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By Suze Orman
MARC ROYCE
I am retired and live on Social Security of
$2,159 per month and a private disability
paymentof$2,970. Thatdisabilitypayment
stops in April 2012. I want to reduce my
monthly expense to be able to live on
Social Security.
I have a 401(k) worth about $150,000. My
mortgage is about $150,000, and at 5.875
percent costs about $1,475 per month. My
thought is to pay off the mortgage in three
installments of $50,000, thus avoiding tax on
the distribution. I can shelter a large part of
the tax liability with deductions.
Should I pay off the mortgage?
D. P.
Rancho Mirage, CA
WHILE I TOTALLY understand your objective here,
I am afraid it may not work the way that you think.
If you are going to take $50,000 a year out as a distribution, I just want to be clear that there is no way to
totally avoid tax on the distribution; all 401(k) withdrawals are taxed at your ordinary income-tax rate.
I know you hope to offset that taxable income
with deductions, but make sure you have checked
with a CPA and that you know exactly what your tax
bite is going to be. I have a feeling that you may not
have as much left after taxes as you think, and therefore it may not make sense to do this.
Here’s another possible strategy: Given that you
have only about $150,000 left on your mortgage, you
might want to try to refinance into a 30-year mortgage; if you qualify for a 5 percent rate your payment
would be about $800. If you keep the $150,000 in
your 401(k) and invest conservatively, I think you
could earn 4 percent a year. That would generate
about $500 a month in income; after paying tax you
might have $400 to $425 or so. That covers at least
half the mortgage. Then you could tap just some of
your Social Security payment to cover the rest.
I am 69, still working but receiving about
$21,000 per year in Social Security, and I pay
myself $12,000 per year from my self-employed business. I am debt-free except for
my home mortgage, which is $53,000. I have
a money market account with my bank with
a balance of just over $102,000, which is pay-
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ing only 2. 5 percent interest. Would it be to
my advantage to pay off my mortgage with
the money market account to rid myself of
the mortgage payment, which is costing
me 5. 9 percent, and rebuild my money market account back up by paying my monthly
mortgage amount into it?
D.K.
Plano, TX
HEY, 2. 5 PERCENT is actually pretty good right
now; it’s about double the national rate for bank
money market accounts. And inflation is close to
zero, so the “real” return of your money market is
actually better than if you were earning 5 percent
interest and inflation was at 3 percent.
But I totally hear you on wanting to make the
most of your money right now. If you intend to stay
in that home, then using half of your savings to pay
off the mortgage makes a lot of sense. But I just
want to make sure that other readers understand
that it makes no sense to use all of your savings to
pay off a mortgage.
I have always stressed the importance of an
emergency cash fund; in the midst of this financial
crisis it is doubly important to have money you can
tap in a pinch. You can’t rely on your credit card, as
the credit-card industry is aggressively cutting credit
limits and closing down accounts. Nor are home
equity lines of credit a viable cash source for many
people. Everyone needs a cash account; eight months
of living expenses is my recommended target.
Please don’t use up all your emergency savings,
no matter what.
I am 53 years old, have a 401(k) with my
employer and put away 10 percent weekly
toward this account. Should I drop it to 5
percent and use the extra money as an additional payment on my car loan every month,
or put it away in my savings account?
Maria Leonblez
Via e-mail
IDEALLY YOU SHOULD invest up to the point of
the employer match in your 401(k), which is usually
about 6 percent of your base pay. So I would keep
contributing so you get the maximum employer
match. Then, with the extra money that will show
up in your paycheck, you can tackle other goals.
Paying off the car is smart, but if you have less
than an eight-month emergency savings fund I
want you to use half of your extra money each
month to build up your savings too. C
