Pay off Mortgage or Max TSP?

[EricDeLee]

Kinda in a bit of a delimma here and would like to gather some advice for a general perspective of the forums:

The wife and I have decided to work out the kinks and work towards financial independance.
The goals are pretty simple: Pay off everything right now, and invest as well.

Simple, but going about it is what I'm curious about.
I figured out I can pay off my mortgage in 4 1/2 years. With that, the two cars will be paid off in the next year, and the only other debt we have is two minor credit card balances (with a total of less than $5k for both of them).

The question I have is this:
Is it better to pay off the mortgage now, and then start maxing out the TSP once that is complete, or stretch my mortgage out until later and add more to the TSP now?

I can see advantages of both situations. But what concerns me is once the bigger payments are made towards the house, I'll start cutting into tax advantages. No more intrest to write off on the taxes. And that will actually happen within roughly 2 years, being that I'll be dropping roughly $34K into house payments. While doing so, I am currently giving TSP 10% of my base pay.


What I am considering doing, is to continue paying off the house at the alccelerated pace, but each 6 months or so, increase my TSP percentages by adding an additional 2.5% (which will place me around 30% on the fourth year... thus decreasing my overall AGI for taxes). That'll put me at contriputing max (maybe more... so I'll need to look at that) at the time my house is paid off. At that point, all of our income (hers and mine) will be going towards our retirement nest, normal expenses, and we'll be debt free. That puts me on schedule to be debt free 4 years before I retire from Active Duty.

But is it better to throw that money in NOW so it can compound? or will my method work ok to still help reduce my tax bracket? We currently don't have other retirement accounts (aside from her 401K) Just trying to figure out what others have done.

[Birchtree]

The important fact to take into consideration is that we are in a rampaging bull market that will last for another decade. The opportunity cost is your decision to make. I wouldn't accelerate the mortage pay down but would rather open a separate Roth IRA to produce tax free income at a later date - and you can always pull from it if necessary without penalty - just not the gains. Grab the bull by the horns.

[jpcavin]

What is the interest rate on your home loan and do you have other investments (i.e. Roth IRA)?
Me, personaly, I probably would not pay off the house unless I was going to be really strapped for money when I left the military.

BT and Frixxx will jump on this one..wait for a reply.

[jpcavin]

I spoke too late..:laugh:

[Scout333]

Kinda in a bit of a delimma here and would like to gather some advice for a general perspective of the forums:

Simple, but going about it is what I'm curious about.
I figured out I can pay off my mortgage in 4 1/2 years. With that, the two cars will be paid off in the next year, and the only other debt we have is two minor credit card balances (with a total of less than $5k for both of them).

The question I have is this:
Is it better to pay off the mortgage now, and then start maxing out the TSP once that is complete, or stretch my mortgage out until later and add more to the TSP now?


Eric, as you have already figured out its not an easy question.:)
1. You may want to focus on the credit card debt first, then the cars, and then the mortgage. Its more of a cash flow deal since you will have more available to pay down debt out of your regular budget if you do it that way. Check out the Dave Ramsey debt snowball discussion on his website.
2. The second part of your question i.e. to pay off house first or build up retirement has a math component. How much profit do you think you can make in your retirement accounts (net of taxes which will be due when you take it out since these are tax-deferred accounts) vs. how much interest you are paying on your mortgage (also net of tax deduction benefit). For example, if you think you can make 8%-2% taxes or 6% net vs. a 6% mortgage rate- 1.5% tax benefit or 4.5% net cost you would be slightly ahead by putting the money in the retirement accounts. The other side of the coin is that the mortgage payoff is essentially a guaranteed return on your money. Also, paying your house off provides you a paid for roof over your head which the retirement account doesn't. I personally like paying the mortgage off first better but can certainly see a case for building up the retirement accounts first as well. Note. On the tax side because standard deductions for married couples are so high now you may not lose as much of the interest deduction as you might think.
Hope this helps.

[k0nkuzh0n]

If you think you might be the type of people that once they pay off debt, they use that freedom to buy more stuff (re-creating the debt) then I would put the money into retirement (I'd suggest outside of TSP); Although I doubt you are or you probably wouldn't have created this thread in the first place. I personally wouuld pay off the debt from highest interest to lowest interest.

I personally was debt free and have never paid a penny of credit card interest, but just took out an auto loan because at 1.99% its cheap money. Not that I needed the money; I'm transferring most of it to a brokerage account.

