I have this correct now?
Good. It looks like you understood the concept, but you don't have to wait 18 years to benefit from the mortgage payments if we assume that your portfolio grows at a constant 4% per year (which we already assumed by using the 4% rule).
In the math below I'm going to draw monthly from net worth instead of drawing yearly from investment accounts only and dividing the income by 12 months, so my numbers won't quite match what you figured above. To do this I will multiply the present value of all accounts by the monthly effective discount rate. I will use the discount rate instead of the interest rate since the first payment occurs today, not one month from now. The monthly effective discount rate can be calculated from the monthly effective interest rate, i = 0.3274%, from my post above with the formula d = i/(1+i) = .003274/(1.003274) = 0.3263%.
Option 2 (pay the mortgage off immediately): This will transfer $104,500 from our investment account to the mortgage leaving us with a present value of $586,000. Multiplying the monthly effective discount rate by our present value gives us a monthly payment of $586,000*.003263 = $1,912.15 for life.
Option 1 (pay the mortgage off in $626 monthly installments with a smaller last payment): To smooth out our living expenses, we need to figure out the present value of our mortgage payments and subtract that amount from the value of the house plus the amount in the investment accounts. I already showed the math to calculate the present value of the mortgage payments above, but this time I'm going to assume that our first payment is today (whereas the above calculation assumed that the first payment was one month from now) to get a present value of $95,276.13. Subtracting that from the value of the house plus the value of the investments, we get PV = $540,000+$150,500-$95,276.13 = $595,223.87. Multiplying the monthly effective discount rate by our present value gives us a monthly payment of $595,223.87*.003263 = $1,942.24 for life. Note that this is just the extra amount you get every month on top of the mortgage payments. When the mortgage payments stop, you still get $1,942.24 every month. That's about $30 extra in spending money every month for life.
Remember, this is just the value of each option weighted by our assumed 4% interest rate. I cannot account for individual risk/debt tolerance and I have not accounted for the tax implications of each option, since I am unfamiliar with your tax situation, with this math.
I've attached a spreadsheet that illustrates this concept. The whole thing is driven off of the grey cells at the top left of the spreadsheet, so changing the grey cells will allow you model different situations. Here's a link to the Google Docs version for those without Excel or those who don't like to download things from anonymous internet people:
https://docs.google.com/spreadsheet/ccc?key=0AoGy5FAuORHndF9xVW5RWFF4X3dCM0VZV2IyXzBFZ2c&usp=sharingNote that this spreadsheet is for illustrative, comparative purposes only and should not be utilized for actual financial planning without understanding all underlying assumptions of the model.Tl;dr continuing to pay the mortgage on schedule can result in $30 extra every month for life under the assumptions of the original post.