Dear Dr. Don,
Is it better to make extra payments on my mortgage (which currently has a balance of $157,000 at 5.625 percent interest) or invest more in my Roth 401(k)?

I am 45 years old and have 27 years left to pay off my mortgage. I have about $600 a month that I could put toward paying off my mortgage or investing in my Roth 401(k). I’m not sure what the best strategy is with this money.
— Kristin Conundrum

Dear Kristin,
In deciding whether to invest or pay down the mortgage, my rule of thumb is to compare the effective interest rate on your mortgage to the expected after-tax return on your investments. The more conservative the investor, the easier it is to justify repaying the mortgage.

Assuming you can fully use the mortgage interest deduction on your taxes, you can calculate the effective rate on your mortgage by using Bankrate’s “mortgage tax deduction calculator.”

To fully use the deduction means you aren’t just replacing the standard deduction with a mortgage interest deduction.

Roth 401(k) contributions and investment earnings aren’t subject to federal income taxation when they are distributed out of the account as qualified distributions.

A big factor in the analysis is whether your employer has matching plan contributions. In general, you want to contribute up to the limits of the company match before considering alternatives when investing.

A tax wrinkle here is that employer contributions to a Roth 401(k) are made to a separate tax-deferred account and are taxable when taken as distributions out of that account.

Both goals are being funded with your after-tax dollars, so that part is an apple-to-apples comparison: Make additional principal payments and save on interest expense for up to 27 years; contribute to a Roth 401(k) and let your money grow free of federal taxes.

The Roth 401(k) is subject to required minimum distribution, or RMD, rules, but converting the funds to a Roth IRA would finesse the RMD rule. You can calculate the interest savings on the mortgage. You have to guesstimate the investment earnings on the Roth 401(k).

I’m recommending you invest in the Roth 401(k) up to the limits of any company match. From there, you have to decide whether you think you’ll get a better return on your investments or by paying down the mortgage.

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