[EricDeLee]

Like I mentioned earlier, there is literally no debt on the credit cards. That $5K we owe will be paid off in OCT. Between now and DEC we are making the extra payments to that, and paying ourselves (sock drawer money for emergencies). So we will have roughly $15k nestled away for the minor issues, an the CCs will be paid off. Then in January the extra car payments will be started, and we should be able to finish that off by NOV of 2014. At the same time, I'll be tossing an extra $1k a month to the principle of the house loan. Then we take the month of December "off" for extra payments. Jan of 2015, I'll be tossing an additional $1500 a month (total of $2500 extra each month on principle of house loan). That goes until scheduled payoff of around DEC 2017.

Investment-wise:
I'll be investing in TSP still. Currently at 10%, but by 2017 it will be at 30%-ish
My wife is investing as well in her defined contribution plan. She's investing roughly $500 a month. she has the option to invest $8 an hour of her pay, I think he is doing half right now.

We do not have any IRAS or Roth accounts. But that is something I am considering for 2014.
I don't know if I like the TSP ROTH, but I do like the concept of what Birch mentioned that I can do the Roth and get the money tax-free upon withdraws.

The house loan is 3.75%.

The hardest concept to wrap my brain around is not maxing TSP now when I could. But then again the idea of killing off all debt sounds really nice as well. I'm not too worried about gathering more debt, as I think we'll be okay in that area. I can start drawing my military pensions in 2020 or 2021... Grab a tech job somewhere close to home (lots of opportunities here for that) and then continue investing by possibly rolling that my TSP into that TSP (I am unsure how that works though). I have another 15 years there investing, while just basically paying normal expenses with just my military pension.

But I was curious as if it was a bad idea to pay the house off right away or not. I haven't dived into tax advantages all that much yet, so that's what I was worried about. Between my pension, the wife's pension and both of our "401k" plans.... And addition Roths and IRAs... We should be doing okay. Debt free sounds like the way to go. I know we are in a bull market, but I still think by paying off debt quickly I should be able to reach "critical mass" easier then when I have a mortgage payment.

Now I just got to see if I can get both 401k accounts to that critical mass, money-printing point.


Please keep the comments rolling! Thanks

[JTH]

Max out the TSP, you only have a limited window where you can contribute to TSP, once your done, that's it. You can pay off the house anytime, but you can't pay into the TSP once your retired. House debt is good debt (as good as debt gets) plus it may still be deducible.

[Birchtree]

Eric, with the mortgage deduction your interest cost might be closer to 3.0%. When you have equity built up in the house an equity line of credit would pay down other bills and the interest is also dedutable. You can use excess equity cash to buy individual stocks that pay a higher yield and you get the benefit of possible capital appreciation. Just something else to think about. And when you get to my level you can margin your life up to the max and ride the winds of prosperity. Most debt is a privilege and has to be earned. Now is a good time to start working on an income stream that will grow year round.

[hotwings]

Looks like you are the right path and have your financial house in order. Although you don't indicate how old you are or how many years you have until you plan to retire, you should try to plow as much into TSP as possible, especially if you are under the FERS retirement system as it plays a key part in your retirement nest egg down the road. By investing now, you will have more time for your investment to grow and if you are not under Roth, your contributions come out of your paycheck tax free. You don't pay taxes until you withdrawal down the road hopefully in a lower tax bracket. If you have a choice between Roth and Regular TSP, I would go with the Roth as you can withdraw it tax free after you retire, however, you pay taxes on the contributions now. If you think your salary is going to rise going forward, Roth is the preferred plan. My wife is under CSRS and is retiring on 3 Sept and we are trying to contribute a full year's worth of regular IRA and catch up contributions amounting to $23K before her last paycheck because she never plans to work again, nor will she have to. The darn furlough made it difficult but the annual leave cash payout in her last paycheck will make it easier for us to manage. I'm under FERS (missed CSRS by 15 days) and I'm maxing out as well. Next summer is my KMA day and it looks like all the savings via TSP and IRAs over the past 29 years will pay off. Good luck in whatever you chose to do...

[EricDeLee]

Another thing I was looking at: paying off a 30 year mortgage in 5 years saves me nearly $60k in interest.

Ive got a lot to think about in this aspect. Birch... I know you know what you are talking about, I've already got about $40k in equity. Just don't know a lot about all of the other stuff. But, that's why I am here !

[Boghie]

Scout was 100% correct...

But, you were already on that target - so the question is whether to invest in a guaranteed 3.5% fixed interest product or a variable product that normally gains about 10%...

