Contribute to 403b or pay down/off mortgage in this situation?

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mesaverde
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Contribute to 403b or pay down/off mortgage in this situation?

Post by mesaverde »

I’m 47, single, a teacher, and plan on retiring at age 55.

Currently I’m maxing out a 457b and 403b with Fidelity. Maxing these accounts out puts me in the lower end of the 22% federal income tax bracket (my taxable income last year was $43k).
Because I’m maxing both of these out I’m only paying the 22% rate on ~$3,500 of my income. I’ll be able to draw from both the 457b and 403b penalty free starting at age 55.

I’m also maxing out a Roth IRA with Vanguard.

I have a 30 year fixed rate mortgage at 3.5% with 29 years remaining. Manageable P&I because I made a 50% down payment.

I’m debating whether to stop contributing to the 403b (because it’s less flexible in regard to penalty-free withdrawals compared to the 457b) and pay down the mortgage instead. By my calculation I’d have the mortgage paid off soon after age 55 if I do this.

When I retire at age 55 I’m 99.9% sure I’ll be in the (current) 12% federal income tax bracket with a taxable income of approx. $39k. That’s even if I still have the mortgage. So it seems to make sense to max both the 457b and 403b out now to keep my taxable income low… it’s essentially a guaranteed 10% return (in federal income tax savings) plus any investment earnings.

Am I missing anything here? Does this strategy make sense? Any feedback would be much appreciated!
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lakpr
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by lakpr »

You are right on the money there, and what I would suggest for someone in your position.

Here is a thought you may not have considered. If your taxable income is $43k, your AGI is about $55k. This is an income where, if you choose to, the Traditional IRA contribution is fully deductible.

You may want to consider making $3500 contribution to Traditional IRA, then make the remainder $2500 to Roth IRA. This guarantees that even those last few dollars will escape 22% tax bracket. You may then further think about rolling the Traditional IRA back to Fidelity 403b; Fidelity usually accepts rollover from Traditional IRA into 403b. Or leave the money be within the tIRA too. The advantage of rolling to 403b is that you will be able to access it at age 55, in IRA it is locked up till age 59.5
retiredjg
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by retiredjg »

Do you expect a pension?

What is the approximate value of your tax-deferred accounts now?
KlangFool
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by KlangFool »

mesaverde wrote: Thu Apr 30, 2020 5:36 pm
I have a 30 year fixed rate mortgage at 3.5% with 29 years remaining. Manageable P&I because I made a 50% down payment.
mesaverde,

1) Why would you want to pay 20+% taxes in order to save 3.5% interest?

2) You do not need the money from 403B until after you used up all your 457's money.

3) In this time, you want as much money in your own pocket as opposed to paying taxes.

4) There is no penalty to withdraw money from 457B at any time.

KlangFool
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mesaverde
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by mesaverde »

lakpr wrote: Thu Apr 30, 2020 5:49 pm You are right on the money there, and what I would suggest for someone in your position.

Here is a thought you may not have considered. If your taxable income is $43k, your AGI is about $55k. This is an income where, if you choose to, the Traditional IRA contribution is fully deductible.

You may want to consider making $3500 contribution to Traditional IRA, then make the remainder $2500 to Roth IRA. This guarantees that even those last few dollars will escape 22% tax bracket. You may then further think about rolling the Traditional IRA back to Fidelity 403b; Fidelity usually accepts rollover from Traditional IRA into 403b. Or leave the money be within the tIRA too. The advantage of rolling to 403b is that you will be able to access it at age 55, in IRA it is locked up till age 59.5
Thank you for the suggestion of contributing to the Trad. IRA instead of the Roth. Definitely something to look at/consider for even more tax savings.
Last edited by mesaverde on Thu Apr 30, 2020 6:27 pm, edited 1 time in total.
"Learn from the past, live in the present, plan for the future"
Topic Author
mesaverde
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by mesaverde »

retiredjg wrote: Thu Apr 30, 2020 5:55 pm Do you expect a pension?

What is the approximate value of your tax-deferred accounts now?
I will have two pensions starting at age 65. Those pensions will provide most of my income at that point (social security icing on the cake).
So the idea is that the 457b and 403b will act as a "bridge" from age 55 to 65.
Last edited by mesaverde on Thu Apr 30, 2020 9:24 pm, edited 1 time in total.
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Ron Ronnerson
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by Ron Ronnerson »

I like your plan. I’m a teacher too; age 45, single-income household, and also maxing out my 403b and 457b. If you think you will be in a lower tax bracket later, I think you should continue to do just as you have been. Personally, I consider the 22% bracket to be high and do what I can to avoid it.

