Nearing retirement, should I focus on 401(k) contributions or paying off my mortgage?

Here are my stats: Married 57, spouse 62. Household income $127,000. Retirement savings is $1,247,000. Power percentage 36%. No consumer debt, no auto loans. Our brokerage account is $40,000. Emergency fund is $38,000. Mortgage is a 30-year (3.75%), $1,200 a month. Spouse contributes 25% to her 401k. I was contributing 33% plus an 8% employer match to my 401k. We lost approximately $200,000 on the sale of a home during the housing bust. Took out a 30-year mortgage 1 year ago due to a job transfer when my wife’s position when from full-time to part-time. She has recently gone back to full-time. I recently cut back my 401k contributions to 8%+ 8% match and I’m applying the difference ($1,000) to my mortgage. I should have the house paid in about 11 years. I plan on working til 70. Am I doing the right thing? I would really appreciate your feedback.

Don

In 1991, the rap group Black Sheep told their listeners that, “you can get with this, or you can get with that.” Like a number of different situations we face in life, our resources typically limit us to being able to choose only one option and that choice has natural ramifications. Were the Sheep talking about saving for retirement vs paying off their mortgages prior to retirement? Um, no. And, does their declaration really apply to your circumstances here? Let’s find out.  

Let’s start with the undeniably good:

Power Percentage: 36% is just into “great” territory on our Power Percentage Key. This means you’re using your income very efficiently (primarily retirement savings and aggressively paying off the mortgage) and becoming less reliant on it as you near retirement. The less you depend on your income, the higher the likelihood of success in retirement because you won’t have to raid your savings to maintain your lifestyle. This is a very good thing. (Click here to learn more about Power Percentage and how to calculate your own.)  

Emergency Fund: Making a few assumptions, it seems that you’ve most likely got a solid emergency fund prepared. Emergency funds are critical, especially as you near retirement. Why? If you don’t have money set aside for the inevitable emergency, you could be tempted to take the money out of a retirement fund, especially if you’re past the age of 59 ½ when you can take the money out penalty free. While this particular solution may seem like it solves your immediate problem, it really just punts your headache down the field a few yards. Now you’ll be faced with fewer funds to live off of in retirement since you’ve already dipped into them. This is not a very good thing. Not even a little.

Brokerage Account: This account can give you all sorts of flexibility. It can serve as either an additional emergency fund or, since the money has already been taxed, a source of supplemental income if you’re getting close to crossing into a higher tax bracket.

Debt Free: You’ve managed to eliminate all types of debt with the exception of your mortgage, and that’s a huge advantage. You aren’t obligated to pay other people for decisions you made in your past and can use that money to fund your future. Again, while this is a great position to be in at any point in life, it’s even more important entering retirement when your income is more or less fixed and any money going towards debt is money you can’t live on.

Retirement Savings: I’m not putting this in the good column because you have $1,247,000 set back for retirement. I’m putting it here because I think you’re on track to have an amount that will take care of your needs in retirement. Based on your Power Percentage and what you probably pay in taxes, I’m reasonably confident that you’ll have the assets you need to maintain your lifestyle well into retirement. Once you factor in your Social Security benefit to your monthly income resources, things will probably look pretty comfortable for you.

So, should you continue paying off your mortgage aggressively to have that taken care of prior to retirement and maintain your current funding for retirement? Based on what you’ve shared with me, yes, that’s exactly what you should do. If I use a conservative rate of growth for your retirement assets and a conservative distribution rate for your assets in retirement, you’ll have in the neighborhood of $6,000 of income available after the effects of inflation are accounted for. Please note that I didn’t include any additional retirement contributions between now and the time you retire for either you or your wife, so that number should be reasonable.

At the rate you’re paying your mortgage off, you’ll be debt free with roughly two years left to work. This gives you some a couple of options to choose from. First, you could continue with your current payment plan. Once the mortgage is satisfied, I suggest you then save the entire mortgage payment you were making into your brokerage or 401(k). This would accomplish two things: 1) give you extra savings to draw on in retirement, and 2) ensure you aren’t increasing the cost of your lifestyle right before retirement. You’ll focus on one goal at a time with this solution, but make progress on both before you retire.

The second option is to refigure your mortgage payment plan to have it end closer to your retirement. This change would decrease your additional mortgage principal payment and allow you to divert that money to your 401(k) contribution and increase it a smidge each paycheck. This approach would give your contributions a longer time to compound prior to retirement and still pay off the mortgage before you retire. Yes, with this option you’re choosing “this AND that”, and still working your plan. Thus, proving once again that 90’s rap is entertaining to listen to, but not always the best place to get your financial advice from.

Which option should you choose? I really like them both, to be honest, and I wouldn’t fault someone for choosing either one. In other words, pick the one you’re most comfortable with and go with it. You’ll be setting yourself up for a successful retirement, either way.

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