However, because of the tax advantages of the mortgage, that guaranteed 3.5% 'bond' is really worth about 2.5% or so. The 'C Fund', however, will normally provide between -6% and +26% centering on 10%. I think the answer presents itself. Your investment in the 'C Fund' compounds on itself, the mortgage does not. The 'C Fund' is tax advantaged, paying down a mortgage is a tax negative till you no longer get the write-off (which is were I am). And, you seem to be starting a bit late in your TSP so you want to plow as much as you can early on so those assets can compound. Finally, a nice market dump would be just grand for you - just plow contributions into the C/S/I at cheaper prices.

It is rarely a great idea to buy down a mortgage early. They get cheaper as inflation increases pay. The only reason I can think of buying one down at the expense of growing and dynamic investments is to beat the affects of deflation. Deflation is a misery for holders of debt. But, if you are a long way from buying it out you will still have the same payment if/when deflation rears its ugly head...

[jpcavin]

Let me simplify the math if I may....

You're passing up a possible 10, 20 or even 30% gains in TSP in order to eliminate 3.75% interest fees a year as well as pass up the tax write off of your mortgage(resulting in higher taxes)
Also, lets not forget that your tsp contribution lowers your taxable income so more money in your pocket and less money to Uncle Sam.

Please consider the glowing:
1. Get rid of the credit card and car debt.
2. Keep the good debt (mortgage).
3. Increase TSP contribution
4. Start Roth IRA (not TSP Roth)
5. If you get bored watching your money multiply, you could try passing up Birch just for fun. That should get some bull tinky flying.

[PessOptimist]

I agree that maxing out the TSP is a good idea. That's what I did and the 30 year mortgage did get paid off in 14 by scraping together a few hundred bucks when possible to throw at the principal. I think the interest was 5.25, which was refinanced a couple of times. It got to the point where it was not worth refinancing for a lower rate. Tax wise, once the interest deduction got to the point of being less than the standard deduction, we got serious about paying it off.

A caveat about my situation v yours is that I retired from the military and once I found a job, made a rule that the military annuity was only for mortgage payments and other housing expenses. Both my kids are grown and gone. It is about the same as having two incomes. My spouse does not work. In case you are thinking that military annuity is a fortune, I retired as an E-7. No 40k O-5 annuity here. Just enough to make a house payment.

Sounds like you have a good plan. I vote for maxing the TSP while the market is going up and paying off what you can in the mean time.

Other thoughts after reading Boghie's reply are

-real estate is going up right now in most areas but your house's value may not continue to increase, a house is a place to live, not an investment tool

-if you are planning on living in the house for a while, what used to go to the mortgage payment needs to go to updating the infrastructure

Now Judy has replied. The market does not always give you 10, 20 or 30%. YMMV

MHO. Remember about opinions.

PO

[EricDeLee]

Let me simplify the math if I may....

You're passing up a possible 10, 20 or even 30% gains in TSP in order to eliminate 3.75% interest fees a year as well as pass up the tax write off of your mortgage(resulting in higher taxes)
Also, lets not forget that your tsp contribution lowers your taxable income so more money in your pocket and less money to Uncle Sam.

Please consider the glowing:
1. Get rid of the credit card and car debt.
2. Keep the good debt (mortgage).
3. Increase TSP contribution
4. Start Roth IRA (not TSP Roth)
5. If you get bored watching your money multiply, you could try passing up Birch just for fun. That should get some bull tinky flying.


The last few responses are the exact reason why I asked this here. I don't have it all figured out, yet it seemed like a bit of a mistake paying the mortgage off quickly. It is just so tempting to see that part of the output of money staying in the bank. I'm going to rerun the numbers. Hell... I suppose I could just pay the mortgage off with military retirement paycheck. Thanks for the responses. I appreciate it all!

[jpcavin]

Should read "Please consider the following" not "Please consider the glowing" I was replying from my phone. :embarrest:

[jpcavin]

Now Judy has replied. The market does not always give you 10, 20 or 30%. YMMV

MHO. Remember about opinions.

PO

What is YMMV??? I agree with you PO, but you gotta be positioned to take advantage of the markets when it wants to be generous and giving. :D

[burrocrat]

Should read "Please consider the following" not "Please consider the glowing" I was replying from my phone. :embarrest:

dang, i liked it better when you were glowing not following. stupid phone.

[GrandeBabbo]

JP,
You are the most right IMO.

J,
CC debt is the worst. Unsecured debt like CC and auto notes MUST be paid off first.
One life lesson I've lived by. If you can't afford it, don't buy it unless you NEED it. Something tells me the CC debt and auto notes weren't needs. But hey, live and learn right?

