Author Topic: Crazy shell game...or good idea?  (Read 3127 times)

MarciaB

  • Bristles
  • ***
  • Posts: 469
  • Age: 57
  • Location: Oregon
Crazy shell game...or good idea?
« on: May 10, 2014, 09:08:27 PM »
I’d appreciate some help thinking through a potential scheme, it’s got three moving parts. For the sake of simplicity (and because I’d like to think through the concepts involved) I’m going to leave off the numbers for now.
Here are a few pieces of information:

1)   I have income-producing rural investment property that is 44 acres and has a mortgage at 5.75%. Because this property is this size, I have had no luck at all with refinancing it at a lower rate (despite trying continually over the past 5 years). The only people who do mortgages with rural property of this size are the ones who currently hold the mortgage (and they’re not dropping the rate, despite my frequent begging inquiries). The property has a vineyard and a house, both of which are leased out. The lease money all goes to covering operating costs and debt service.
2)   Looking at my statements for my Roth Ira at Vanguard I see that the contributions I made over the last decade are coincidently just about the same amount as the remaining principal on the mortgage.
3)   I am a public employee (in the US) and participate in the 403(b) deferred compensation plan (the public servant’s equivalent of a 401(k), there is no employer match); I don’t contribute the maximum amount at this point (because I’m focused on paying down this $$#!! mortgage as part of my “savings”…I hate debt like the Hatfields hate the McCoys).

Scheme – here’s what I’m thinking I might do?
•   Withdraw the contributions made from the Roth IRA and pay off the mortgage.
•   And to make up for the “hole” in the retirement account, I would increase the 403(b) contributions to the max this year (and in     future years).

Consequences:
•   Are there tax consequences to withdrawing Roth contributions? (I don’t think so, but I’m checking assumptions).
•   Retirement funds would be replaced, but would be pre-tax instead of the Roth they are now. At this point 40% of my retirement is pre-tax and 60% is Roth. By playing this shell game I would shift that balance. My thinking is that at FIRE (3-5 years from now) I would have very little income and could do the Roth conversions at the capital gains rate of 0%.
•   My paycheck would be drastically reduced (due to the greatly increased 403(b) contributions) but any shortfall could be made up from the leases on the investment property. My savings rate is over 40% now, so the reduced paycheck would require me to use only about a third of the net leases, the rest would go towards investment - now that it isn't all going to debt service).

Am I crazy? And what am I not considering? Please shoot holes in this, and/or give me some directional feedback.

MDM

  • Walrus Stache
  • *******
  • Posts: 9244
Re: Crazy shell game...or good idea?
« Reply #1 on: May 11, 2014, 12:06:58 AM »
Not crazy if you do, and not crazy if you don't.  Getting a 5.75% return by paying the mortgage is less than what you might expect in the stock market, but it is completely risk free.  One can make a good case either way, and only with hindsight will you know if you were "correct".

Careful about the statement "...could do the Roth conversions at the capital gains rate of 0%."  These conversions are taxed as ordinary income, not capital gains - e.g. see http://www.bankrate.com/finance/money-guides/take-tax-control-of-your-ira-conversion-1.aspx.

The main downside seems the loss of future tax-free investment returns if you withdraw your Roth contributions.  That would bother me - but that's me, so if the unpaid mortgage bothers you more...again, a case can be made either way.

The Happy Philosopher

  • Bristles
  • ***
  • Posts: 343
    • thehappyphilosopher
Re: Crazy shell game...or good idea?
« Reply #2 on: May 11, 2014, 12:42:03 AM »
No right or wrong answer in my book but I'll give you some things to ponder.