I’m 8 years into paying off my 30-year mortgage with a rate of 3.25%. Similarly to you, I also have over 50% equity in the house. Currently, I am looking to refinance my loan and start the 30 years over again to take advantage of the low rates that exist these days. My plan is to keep expenses as low as possible and maintain that for the long term. Like you, pension income and social security later on should help meet our basic needs and that takes away some of the pressure to pay off the house before retiring. At a low enough rate, I wouldn’t be in a big hurry to pay off a debt.
Topic Author
mesaverde
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by mesaverde »

Ron Ronnerson wrote: Thu Apr 30, 2020 6:35 pm Personally, I consider the 22% bracket to be high and do what I can to avoid it.
Agreed. 22% is quite a jump from 12% even though only a portion of one's income is taxed at that higher rate.
10% more saved/invested instead of 10% more to the federal government. So staying within the 12% bracket makes complete sense.
I've also noticed that there's a significant health insurance premium discount (from healthcare.gov) if one is within the 12% bracket... another added bonus if one plans to retire "early".
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grabiner
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by grabiner »

KlangFool wrote: Thu Apr 30, 2020 6:00 pm
mesaverde wrote: Thu Apr 30, 2020 5:36 pm
I have a 30 year fixed rate mortgage at 3.5% with 29 years remaining. Manageable P&I because I made a 50% down payment.
1) Why would you want to pay 20+% taxes in order to save 3.5% interest?
This is not the right comparison, for several reasons.

The most important reason is that the tax difference is a one-time cost, while the compound interest is an annual benefit; it would make sense to pay 22% this year to save 3.5% per year for more than six years if that were the only issue.

A second issue is that the tax benefit is 13%, not 22%; if you contribute $1000 to the 403(b), you pay $780 out of pocket, but you only receive the growth on $880 because you pay 12% tax when you withdraw.

But working the other way, equally important, is that you don't really save 3.5% interest by paying down the mortgage. If you put money in the 403(b), you pay 3.5% interest on the mortgage, but you can invest the money in a bond fund which pays some interest.

And it is that last argument that is the reason I would advise not paying it down, assuming you have low-cost options in the 403(b). Vanguard Long-Term Bond Index yields 2.44%, and has a shorter duration than the mortgage; you are probably losing only half a percent annually by investing in bonds at the same risk level (if you refinance to 15 years at 3%, the durations are close and the spread is 0.56%), and the tax advantage of the 403(b) outweighs that.

If your 403(b) is with TIAA, that gives an even stronger argument to invest in it; you can invest in TIAA Traditional Annuity for a guaranteed 3%, and you don't care about the lack of inflation protection since you are using this to cover a fixed-dollar future expense.
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retiredjg
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by retiredjg »

mesaverde wrote: Sat May 02, 2020 11:19 am
Ron Ronnerson wrote: Thu Apr 30, 2020 6:35 pm Personally, I consider the 22% bracket to be high and do what I can to avoid it.
Agreed. 22% is quite a jump from 12% even though only a portion of one's income is taxed at that higher rate.
10% more saved/invested instead of 10% more to the federal government. So staying within the 12% bracket makes complete sense.
I've also noticed that there's a significant health insurance premium discount (from healthcare.gov) if one is within the 12% bracket... another added bonus if one plans to retire "early".
Something to consider....it's pretty easy for a couple to be in the 12% tax bracket. And not so hard to avoid the 22% bracket even if doing some Roth conversions.

The same is not true for singles. A single with a pension....even doubly so.
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FiveK
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Re: Contribute to 403b or pay down/off mortgage in this situation?

Post by FiveK »

mesaverde wrote: Thu Apr 30, 2020 6:07 pm I will have two pensions starting at age 65. Those pensions will provide most of my income at that point (social security icing on the cake).
So the idea is that the 457b and 403b will act as a "bridge" from age 55 to 65.
If the tax law is at all similar to today's, you may want to do Roth conversions in the age 55-65 years, at least to and maybe through the bracket you will be in when pension and SS start. Just a thought to file away for future reference.
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