Secured debt is ok. Looks like a refi on the house worked out well. My wife and I own 3 houses. 2 of these are rentals. Refi on 2 this last winter and spring and bought the last rental a year ago. Cash leveraging is the name of the game. You have a great rate on that house. It's time to max out retirement. I do the same thing by looking at the interest liability on the houses and think, "wow, look at all that interest". But really you are only paying about 20 - 40% of that interest in the long run because of the tax write off.

That is great that you came here looking for advice. I'm sort of new here but a long time invested and saver. I'm prior military and retire after 24 years. Maxed out my TSP and Roth IRA . I'm 44 but retired almost 2 years ago and will never have to work another day of my life. My wife works but every cent she brings in is just extra. We are sitting on $456k in retirement and $160k in investments. That is freedom my friend.

JP has it right. Follow that checklist and you'll be just fine.

Take care,
GB

[GrandeBabbo]

J = Eric

Sorry about that.

[DreamboatAnnie]

Strategy to keep itemizing as long as possible: Once the mortgage interest plus property taxes get below standard deduction or your deductions with interest and real estate taxes, etc get too low to itemize, you can try paying two years of taxes in one year (January and in December) to pull it back up above standard deduction to enable you to itemize one year and then use standard deduction the next year. Just keep alternating years until you can no longer itemize.

[k0nkuzh0n]

What is YMMV??? I agree with you PO, but you gotta be positioned to take advantage of the markets when it wants to be generous and giving. :D

YMMV = your mileage may vary


Another thing I was looking at: paying off a 30 year mortgage in 5 years saves me nearly $60k in interest.


That is likely misleading though because of inflation. Its very likely $60k will not be the same as $60k in 30 years from now.

[Khotso]

Strategy to keep itemizing as long as possible: Once the mortgage interest plus property taxes get below standard deduction or your deductions with interest and real estate taxes, etc get too low to itemize, you can try paying two years of taxes in one year (January and in December) to pull it back up above standard deduction to enable you to itemize one year and then use standard deduction the next year. Just keep alternating years until you can no longer itemize.

Pay 2 years of taxes in 1 year? Can you explain that a little further for me? My ability to itemize may be gone by this year, but certainly next.

[bazinga!]

JP,
I am very new at all of this. May I ask acouple of questions?
First, What is the difference between a Roth IRA and a TSP Roth? How would one go about getting into a "Roth IRA"?
I am getting ready to max out my TSP contributions and add the $5000 catch up but would also like to get involved in a Roth of some sort. I don't want to sit here everyday pulling my hair out about where to move my money, (TSP is enough already):)
My knowledge is too limited to trade with the big dogs as of now.
Any suggestions, comments?
Thanks in advance.

Lori (Bazinga)


Let me simplify the math if I may....

You're passing up a possible 10, 20 or even 30% gains in TSP in order to eliminate 3.75% interest fees a year as well as pass up the tax write off of your mortgage(resulting in higher taxes)
Also, lets not forget that your tsp contribution lowers your taxable income so more money in your pocket and less money to Uncle Sam.

Please consider the glowing:
1. Get rid of the credit card and car debt.
2. Keep the good debt (mortgage).
3. Increase TSP contribution
4. Start Roth IRA (not TSP Roth)
5. If you get bored watching your money multiply, you could try passing up Birch just for fun. That should get some bull tinky flying.

[jpcavin]

JP,
I am very new at all of this. May I ask acouple of questions?
First, What is the difference between a Roth IRA and a TSP Roth? How would one go about getting into a "Roth IRA"?
I am getting ready to max out my TSP contributions and add the $5000 catch up but would also like to get involved in a Roth of some sort. I don't want to sit here everyday pulling my hair out about where to move my money, (TSP is enough already):)
My knowledge is too limited to trade with the big dogs as of now.
Any suggestions, comments?
Thanks in advance.

Lori (Bazinga)


Lori
There are way more qualified members of this board that can give you a better answer than I can. However, I'll give you my elementary anwer and hopefully someone else can elaborate and correct me if necessary. I am also new to investing :D

The TSP Roth and the regular TSP refers to the same 401k type account. The main difference is that the regular TSP contribution is pretax and the Roth TSP contributions are post tax. You can contribute to each as you see fit but your contributions cannot exceed $23,000 ($17,500 in regular TSP contributions
plus $5,500 in catch-up contributions) between the two TSP types combined.

