Q. In mid-July, I will be getting a job-related lump sum payment of $175,000 (before taxes). I'm trying to figure out the most responsible use for the money. I max out my 401(k) plan contributions every year and my wife - who is self-employed - contributes to her SEP.
All of our savings are in tax-advantaged retirement accounts. They total about $950,000. One obvious option for our windfall is to pay down our mortgage a bit. The outstanding balance is about $500,000, but it is at a very low interest rate (3.875 percent), and with the mortgage interest tax deduction, I'm not sure that's the best option.
Are there other ideas I haven't considered? If it matters, I'm 48 years old.—J.B., by email
A. Let’s do some arithmetic here. I know we all love tax deductions, but the reality is that although the interest we pay on borrowed money may be deductible, that isn’t the same as free. In this specific case, for instance, you are paying at 3.875 percent. I’m guessing you are in the 25 or 28 percent tax bracket. That means you net cost of borrowing, after the tax benefit, is about 2.79 percent. That’s a pretty high cost.
If you invest the lump-sum payment, what yield could you get? Recently, the highest yield you could get on a 5-year jumbo CD, according to bankrate.com, was 2.27 percent— and that was way over the national average rate of 0.9 percent. So paying down your mortgage is a really good, conservative use for the money. And it will be a big step in getting your mortgage paid off early.
If you are more daring, you can bet on realizing a higher long-term return than 3.875 percent by investing the lump sum payment in a low-cost income oriented equity fund or exchange traded fund. Currently the Vanguard U.S.Total Market ETF (ticker: VTI) yields 1.79 percent. That won’t cover your mortgage interest, but your long-term return— I’m talking 15 years— should be better than 3.875 percent. And the dividend income will be taxed at only 15 percent.
Both paying down your mortgage and investing in a low cost equity fund are good choices.
Q. I am about 6 years from retirement, but I am plagued by some credit card debt. I am having a hard time paying it down quickly enough. I am toying with the idea of borrowing some money against one of my retirement accounts to help this process, although the loan would not be enough to pay off the debt entirely. What is your opinion of this strategy? —D.P., Florence, Oregon
A. If you can’t borrow enough from your retirement accounts to pay off your credit card debt entirely, and easily, you probably need to do a radical reset on the money you spend because borrowing from one source to pay another is akin to rearranging deck chairs on the Titanic.
Q. I am 57 and currently employed. I have a pension that is worth about $400,000 at this time. My company will allow me to take a lump sum and rollover this amount into an IRA or accept monthly payments of about $2000 a month if/when I retire.
My question is what things should be considered in deciding whether to take the lump sum and move it into an IRA. (I would move into index funds.) or take the monthly amount of $2000 until I die. The amount drops if I die and my wife receives the monthly sum. —F. D., by email
A. It’s generally better to keep the lifetime pension option than to take the lump sum. The pension, added to your Social Security income, will increase the amount of guaranteed income you have. That, in turn, will reduce the pressure you will feel to produce income from your other savings/IRA accounts.
In the current interest rate environment, that pressure is a major problem for retirees. Basically, low yields on both bond and stock investments means you are more likely to “reach for income” or spend more of your principal than is prudent, just to support your current standard of living.
Once you accept the pension option, you can view it as a large bond fund and invest your other savings accordingly.