{"id":740,"date":"2013-02-24T22:28:36","date_gmt":"2013-02-25T03:28:36","guid":{"rendered":"http:\/\/jlg.name\/blog\/?p=740"},"modified":"2013-02-25T10:21:47","modified_gmt":"2013-02-25T15:21:47","slug":"nondeductible-ira-contribution-or-mortgage-prepayment","status":"publish","type":"post","link":"http:\/\/jlg.name\/blog\/2013\/02\/nondeductible-ira-contribution-or-mortgage-prepayment\/","title":{"rendered":"Nondeductible IRA contribution or mortgage prepayment?"},"content":{"rendered":"<p>Having just filed our 2012 taxes, I&#8217;m pondering an interesting question. \u00a0Over the past year I set aside $5,000 that I&#8217;d planned to put into a traditional IRA as a nondeductible (after-tax) contribution. \u00a0It occurs to me that I could instead use the money as a principal prepayment on our mortgage. \u00a0The question is: \u00a0<strong>Should I?<\/strong><\/p>\n<p>[The IRA contribution is nondeductible\u00a0because I participated in my company&#8217;s 401(k) plan in 2012. \u00a0As a result I am not eligible to deduct my IRA contributions from our federal taxes. \u00a0<a href=\"http:\/\/www.irs.gov\/instructions\/i1040\/ar01.html#d0e5390\">As the IRS explains<\/a>: <em>&#8220;If you were covered by a retirement plan (qualified pension, profit-sharing (including 401(k)), annuity, SEP, SIMPLE, etc.) at work or through self-employment, your IRA deduction may be reduced or eliminated. But you can still make contributions to an IRA even if you cannot deduct them.&#8221;<\/em>]<\/p>\n<p>If every year I chose $5,000 mortgage prepayments over nondeductible IRA contributions, then:<\/p>\n<p>Advantages:<\/p>\n<ul>\n<li><strong>Faster payoff. \u00a0<\/strong>We would pay off the mortgage in 20 years (or fewer) instead of 30.<\/li>\n<li><strong>Less interest. \u00a0<\/strong>We would save at least $75,000 in interest payments over the life of the loan.<\/li>\n<li><strong>Zero risk. \u00a0<\/strong>Each prepayment would yield a guaranteed return of 3.625%\/year (our mortgage rate) through 2042.<\/li>\n<li><strong>More equity. \u00a0<\/strong>We would have more equity in the house if we decide to sell (if we move or &#8220;trade up&#8221;) or if we need to do a cash-out refinance.<\/li>\n<\/ul>\n<p>Disadvantages:<\/p>\n<ul>\n<li><strong>Underfunding retirement? \u00a0<\/strong>We\u00a0would be reducing our retirement savings. \u00a0(However, during years 21-30 we could pay ourselves &#8220;mortgage payments&#8221; directly into our retirement savings. \u00a0If we are disciplined about it, those payments would make up much of the difference.)<\/li>\n<li><b>Tax deferral. \u00a0<\/b>The prepayment wouldn&#8217;t experience tax-deferred growth as it would in an IRA.<\/li>\n<li><strong>Lower returns? \u00a0<\/strong>There&#8217;s the chance that an IRA would grow in value significantly more than 3.625%\/year. \u00a0Additionally, the IRA would continue to grow (or shrink) in value until withdrawn (or until we die, I suppose), whereas a prepayment&#8217;s &#8220;zero-risk return&#8221; ends when the 30-year mortgage term ends.<\/li>\n<li><strong>Inflation hedge. \u00a0<\/strong>If the dollar experiences <a href=\"http:\/\/www.bankrate.com\/finance\/investing\/winners-and-losers-if-inflation-skyrockets-1.aspx\">high inflation<\/a>\u00a0in the next few years, we&#8217;d be better off if we were carrying lots of debt (i.e., a high mortgage balance).<\/li>\n<\/ul>\n<p>Either way I wouldn&#8217;t be putting all of our retirement eggs into one basket, in that I&#8217;m already making contributions to a 401(k) retirement plan. \u00a0(By the way, the best answer I&#8217;ve found to <i>how much should I save for retirement?<\/i>\u00a0is in\u00a0<a href=\"http:\/\/www.schwab.com\/public\/schwab\/resource_center\/expert_insight\/retirement_strategies\/planning\/how_much_should_you_save_for_retirement_play_the_percentages.html\">Rande Spiegelman&#8217;s article &#8220;Play the Percentages&#8221;<\/a>.)<\/p>\n<p>Two things made me start thinking about this trade-off between mortgages and nondeductable IRAs:<\/p>\n<ol>\n<li>the notion that both are illiquid ways to invest for retirement, and<\/li>\n<li><a href=\"http:\/\/www.mtgprofessor.com\/A%20-%20Early%20Payoff\/Potential%20Interest%20Savings%20on%20Your%20Current%20Mortgage.html\">this Mortgage Professor article about mortgage repayment as a long-term investment<\/a>.<\/li>\n<\/ol>\n<p>The Professor addresses a similar question in his article\u00a0<a href=\"http:\/\/www.mtgprofessor.com\/A%20-%20Early%20Payoff\/repay_mortgage_or_invest_in_roth_ira.htm\"><em>Roth<\/em> IRA contributions vs. mortgage prepayment<\/a>. \u00a0(My question is about <em>traditional<\/em> IRAs.) \u00a0The only other relevant advice I&#8217;ve found so far is in\u00a0<a href=\"http:\/\/www.nber.org\/papers\/w12502\">this paper comparing mortgage prepayment with\u00a0<i>pre-tax<\/i>\u00a0retirement contributions<\/a>. \u00a0(My question is about\u00a0<em>nondeductible<\/em>\u00a0traditional IRAs.)<\/p>\n<p>Until this year my strategy for retirement investing has been:<\/p>\n<ol>\n<li>If you have a 401(k) (or similar) plan with company matching contributions, first make contributions up to the company match. \u00a0(For example, if your company matches up to $3,000 of contributions then put your first $3,000 into the 401(k).)<\/li>\n<li>Next, make contributions to a Roth IRA up to the maximum allowable amount.<\/li>\n<li>Next, max out your pre-tax contributions to the 401(k).<\/li>\n<li>Next, make deductible contributions to a traditional IRA up to the maximum allowable amount.<\/li>\n<li>Next, make nondeductible contributions to a traditional IRA up to the maximum allowable amount.<\/li>\n<\/ol>\n<p>So the conundrum is whether I should replace step 5 (or even step 4) with &#8220;Next, make prepayments against your mortgage principal.&#8221; \u00a0Arguably I have until April 15 to decide, although if I choose prepayment then every month&#8217;s delay costs me $500 more in interest paid over the life of the loan.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Having just filed our 2012 taxes, I&#8217;m pondering an interesting question. \u00a0Over the past year I set aside $5,000 that I&#8217;d planned to put into a traditional IRA as a nondeductible (after-tax) contribution. \u00a0It occurs to me that I could instead use the money as a principal prepayment on our mortgage. \u00a0The question is: \u00a0Should [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[6],"tags":[],"_links":{"self":[{"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/posts\/740"}],"collection":[{"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/comments?post=740"}],"version-history":[{"count":10,"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/posts\/740\/revisions"}],"predecessor-version":[{"id":805,"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/posts\/740\/revisions\/805"}],"wp:attachment":[{"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/media?parent=740"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/categories?post=740"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/jlg.name\/blog\/wp-json\/wp\/v2\/tags?post=740"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}