Should extra retirement funds go toward paying off your home?

We need help making a big decision. We have about 1.7 million dollars in our retirement account. My husband, who is 61, is retiring in a week. He took a lump sum on his pension and that is part of the 1.7 million. His employer is providing health insurance for both of us until age 65 when Medicare kicks in. I am 58 and plan to work a few more years and make on average $40,000. My husband may work part-time to bring a bit of extra income.

We still have a mortgage ($264,000) and our house is valued at about $365,000, so we have about $100,000 in equity. We are torn with taking some of the money from our retirement account ($150,000) and adding that towards the mortgage and then refinancing to make our house payment go substantially down. We also think that investing that money towards our mortgage would keep that money safe in the event the economy crashes.

What would your advice be to us? Thanks much.

Linda

Hi Linda,

I’ve read your question way more times than I care to admit. I keep thinking of another line of questions I’d love to ask you after each time through. Unfortunately for us both, though, that’s not how this works. Don’t worry, though. We’ll get to an answer.

$1.7 million dollars is a bunch of money. On the other hand, $264,000 isn’t exactly chump change. Does it make sense to make a lateral net worth move (your net worth will stay the same) by taking money out of your retirement nest egg in order to pay down a significant chunk of your mortgage? The answer, Linda, may lie somewhere you don’t expect.

The one piece of information that will make or break this option for you… was not included in your email. It’s ok, Linda. You didn’t know. But, what is that bit of information? It’s this...

How much do you spend as a household per month?

Here’s why this is important: I’m not a particularly big fan of making lateral net worth moves. Typically, I’d much rather see someone use income to pay off their debt (mortgage or otherwise) instead of using accumulated assets. In your case, this is especially relevant because the reason you’ve gathered those assets, retirement, is here and the income is coming to a stop. You see, when you’re able to use income to pay off your debts it will benefit you in two ways.

1. You’re paying down the debt, therefore increasing your Power Percentage and net worth, and eventually freeing up more cash flow.

1. You’re not killing chickens.

Woah. Bet you didn’t see that one coming.

Here’s what I’m talking about. Chickens are useful not just because they’re tasty, but because they produce eggs. As long as the chicken is around, you’ll continue to get eggs. But, what happens when you kill the chicken and throw it on the grill? No more eggs.

Let’s use this example in context with your situation. If you were to take $150,000 from your account and apply it towards your mortgage, you’d be losing a fair amount of capacity to generate returns either through growth, or interest, or dividends. Those three things are what you’ll want to count on in retirement. Once that cash is removed, it’s very difficult to get it back because you’re consuming the growth/interest/dividends. Also, keep in mind that it if you wanted to pay down an actual $150,000 on your mortgage, you’d have to take closer to $190,000 to net the correct amount.

Now, I hear you loud and clear when you say you’re nervous about the market. I agree that, at some point, we’ll see a correction in the market and prices will decline. When that happens, your resources will be even more stressed because you’re still relying on them to live your lifestyle. If you were to take $190,000 now to pay a chunk of the mortgage, then if the value were to get reduced by an even bigger percentage in a market decline, you can see how this might get a little uncomfortable for you. You could easily go from being comfortable to needing to make some tough decisions.

So what’s the answer? Chances are that by the time you read this, Mr. Linda has already retired. You’re settling into a new stage of life as a couple and your expenses are adjusting accordingly. Figure out what those new monthly expenses are. Track them for a few months to get some consistency. Once you’ve got a good idea of what normal looks like, multiply that monthly total by 12 for your annual number. If your number is around $60,000 or less, you might be able to make your proposal work. If you’re looking at something closer to $100,000, though, you’ll want to reconsider.

Wait! I’m not quite finished. There are a couple of wild cards we should look at. The first one is Mr. Linda’s part-time work. Could the two of you make enough money to not need to use the retirement account to supplement your income for a while? If so, that could be very beneficial to your situation. Even delaying the use of those resources by one year could prove very favorable to your long-term retirement success, potentially growing enough that you’d cover the mortgage payment with the increase in resources. The second wild card is Social Security. I have no idea when Mr. Linda plans on beginning his Social Security income. However, if you’re able to make things work while he’s not drawing his Social Security check, you may be able to use his entire benefit to pay down the mortgage when he begins collecting it. The best part of this option? No dead chickens.

Start working on determining your monthly expenses, Linda. If you’ve got any questions about what I’ve laid out here, let me know. I’d be happy to continue our conversation.