Tapping nest egg for mortgage is risky

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Dear Dr. Don,
I am near 67 years old and plan to retire in July 2011. I have a $68,000 mortgage at 5.625 percent with a payoff date of December 2018. My monthly payment is $860 a month. I have $130,000 in mutual funds, which is showing very little growth. I am considering using $68,000 of that money to pay off the mortgage. It seems the money I would save ($860) would be more than the interest that would be generated for retirement by the leaving the $130,000 in mutual funds, given the slow growth. Am I crazy?
— Richard Real-Estate

Dear Richard,
While I think it’s a great financial goal to have your house paid off before you retire, I’m a little leery of recommending that you cash in over half your retirement nest egg to pay off the mortgage now. If you hold the funds in a tax-deferred retirement account, you’ll have to cash out even more to cover the income taxes due on the distribution.

You didn’t explain how your mutual funds are invested. If they’re in money market mutual funds or other short-term debt investments, I can understand why you’re not seeing any growth in the account. It’s possible that your investment allocation is too conservative.

My rule of thumb is that if you are earning less after-tax on investments than the effective rate of interest you pay on the mortgage, you can justify paying down the mortgage. Use Bankrate’s “Mortgage tax deduction calculator” to estimate the effective rate on your mortgage.

What will you do with the $860 a month you’ve freed up by paying off the mortgage? Using the money to rebuild your nest egg is one thing, but incorporating the money into your monthly budget is something else. I’m a big proponent of financial flexibility. Paying off your mortgage will reduce you financial flexibility short-term, but if your goal is to rebuild that nest egg, you can regain that financial flexibility over time.

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