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Contribute to 457(b) or pay off mortgage?

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Dear Liz,
We are purchasing a home at the end of this month. We did the math, and if we stick to our budget, we could have the new house paid off in about five years. But that would mean no additional retirement contributions for those five years. We automatically contribute to a retirement plan at work that should replace about 70 percent of our pay when we retire, but we have the option of making additional contributions to a 457(b) deferred compensation plan.

What would be smarter: making the larger contributions to the 457(b) plan the next five years, or paying off the mortgage? We have young children, so we plan to work at least until they are out of college, which would be another 20 to 25 years. We are 34 and 31, if that matters. Thank you!
— Erika

Dear Erika,
Forgoing retirement contributions is a bad idea if the plan offers a match or if you’re behind on retirement savings. It’s an especially bad idea to prepay a low-rate, potentially tax-deductible mortgage while giving up a retirement plan’s match, tax break and future tax-deferred compounding.

You, however, are in the enviable position of being on track for retirement while also having the potential to rapidly pay off your home loan. You’re losing five years of contributions and compounding, which is no small matter — every $1,000 you don’t contribute now could mean $10,000 less in retirement, assuming 8 percent average annual returns. But if you redirect the money you’d be spending on a mortgage to your 457(b) plan after the loan is paid off, you may be able to make up for those lost years of saving.

Another solution would be to split the difference: Take a little longer to pay off your mortgage and still contribute to the 457(b) plan. Sometimes financial choices don’t have to be either/or. You can make them both.

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