The Money Class (27 page)

If you just keep up with the monthly payment for 20 years, you will reach age 70 still having 10 years of payments left to make. And even though you are two-thirds of the way into paying off the mortgage, your remaining balance is still nearly $100,000, because your payments in the early years mostly went toward paying interest, not principal.

So here you are at age 70, ready to retire. Your plan is that you will just make annual withdrawals from your 401(k) to cover the mortgage. To generate the $12,156 you will need each year requires that you start with a 401(k) balance of at least $500,000. That in itself is a tall order.

As I will explain later in this class, a solid rule of thumb is to aim to withdraw no more than 4 percent of your retirement assets in your first year of retirement. (You then adjust that for inflation in subsequent years.) So 4 percent of $500,000 is $20,000. But remember, there will be federal income tax, and possible state tax as well, if the money is withdrawn from a traditional 401(k). I am going to assume you will have no more than $15,000 left after paying the tax. Granted that’s more than your annual mortgage cost, but please realize that the $15,000 or so is probably going to need to cover not just your mortgage but also your other housing-related costs, such as property tax and insurance on the home. At the end of the day, that could be a tight squeeze—and that’s making the assumption at the outset that you have a sizable retirement fund to work with. And bear in mind that these are just costs associated with the home. We haven’t yet accounted for other living expenses, such as food, electricity, clothing, healthcare, entertainment, etc. And if you were to use most of your 401(k) to cover the mortgage, are you confident your other income sources—such as Social Security—would be enough to allow you to live comfortably in retirement?

The truth is, I know that many of you will not have ample savings in your retirement funds to cover your mortgage and other living costs, no matter how much you can manage to save between now and retirement. So that is why my advice is—if you answered an unequivocal yes to both of those major questions above—that you make it your goal to get the remainder of your mortgage paid off now. Going back to my example, I think it is more sensible to set as a goal paying off the $100,000 or so left on your mortgage before retirement, rather than hoping you will have enough income in retirement to cover the mortgage
and
your other living costs in retirement.

HOW TO PAY OFF YOUR MORTGAGE AHEAD OF SCHEDULE

Get a New Amortization Schedule

At what age do you think you will retire and by when would you like to pay off your home? Later in this class I will make a case that you consider working at least until age 66 or 67 in order to maximize your other retirement benefits, including Social Security. I recommend you use that as a general target. But if you think you may need or want to retire earlier, or you know enough about your industry that it is unlikely you will be able to stay at your current job—and your current salary—all the way until 67, then please stand in the truth and aim to have your mortgage paid off even earlier.

The next step is to call your mortgage company and ask them to send you a new schedule of your payments—called the amortization schedule—that would allow you to have the loan paid off by the date you choose. This will tell you what you need to send in each month to get the loan paid off by that target date.

You can get an idea of what your payments would need to be to accelerate paying off your mortgage by using the mortgage payoff calculator at
www.bankrate.com
.

Let’s say you are 55 years old and have 25 years left on a $200,000 30-year, fixed-rate mortgage that you took out with a 6.0% interest rate. I realize interest rates as of this writing are considerably lower, but I also know that many of you who took out mortgages during the last gasp of the real estate bubble may have been unable to refinance because of lost equity or a lost job, or maybe the new tighter lending standards banks are currently imposing meant you were turned down.

If you don’t add extra payments you will have the mortgage paid off when you are 80 years old. So the question you should be asking yourself is whether you will be able to keep making that payment through your 60s and 70s, or would it make more sense to find $500 a month today while you still have a paycheck coming in, so you could be mortgage-free by age 65? Let’s really think about that: Find $500 more a month today, or else put yourself in the pressure-packed situation of needing to keep paying $1,200 a month from the age of 65 to 80—years when we both know you will not be working at all, or just working part-time—before the mortgage is fully paid off. Stand in your truth: Of course it makes sense to try to pay off the mortgage sooner rather than later. And an added benefit to keep in mind: By accelerating your payments you will avoid owing more than $100,000 in interest payments. That’s a huge savings. But the real savings here in my opinion is the money (and stress!) you won’t need between the ages of 65 and 80 to keep paying off the mortgage.

How to Come Up with the Extra Money

Accelerating your mortgage payments is something to be considered only if you are in good financial shape. That means:

• You have an eight-month emergency savings fund.
  
• You do not have any credit card debt.
  
• You own your car outright, and you are saving for when you will need to purchase another car.
  

I realize there may be other pressing financial needs for your dollars today, such as lending a hand to adult children who could use help paying their own mortgage as they grapple with a layoff, or assisting parents who are struggling to make ends meet when the income they can earn in this low-rate environment has been reduced so drastically from a few years ago. I am not going to tell you what takes precedence; this is your truth to work through. Instead I would suggest that you spend time in the Family Class, where I discuss how to work through the how and when of offering assistance to your loved ones.

For those of you who are able to take on the goal of paying off your mortgage ahead of schedule, here’s your game plan:

•
If you have more than eight months in your emergency fund:
You may use that excess amount to pay down the mortgage. Your emergency savings are likely earning just 1% or 2% these days. Using that money to retire a 5% or 6% mortgage is a great use of your money. But you must never reduce your emergency savings below eight months. You must always have eight months of liquid cash available to cover life’s surprises.

•
Reduce your monthly expenses so you can add more to your mortgage payment
. If you are ready to stand in the truth that paying off your mortgage before retirement is the best way to ensure a secure retirement, then you must also stand in the truth that having more income available at the end of the month to add to your mortgage payment is how you make this particular dream come true.

