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Using annuity cash to pay off mortgage

Dr. Don TaylorDear Dr. Don,
I owe $123,000 on my mortgage and have no other debt. Would it be a wise move to withdraw money from one of my annuities to pay off the balance? A $100,000 annuity would be $94,000 after penalties, and I am under age 59. I'd like to think I am saving a lot of money in interest that way. Or is it better tax wise to carry a mortgage?
-- Shelley Serial

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Dear Shelley,
There's a difference between surrender charges on an annuity and the penalty tax due on withdrawals prior to age 59 ½. If you owe both surrender charges of 6 percent and a penalty tax of 10 percent, then the economics of cashing in the annuity to pay off the mortgage change quite a bit, with $16,000 in penalties in cashing in a $100,000 annuity instead of $6,000. Talk to your tax professional about applicability of the penalty tax.

A qualified annuity is purchased as part of an employer-sponsored retirement plan or an individual retirement arrangement. A nonqualified annuity is not part of an employer-sponsored retirement plan. A nonqualified annuity is funded with after-tax dollars, but taxes aren't due on investment earnings until they are withdrawn. I'm assuming your annuity is nonqualified.

Being able to use the mortgage interest deduction on your income taxes does reduce taxes paid but it isn't, in and of itself, a reason to keep your mortgage. That's especially true in the later years of a mortgage, when most of the monthly payment is going toward the repayment of principal and less and less money is paying interest expense. You can input you loan balance, interest rate and remaining loan term in Bankrate's Mortgage Calculator and have the calculator run an amortization schedule that will show the remaining interest expense and the interest expense year over year.

My rule of thumb is, if the expected after-tax return on an investment exceeds the after-tax cost of debt, then it doesn't make sense to pay off the mortgage. In your case, I don't know what rate of return the annuity is earning, but I do know it will cost 6 percent to 16 percent to cash out the annuity plus any taxes due on the investment returns. I'd hold off on cashing in the annuity to pay off or pay down the mortgage.

 
-- Posted: March 9, 2005
     

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