Dear MarketWatch,
I am 68 years old and have been retired for three years. I realize that I am very fortunate in that I am making $12,000 a month after taxes. All this income comes from two separate government pensions and Social Security. We have excellent medical coverage and have virtually no out-of-pocket expenses.
Throughout our 40-plus year marriage we have been a one-income household. We have $500,000 in savings and our 401(k). I have a very low mortgage rate of 2.25%, which has a balance of $100,000 on a $600,000 house. We want to pay the mortgage off with funds from our 401(k), which will make us debt-free. We can easily live off our monthly income while still saving a considerable amount each month.
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After paying off the mortgage our 401(k) will sit until we are required to begin taking the RMDs in four to five years. Our 401(k) is sitting in a fund that mimics the S&P 500. I know this is a higher risk, but with our guaranteed monthly income, I feel we can accept this risk.
Are we following a sound plan, or would you recommend something different?
Almost Debt-Free
Dear Almost,
Having that much put away, plus income from two pensions, is a wonderful feat.
Many people wonder if they should pay off their mortgage in retirement, and the answer depends on if they are financially able to do so without risking their future security. For some people, taking such a big chunk out of their retirement savings to pay off the mortgage is not a sound plan because they’re using those assets to pay for some, or most, of their living expenses in their old age. The more money in your account to grow with investment returns and/or interest, the more money you’ll have later on to live off of, after all.
Your situation is a bit more unique. You have healthy, guaranteed income streams, and for that, you are right to say you’re fortunate. Taking $100,000 — or 20% — out of your 401(k) to pay off the mortgage might not hurt your future security as much as someone without those pensions, but you should still ask yourselves if you really want to do that. Your interest rate is low compared to the current 30-year fixed rate, which hovers at 7%.
A mortgage isn’t the type of “bad debt” retirees should necessarily avoid in retirement, such as credit-card debt, and if the monthly payments aren’t pressuring your lifestyle month-to-month, it doesn’t necessarily hurt to keep it. You also get a tax break every year with a mortgage — couples who are married and filing jointly are allowed to deduct the mortgage interest they have on up to the first $750,000 of that loan, if it’s the primary or secondary home.
On the other hand, by lowering your 401(k) balance, you are helping yourself later on when it’s time to take required minimum distributions, since the balance does impact how much you must withdraw. Just another thing to consider when you assess your plans.
For some people, paying off a mortgage is a badge they can wear proudly. For others, it is just having one less thing to pay every month. If those are the only reasons you’re doing it, that’s fine, but at least weigh the alternatives, which would be to keep more money in your retirement account to fall back on and a little tax perk for the next few years.
Or you could also meet in the middle — pay off half of the mortgage with some savings, and pay more on top of your monthly bill that goes toward your principal alone. That would allow you to drain less from your 401(k), but speed up your payoff date.
Regarding your asset allocation in the 401(k) — yes, it is risky to have your retirement savings only mimic the S&P 500 SPX without any other diversification. You’re also right that you can take on more risk given your monthly income, but again ask yourself if you really want to, or if there’s a compromise you could make with yourself?
You do have a substantial monthly income to rely on, but if you’ve worked so hard to amass that small fortune in your 401(k), you don’t want to take too much of a chance on it. You never know what the future can bring, and you may need some of that money when you’re older.
If you’d like to keep an aggressive position with your investments, why not separate it into buckets, where one bucket is a mixture of conservative and aggressive assets that generates income but has some protection from the market, and then another bucket that is riskier? With a strategy like that, you won’t have to worry too much if the market takes a dip.
Whatever you decide, you sound like you’re in a great spot. In the meantime, keep up with your monthly saving habits.
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