By Scott Burns
Q. My wife and I are 43 and have a young child. I make $140,000 a year. We are fortunate to have $1.3 million in an investment account. Of that amount, about $160,000 is earning very little in money markets. Our home is worth $400,000 and we don't plan on moving. Our only debt is a 5 percent 30-year mortgage with a 2024 maturity date and monthly payments of $1,100. We always pay a little extra toward principal each month. We could pay off the mortgage early for $150,000. Should we use our cash to become debt free? ---B.C., Dallas, Texas
A. Young people aren’t harmed by delaying the payoff of debt because inflation is on their side. Since you are probably in the 25 percent tax bracket, the after-tax cost of your 5 percent mortgage is 3.75 percent. That’s more than the current rate of inflation— but it may not be by the end of the year. Making regular--- but not extra--- payments on the mortgage can benefit you.
The mortgage is a fixed payment. It can reduce the overall pressure on your income if there is inflation in the future. In the 1970s, for instance, many people treasured their 6 percent mortgages as inflation reduced the real value of the payments they had to make because their incomes were rising, if only with the rate of inflation. You can also view your mortgage as a hedge against a dull-witted government that believes it can restore an economy over-burdened with debt by adding more debt.
If you were older and starting to think about how to manage your retirement spending the answer would be different. For most people approaching retirement, eliminating debt is the fastest way to increase the net cash available to meet ongoing living expenses. Also, paying off a mortgage before retiring can reduce the amount of cash you need to withdraw from an IRA account in retirement. That, in turn, can work to reduce the amount of your Social Security benefits that will be subject to taxation.
Relatively affluent people, whether working or retired might consider keeping a mortgage for two reasons. First, if they have a fixed pension, the pension can be used to pay the (fixed) mortgage. Second, the mortgage can function as the same hedge as it does for younger people.
Q. I am a retiring educator with an investment decision to make. When I retire I have the option of taking a lump sum and a lower monthly retirement check for life, or no lump sum and receiving my full monthly retirement for life. In my case, the lump sum is $140,000. The
difference in my monthly check is about $1,000 per month. And here's another important fact: I am only 54 years old.
I do plan to go on to a second career, but at this time there is no guaranteed income from my new business venture. I also have $70,000 in 403(b) accounts that have accrued over the years.
Should I take the lump sum? If I do, what investments would you suggest? ---G. G., by email
A. If your numbers are right, taking the full retirement check is a very sweet deal. Basically, that $1,000 monthly check difference represents a cash flow return of 8.57 percent on $140,000. Trust me; you won't be able to get that kind of income if you try to invest the $140,000. Worse, if you try to get an income return at that level you will likely be making a very risky investment.
That monthly check is as though you loaned $140,000 to someone as a 15 year mortgage at a bit under 5 percent, because that's close to the payment you would get, about $1,000 a month. The better news is that after 15 years are up, you'll still be getting those $1,000 monthly checks because you will get them as long as you live. At 54 the odds say you'll live well beyond 15 years.
This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational puposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
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