1. Your money in the Roth is liquid (relatively) and could be accessed in an emergency.  This is not true of investment real estate.  Once you pay it off there is no easy way to pull money back out.  Selling the property may take time and likely has a large transactional cost.  Since you can pull out Roth principal penalty free it really acts like an emergency fund.  I know more than 1 person dumping cash into paying off real estate and regretting it later when they needed the money due to unemployment, etc.  If bad stuff happens you can walk away from the property and still have your Roth IRA.  Paying down a mortgage is not risk free return, you can always have loss of principal and there is liquidity risk which is hard put a value on - it's different for everyone.
2. If you are going to drain your retirement accounts to pay it off, pay the whole thing off.  You don't want the liability of a mortgage payment AND no emergency fund, you are introducing risk here for no good reason.
3. If you have good options in the 403 don't forget to consider the tax benefits.  By investing tax free money the 5.75% note you are paying off is effectively a lower rate. (ie: in a 25% tax bracket investing $1000 in a 403b saves you $250 in taxes.  If instead you decide you will pay down debt with this money you first have to use $250 to pay taxes and really only have $750 left to pay down debt).  Crappy funds in a 403b can negate much of this benefit, you have to do the math.

If it were me I would probably max the 403b, then pay off debt.

marty998

  • Walrus Stache
  • *******
  • Posts: 6188
  • Location: Sydney, Oz
Re: Crazy shell game...or good idea?
« Reply #3 on: May 11, 2014, 04:54:24 AM »
1)   I have income-producing rural investment property that is 44 acres and has a mortgage at 5.75%. Because this property is this size, I have had no luck at all with refinancing it at a lower rate (despite trying continually over the past 5 years). The only people who do mortgages with rural property of this size are the ones who currently hold the mortgage (and they’re not dropping the rate, despite my frequent begging inquiries). The property has a vineyard and a house, both of which are leased out. The lease money all goes to covering operating costs and debt service.

Don't confuse returns on investment with returns on equity. It's likely you will do much worse overall replacing your debt with equity if you do have an income producing business.

Not all debt is bad. You can leave the debt in place, and contribute more to your retirement accounts.

Catbert

  • Handlebar Stache
  • *****
  • Posts: 1655
  • Location: Southern California
Re: Crazy shell game...or good idea?
« Reply #4 on: May 11, 2014, 10:57:31 AM »
I'm with the others...not a clear right or wrong strategy.  In addition to the things others have mentioned:

-I'd play with tax software a bit.  You'd lose mortgage interest deduction but gain 403b deduction.  OTOH you'd have tax to pay later when money comes out of 403b.  Depending on your overall situation you might gain some deductions that you were previously limited on because of your income. 

-Pensions and 401Ks are judgment proof (witness O.J. Simpson).  IRAs may or may not be (I think), depending on the state.  Not sure about 403b's.  If "something bad" happens you'd be better off with you funds in retirement accounts.


phred

  • Pencil Stache
  • ****
  • Posts: 506
Re: Crazy shell game...or good idea?
« Reply #5 on: May 11, 2014, 11:21:32 AM »
What operating costs do you have on this rural property?  Does the vineyard cover the entire 44 acres less the plot for the house?
You do take depreciation on the house, and speedier depreciation on the house fixtures, rugs, etc?  Ditto for depreciation and amortization on the vineyard?

Is title for the house separate from title for the vineyard?  If so, you may be able get a bank to refinance the house.
If some of the land is not in production, and is "far" from the house, you may be able to lease out a couple of two to three acre improved  sites for a mobile home

MarciaB

  • Bristles
  • ***
  • Posts: 469
  • Age: 57
  • Location: Oregon
Re: Crazy shell game...or good idea?
« Reply #6 on: May 11, 2014, 12:33:07 PM »
Thank you all for the suggestions and good questions. And I appreciate the correction on the taxation issues of Roth conversions. All ya'll are a very smart bunch!

Phred - land use laws in my state (Oregon) and the zoning involved, are such that the house/vineyard/land are all on one title and can't be subdivided. Banks lump the whole shebang into one big pile and cross their arms and say no to a refi. Vineyard is pretty much depreciated out. House is 3 years into a straight-line 27.5 year depreciation schedule. Operating costs (plus contingency fund) are about 25% of total leases.

Again, thanks for all the good help with this I will be meeting with my accountant soon and am feeling much better prepared to have this conversation with her.