After taking those steps, if you are still looking for more money to use to pay off your mortgage, you can carefully consider scaling back contributions to your retirement funds. Here is a game plan:

•
If you contribute to a 401(k) up to the point of the match:
Keep contributing enough to continue to get the match. But if you have been contributing more than that to your 401(k), redirect anything beyond what’s needed to get the match toward paying off your mortgage.

•
If you have less than $100,000 in your traditional IRA:
Keep investing in your IRA, but once you get within 10 years of retirement, consider reducing your IRA contribution by 50% and use that money to pay down your mortgage. For example, let’s say you are contributing $500 a month to your IRA. My advice is to reduce that to $250 a month and then put the remaining $250 into accelerating your mortgage payments.

•
If you have less than $100,000 in a Roth IRA:
Same advice as with the traditional IRA, above.

•
If you have more than $100,000 in a Roth IRA:
Figure out how much you need to accelerate your mortgage payments to get it paid off by your expected retirement date. If that monthly sum is more than your current monthly Roth IRA contributions (or the annual equivalent), stop the Roth contributions and use the money to pay down the mortgage. If the amount you want to use for your accelerated mortgage payment is less than your current Roth contributions, great. You can put more money into paying off the mortgage and still continue to make smaller Roth contributions. Let me illustrate that with an example: If all you need is $300 more a month to pay off your mortgage by the time you retire, and you are depositing $500 a month into your Roth, continue to deposit $200 a month into your Roth and add $300 to your mortgage payments. However, if you need all $500 to pay off your mortgage before retirement, stop the contributions altogether and put all that money toward paying down your mortgage.

•
Use money from a Roth IRA
. Money you invested in a Roth IRA—your contributions—can always be withdrawn in any amount at any time without a penalty or tax. And your earnings on those contributions can be withdrawn tax- and penalty-free once you are at least 59½ and have had the account for at least 5 years. If you converted a traditional IRA to a Roth IRA and paid the tax, you need to leave the amount you originally converted inside the account for at least 5 years or until you turn 59½—whichever occurs first—to avoid all tax and penalty. The earnings on your converted money must stay untouched until you are 59½ to avoid tax and penalty.

In any case, I strongly recommend that you do not touch any retirement savings before age 59½. You want that money to grow as long as possible. It is better to aim to get your mortgage paid off by using other income sources while you are working. Once you are within a few years of retirement, tapping your Roth is fine. But please think carefully about how much you can truly afford to withdraw. If you will need income from your Roth to help pay your ongoing expenses in retirement, then it makes no sense to deplete the account. This goes back to my stand-in-the-truth challenge: You are only to pay off the mortgage if you can truly afford to stay in the home.

Later on in this class I am going to ask you to work through an exercise that will give you an estimate of what your monthly retirement income sources may be—from Social Security, from a responsible rate of withdrawal from your 401(k)s and IRAs, and perhaps from a pension. When you go through that exercise, I want you to run the estimates based on a few different scenarios for your Roth IRA: if you don’t touch it at all right now, if you were to use 20% of it to pay off your mortgage, if you were to use 40%, etc. The challenge here is to not use so much of your Roth IRA today that it reduces your potential income in retirement to a level that makes you nervous. It’s a balancing act. If you have a big pension or you are confident that your Social Security and 401(k) assets will provide plenty of retirement income, then you can afford to tap more of your Roth IRA today.

•
Under no circumstances are you to take an early withdrawal from a traditional 401(k) or IRA
. It makes no sense to withdraw money if you will have to pay the 10% early-withdrawal penalty. Moreover, remember that withdrawals from these traditional accounts count as income in the year you make the withdrawal. A large lump sum withdrawal could put you in a higher income tax bracket for the year. That is not a wise move. Even once you turn 59½ I do not recommend you make large lump sum withdrawals simply to pay off your mortgage. The tax hit will invariably bump you into a higher tax bracket. My advice is to start today with the intention of finding extra monthly income or focus on reducing your expenses so the income you do have can be put toward accelerating your mortgage payment so the mortgage will be paid off before you retire.

STAND IN THE TRUTH

Paying off your mortgage before you retire has an undeniable allure. What greater security is there than knowing no one can take your home from you? And if, later in retirement, you find you need more income, you will be able to take out a reverse mortgage. (See the Home Class for a lesson on reverse mortgages.) So if you are in the home you intend to retire in and your financial truth makes it possible to accelerate your mortgage payments, I think this is a great step to take, beginning in your 50s.

But please promise me that if you reach this conclusion, you have made the decision while standing in a very real and responsible truth. I know you love your home. I appreciate that the idea of having a family home for your children and grandchildren to return to is a classic part of the American Dream. The allure of this image is incredibly powerful. So I recognize that it will take a great amount of fortitude to face up to the reality of your situation as a homeowner. And if you have to rewrite this part of the American Dream for yourself, it will no doubt be a painful and disappointing reckoning. It may be the most difficult kind of letting go to relinquish the dream of a family home and replace it with a more modest living arrangement. The consolation I can offer you in return, however, is security and peace of mind, in knowing that you have made a difficult but correct decision that is in accordance with your truth. You will know you did what was right, not what was easy.

LESSON 2.
HAVE A REALISTIC PLAN FOR WORKING UNTIL AGE 66–67

If there has been one singular shift in America’s retirement dream since the onset of the financial crisis, it is that many of us must plan on working longer to make up for the money lost in the market crash, for the loss in home equity, or to make up for years when we may not have been saving as much as we needed.