Q. My nephew was asking me if I thought it was better to bump up his 401(k) contribution to the max, or to pay more money towards his two-year-old 3.5 percent mortgage. The case for the 401(k) bump is obvious, but if he could pay enough additional towards the mortgage principal to eliminate the PMI - wouldn't that make at least as much sense as the 401(k) strategy? Either way, he is still "paying himself." —B.W., by email
A. If he has already captured his employer match, then accelerating the elimination of mortgage insurance with additional principal payments is a good move. Mortgage insurance premiums aren’t tax deductible. And they can cost 1 percent of the amount owed.
Suppose, for instance, you buy a $200,000 house but only have a 10 percent down payment. This means another 10 percent of equity stands between you and eliminating the mortgage insurance cost. If the mortgage insurance cost is 1 percent of the mortgage, which would be $180,000, it would be $1,800 a year. And you’d save that cost, which is paid in after-tax dollars, by paying the mortgage down by 10 percent, or $20,000.
If you could do it in a lump sum, you’d be getting a 9 percent “return.” And since you would enjoy the end of PMI as a lower expense, not taxable income, the return is effectively tax-free. Better still, it’s a sure thing, while the investment in your 401(k) is not.
The only caveat here is to capture the employer match first because that’s “free money.”
Q. I would appreciate your advice on my current situation. I will be 66 this summer and my wife will turn 63. I lost my job in healthcare sales last year and am still looking to do something, perhaps part time. I started collecting social security last summer. It’s about $2,300 monthly, and I have a very small pension, about $525 per month. My wife is still working and makes about $25,000 per year.
We have the bulk of our money with Vanguard and T. Rowe Price, close to $2 million total. Mostly IRAs, ROTHs, Muni-bond funds, and some stock funds. In addition, we have held 3 individual stocks for the last 30 years, worth $450,000. All dividends are reinvested for now, about $900 per quarter per stock. I will need to start taking these dividends soon.
My only debt is our mortgage, $46,000. The home was appraised at
$660,000. I want to get rid of the mortgage this year. I have the necessary money in a short-term bond fund that is our "emergency" cash.
Problem is once I take it, it’s totally gone. However my real dilemma is if I withdraw that amount, won't this affect my tax bracket going forward? Should I instead liquidate part of a ROTH, with no tax consequences? —S.C. Newark, NJ
A. You should visit with your tax accountant about this, but paying off a $46,000 mortgage isn’t likely to affect your tax bracket. Indeed, the deduction you get from the mortgage probably hasn’t done you any good for quite a few years. The interest deduction from your mortgage will depend on the interest rate, but if it is 5 percent the cost (and deduction) would be $2,300.
Since the standard deduction on a joint return is $12,600 this year, you would have to have at least $10,300 in real estate taxes and other deductions before you enjoyed any benefit from itemized deductions. With a $660,000 house in New Jersey, your total deductions probably net you some reduction in taxes. But it won’t be much since the tax benefit only begins after your itemized deductions exceed the $12,600 standard deduction. Many people don’t understand this.
If the $46,000 you need is in a qualified plan, withdrawing it would be a “taxable event.” But if it is in a taxable account, redeeming the shares may not create any new taxable income. Again, if you have any doubt, see your tax accountant.