Q & A

Should I use my IRA to pay off my mortgage?

Full question:  I’m single, recently retired at age 65 and have approximately $450,000 in my IRA. My Social Security and a small pension total $2,000/month, and I can meet all my expenses with this amount of money except for my mortgage. I only have seven years until it is paid off, but with my other expenses, I can’t make the monthly payment without tapping into my IRA. My mortgage interest rate is 6.5 percent, and now that I’m retired, I’ve been told that it will be extremely difficult to refinance. I should have refinanced while still working, but I traveled a lot and thought I’d do so once in retirement when I had more time. My question is this: Should I continue to take $1,500/month out of my IRA for the next seven years for my mortgage payment, or should I just take the money from my IRA and pay off my mortgage? If I take out a lump sum, then I wouldn’t have to draw from my IRA until my required distribution age, and I’d avoid the 6.5 percent interest expense for the next seven years.

Answer:  I would not take a lump sum from your IRA. Based on your $1,500/month payment amount with 84 months remaining and an interest rate of 6.5 percent, your current principal balance is around $101,000. If you are a single tax filer, you would need to take at least $128,000 from your IRA to pay off your mortgage and pay the taxes owed on the distribution. The taxes owed will be more than the approximately $25,000 of interest you will pay on your mortgage over a 7-year period.

This may seem like a close call – pay $28,000 in taxes now, eliminate your mortgage and save $25,000 in interest payments – but time value of money needs to be taken into account. If you leave the $128,000 in the IRA and take out $1,583/month, federal taxes owed will be around $750/year. The $1,583 will provide you with enough additional cash flow to cover your mortgage principal and interest and your tax owed on the withdrawal. If you earn a 5 percent rate of return on your IRA investments, its value will be more than $22,000 greater than if you took the lump sum now, paid taxes and paid off your mortgage. Read more…

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