments.
This way you did not sell the whole amount of the appreciated securities, changed the interest rate to fixed, gained flexibility of still investing with the rest of the money and also gives you more the option of increasing monthly payments with future monies.
Just a thought...
(1) save a lot, (2) select an asset allocation containing both stock and bond asset classes, (3) buy low cost, widely diversified funds, (4) allocate funds tax-efficiently, and (5) stay the course.

User avatar
jr6857
Posts: 41
Joined: Wed Dec 19, 2007 7:51 pm
Location: SW PA

Re: Mortgage Payoff Advice with Appreciated Securities

Post by jr6857 » Sat Jan 20, 2018 4:30 pm

Wagnerjb - thanks, you are right in that the Medicare surcharge does kick in and the capital gains rate will be 18.8%. I missed the fine print on that one:). Thus I've understated taxes by $5k.

I am reluctant to refinance at this stage so the alternative is to aggressively pay it down with monthly cash flow (and limit after tax investing) to reduce it as much as possible until the ARM resets three years in the future.

You've all been very helpful in playing devils advocate for me.

Thanks again!

KlangFool
Posts: 10700
Joined: Sat Oct 11, 2008 12:35 pm

Re: Mortgage Payoff Advice with Appreciated Securities

Post by KlangFool » Sat Jan 20, 2018 4:57 pm

jr6857 wrote:
Sat Jan 20, 2018 3:41 pm

KlangFool - house value is $500K. I indicated "almost" worst case scenario which assumes no dramatic change in the overall economic environment. There are all kinds of really bad things (black swans, etc) that could happen and I understand that but at the end of the day we can't plan for them.
jr6857,

The recession occurs regularly.

https://en.wikipedia.org/wiki/List_of_r ... ted_States

Since 1836, there is at least one recession every 10 years. The last recession was 2007/2009. If the recession follows the historical trend, there will be at least one recession over the next 5 years.

<< I understand that but at the end of the day we can't plan for them.>>

I disagreed. I plan and design my portfolio for the possibility of a recession lasting 5 years.

If between now and the next 5 years, we hit a recession that lasted 5 years, will your portfolio take a permanent damage? Is it safer to pay off the house or not?

KlangFool

User avatar
jr6857
Posts: 41
Joined: Wed Dec 19, 2007 7:51 pm
Location: SW PA

Re: Mortgage Payoff Advice with Appreciated Securities

Post by jr6857 » Sat Jan 20, 2018 8:33 pm

KlangFool - thanks for the continued follow-up. My view is that a recession is an ordinary part of the business cycle. It is why I stay at 60/40 - to allow me to sleep at night. I consider a dramatic change as a once in every 30-50 year event (depression/major market crash; large scale war; other black swan events that can be dreamed up ad nauseum). These are what I was thinking when responding although the wording (after re-reading) certainly doesn't reflect my thinking.

It is also one of the reasons that I am considering the mortgage payoff since equities are at all-time highs right now. Obviously can't predict the future but if I proceed I am giving up the upside of potential further market growth as a tradeoff to protect against the downside of the desire to payoff the mortgage in the future when the value of the portfolio may not be as strong.

Hope that better explains my thinking (and alignment with yours as well).

KlangFool
Posts: 10700
Joined: Sat Oct 11, 2008 12:35 pm

Re: Mortgage Payoff Advice with Appreciated Securities

Post by KlangFool » Sat Jan 20, 2018 8:57 pm

jr6857 wrote:
Sat Jan 20, 2018 8:33 pm
KlangFool - thanks for the continued follow-up. My view is that a recession is an ordinary part of the business cycle. It is why I stay at 60/40 - to allow me to sleep at night. I consider a dramatic change as a once in every 30-50 year event (depression/major market crash; large scale war; other black swan events that can be dreamed up ad nauseum). These are what I was thinking when responding although the wording (after re-reading) certainly doesn't reflect my thinking.

It is also one of the reasons that I am considering the mortgage payoff since equities are at all-time highs right now. Obviously can't predict the future but if I proceed I am giving up the upside of potential further market growth as a tradeoff to protect against the downside of the desire to payoff the mortgage in the future when the value of the portfolio may not be as strong.

Hope that better explains my thinking (and alignment with yours as well).
jr6857,

In your case, the house is only 500K. So, it is not a big concentration of risk if you pay off the house and keep 1.4 million in the 60/40 portfolio. I would be worried if the house is 1 million or more.

KlangFool

JBTX
Posts: 4262
Joined: Wed Jul 26, 2017 12:46 pm

Re: Mortgage Payoff Advice with Appreciated Securities

Post by JBTX » Sat Jan 20, 2018 9:35 pm

jr6857 wrote:
Sat Jan 20, 2018 8:33 pm
KlangFool - thanks for the continued follow-up. My view is that a recession is an ordinary part of the business cycle. It is why I stay at 60/40 - to allow me to sleep at night. I consider a dramatic change as a once in every 30-50 year event (depression/major market crash; large scale war; other black swan events that can be dreamed up ad nauseum). These are what I was thinking when responding although the wording (after re-reading) certainly doesn't reflect my thinking.

It is also one of the reasons that I am considering the mortgage payoff since equities are at all-time highs right now. Obviously can't predict the future but if I proceed I am giving up the upside of potential further market growth as a tradeoff to protect against the downside of the desire to payoff the mortgage in the future when the value of the portfolio may not be as strong.

Hope that better explains my thinking (and alignment with yours as well).

I can definitely understand your thinking about the risk of a market drop and wanting to prevent excessive loss at your age. But I think you are conflating two different issues.

As to the risk of market drop, I’d view it more as an asset allocation question. You are 60/40, which is a reasonable allocation for your age, but if the risk of loss is eating at you then perhaps you should decrease it a bit. You can either sell some of your taxable stock, or else sell some stock in retirement accounts, assuming you have some there which would keep you from having capital gains.

As the the mortgage payoff, I agree paying it off is more attractive than it was previously with the new tax law. But I’d be hesitant to incur unneeded capital gains to make that happen. I certainly would avoid selling into a higher tax bracket. Perhaps just sell some now and some in a later year or wait until retirement when tax rates are lower.

User avatar
jr6857
Posts: 41
Joined: Wed Dec 19, 2007 7:51 pm
Location: SW PA

Re: Mortgage Payoff Advice with Appreciated Securities

Post by jr6857 » Sat Jan 20, 2018 9:45 pm

Thanks JBTX. That is very good advice and the reason I decided to post, which was to challenge my logic. In my own mind I debated if I was conflating the two issues - portfolio structure (risk tolerance) versus market "timing" to complete mortgage payoff. I really am comfortable with 60/40 so I don't feel that I need to adjust the portfolio structure. With that being the case, you are helping me rethink the rationale of paying capital gains taxes at this point. Perhaps the better solution is to aggressively pay down the principal over the next three years and reassess my options when the ARM resets.

Thanks again for challenging my thinking - it is one of the major benefits of the forum.

Post Reply