A Roth IRA is in the same category as the traditional IRA exept that the traditional IRA is pre-tax and the Roth IRA is post-tax. Again, you can contribute to either one or both as you see fit but your contributions cannot exceed $6500 ($5,500 in regular contributions plus $1000 in catch-up conrtibutions) between the two IRA tyoes combined.

There are more rules with the Roth IRA based on your income, etc. that limit your contribution. I didn't cover those details but it is easily googled. :D

I have my Roth IRA account with USAA and it is a Self Directed IRA (SIDRA). I can invest in stocks, mutual funds, etfs, etc.. It's a bit limited but I am new to this so I don't need anything complicated. You can make a lot of money in the stock market but you can also lose your shorts if you don't know what you are doing. Study, study, study, use caution, and then study some more!

[dannyboy]

I am currently giving TSP 10% of my base pay.
Why not cut that down to 5% and get the full match? Leaving money on the table is hard to do. If you are in a non-match agency, "Active Duty"
" then start doing everythig you can to get out and find any agency in the government, that has potential for you. DOD is dying?

[Birchtree]

Just remember that the money in a defined benefit plan is not your money, only a promise to provide a benefit. It can be diddled with anytime.

[EricDeLee]

Just remember that the money in a defined benefit plan is not your money, only a promise to provide a benefit. It can be diddled with anytime.

Rewind here a second...
The money my spouse is throwing into her Defined Contripution plan isn't neccesarily hers?

And another question being that your spouse has a defined plan as well: Can she earn dividends, if she is using the Brokerage route?

[Birchtree]

You fully own your money in a defined contribution plan because you are responsible for the inherent risk of managing the money and benefit from any gains. My wife's defined contribution plan doesn't offer a brokerage plan as yet - but there has been mention of one - it would be purrfect to increase deferred income. The days of the defined benefit plan are numbered - thus the 401Ks and the need to be investment educated. Most people fear being responsible for their own retirement but that is the way forward. My daughter has an employer Roth 401K and is invested in three large cap funds that will grow very nicely over the next 25 years.

[Scout333]

Rewind here a second...
The money my spouse is throwing into her Defined Contripution plan isn't neccesarily hers?

And another question being that your spouse has a defined plan as well: Can she earn dividends, if she is using the Brokerage route?
I'll let BT speak for himself, but I think he means a defined benefit plan such as a pension promised by a company, etc. NOT a defined contribution plan such as a 401(k). Sounds like your wife has a 401(k) type plan. Her contributions should always be hers, but company matches are usually vested in over a period of time depending on the plan. For example, some plans vest in matches at 20% per year for five years. Sounds like you need to check into her plan so you and she understand how it works. Hope this helps!

[Birchtree]

Another beauty of a defined contribution plan is that you can name any heir or beneficiary that you want- it's your money. Defined benefit plan usually restrict beneficiares to a spouse. When the spouse is gone the pension is gone.

[EricDeLee]

Okay.. That makes sense. She is in a Defined Contribution. not a Defined benefit. So she's get her normal pension of around $3500 a month, as well as whatever she gets from the DC plan. So having the brokerage thing is a good thing. I am going to look at that and see where we can make some gains.

[Birchtree]

My wife is not required to take any money out of her defined contribution plan until the required minimum distribution age of 70 - that helps keep the AGI under control. You have to have built in flexibility to avoid some taxes when in retirement. I face the same issue in my TSP.

[DreamboatAnnie]

Pay 2 years of taxes in 1 year? Can you explain that a little further for me? My ability to itemize may be gone by this year, but certainly next.

States often have taxes due towards the end of the year and they sometimes allow payment into the following year without penalty. Here in Texas we have property taxes that are assessed in the Fall and you have until January 31 to pay without any penalty.

So for example, you can pay property taxes in Jan 2013 for 2012, and then in December 2013 you can pay the state tax for 2013. If you do that, you have just doubled up the amount of taxes paid in one calendar year and you can deduct it on your Federal tax return for that year because Federal tax returns are typically cash based for individuals. That tax double up might be enough to get you above the standard deduction so you can itemize and save more on your individual Federal taxes when you are just falling slightly under the std deductible amount and thus unable to itemize.

Then the next year you would pay 2014 taxes in Jan 2015. So calendar year 2014would have no real estate taxes and you would just use the std deduction. It just depends on where you are at in exceeding the standard deduction amount. Also during the year of double up, you might want to do more medical procedures if you are even close to exceeding the medical deductions threshold, or increase your charitable contributions, clothing and donations to goodwill, etc... And make sure to count your mileage for charity and doctor visits,etc