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 Dear
Dr. Don,
I am 57, single, with an income of about $50,000 annually. I have a 6 percent mortgage of $87,000 for a remainder of 26 years. This is my only debt.
I already fund 20 percent to my TSP at work, $5,000
to my Roth IRA at 5.25 percent and my savings currently earn 5.05 percent. I am
in the process of selling a piece of property that I inherited for $150,000.
My question is, should I pay off my mortgage or invest more in my savings?
--
John Juncture  Dear
John,
A good rule of thumb is that you should prepay the mortgage
if you expect to earn less after-tax on your investments then the effective interest
rate on your mortgage. So where do you plan to invest the proceeds from the sale
of the inherited property?
If you plan to add it to
your taxable savings account at 5.05 percent and you're in the 25 percent marginal
federal income tax bracket, you're earning 3.79 percent on an after-tax basis.
I'm ignoring state and/or local income taxes in this example.
If you can use the mortgage interest
deduction on your federal income taxes, again
assuming you're in the 25 percent marginal federal
income tax bracket, you're effectively paying
4.5 percent on your mortgage. I'm ignoring state
and/or local income taxes in this example.
The CCH
Mortgage Tax Savings Calculator can put a
finer point on this number for you and will include
the impact of state income taxes. The effective
rate calculation assumes that you would itemize
even without the mortgage interest expense so
you make full use of the mortgage interest deduction. If
that's not the case, the effective rate is actually
somewhere between 4.5 percent and 6 percent in
my example.
While earning three-quarters of
a percent more after-tax on your investments than
you effectively pay on your mortgage isn't chump
change, I do think it's a good idea to attempt
to have your mortgage paid off before you retire.
Since the $87,000 balance is
only about 60 percent of the expected selling price of the inherited property,
you'll be able to invest part of the proceeds in something other than real estate
and still pay off your mortgage. At your age, it's not a bad decision. Overall,
your portfolio looks to be overly conservative. There are a couple of risks besides
investment risk you need to consider in managing your portfolio, namely longevity
risk and inflation risk.
Consider having a fee-based financial
planner review your portfolio with you along with
your retirement goals and financial needs. The
Bankrate feature, "Financial
planners: not just for millionaires anymore,"
can help you find a fee-based planner, as can
the National Association of Personal Financial
Advisors Web
site.
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