pay off mortgage early vs. other options

[porterboy]

Hi folks - Looking for some advice. We just bought a house and now have a 30 yr, $279k mortgage at 3.5%. We plan to be here long term. This is our only debt and we have an emergency fund. We make around $100k a year, with two kids in childcare ($1000 mo for the next three years, then this will decrease). We currently contribute $950/mo into my husbands 457 (no employer contribution) and my employer puts $450/mo into my 401k. My husband also has a state pension, which they contribute 22% of his salary; and he contributes 6%. We have no plans to retire early, but would like to have the flexibility in ~20 years (I'll be 55; him 59) when our kiddos are out of the house. We feel comfortable with the current state of our retirement savings. We'd like to have our house paid off in ~15 years so we have extra $ monthly to pay for college, if we decide we'd like to. Right now we have the flexibility to contribute an extra $475/mo into our mortgage - this will likely go up with salary increases through time. While we are stashing it monthly, our current plan is to do it as a lump payment of $5700 at the end of each year, should nothing change in our daily life (aka we have a job loss, crazy medical bills, etc). But, due to the low interest rate, I'm wondering if we'd be better off investing it and then using that $ to pay it off all at once once we hit that payoff amount (or keep it invested if we decide we'd rather not pay it off). We currently pay $43/mo in PMI; part of me wants to knock that out as soon as possible but it's so low that not sure it's really a priority. We love the idea of a paid off house, but I can't help to wonder if we're missing out on gains that would be better for us. If we decide to invest, what is our best option? Is it maxing his 457 (but then penalties to remove in ~15 years) or putting in our Roth IRA (we aren't currently contributing but did during grad school..also penalties?)? Or... I don't understand the tax implications of just opening a brokerage account and investing it all in a total market index fund and then pulling it when we want to. Would love some advice. Thanks!

[neo von retorch]

The advantage you have here is time.

https://www.thebalance.com/rolling-index-returns-1973-mid-2009-4061795

Over a 15 year period in the above time span, the S&P 500 has never had a negative return. That doesn't mean it can't. There are chances and the future hasn't been written yet. But looking backward, the odds are in your favor of getting better bang for your buck investing rather than paying towards a 3.5% mortgage.

As for tax implications, the worst case scenario under current (US) tax law is that money made in a taxable brokerage will lose 15% to capital gains tax. That is to say, if you invest $475/mo over the next 15 years and get 7% return after inflation, you'll have made about $63,000 but have paid at most $9450 in taxes. The net return on your investments will still be a pinch below 6% and well above 3.5%.

Overall at that point you'd have about $138,000 available to put towards college.

[Alternatepriorities]

One thing to consider when your kids get to college age is that investments in taxable accounts will be counted for calculating your expected family contribution but your primary residence and you retirement accounts won't. Personally I'd be inclined to contribute enough to either the 457 plan or 401k to avoid the 22% marginal bracket. It sounds like you may already be there. After that max out Roth IRAs before paying additional principle on the house. You can always withdraw the contributions you make (but not the capital gains) from your Roth penalty free if you decided you want to pay off the house later.

[Boofinator]

I'm sure someone will post a link to the investment order thread, but my short summary:

1) Max out all tax-advantaged savings (401k, 457, IRA, etc.) before paying off the mortgage or investing in taxable. These investments should be in index funds holding primarily equities (given your long timeframe). Prioritize the investments in the options that provide the lowest expense ratios. I would do traditional until you get below the 22% tax bracket; below that, it's kind of a toss-up between traditional and Roth.

2) After your tax-advantaged buckets have been completely filled, and if you still have leftover money to invest, still don't pay off your mortgage. Start a taxable brokerage account using the same basic index fund / low expense strategy. If you're below the 22% tax bracket, this is fairly similar to a Roth in that you won't pay taxes on dividends or long-term capital gains (should you need to pull out some money every once in a while).

3) Long in the future (talking decades), it may make sense to pay off the mortgage rather than to continue to invest. The two triggers that you should consider in this decision are 1) closing in on retirement or 2) children starting college.

[nereo]

... well if you insist :-)
https://forum.mrmoneymustache.com/investor-alley/investment-order/msg1333153/#msg1333153

[Valhalla]

I'm sure someone will post a link to the investment order thread, but my short summary:

1) Max out all tax-advantaged savings (401k, 457, IRA, etc.) before paying off the mortgage or investing in taxable. These investments should be in index funds holding primarily equities (given your long timeframe). Prioritize the investments in the options that provide the lowest expense ratios. I would do traditional until you get below the 22% tax bracket; below that, it's kind of a toss-up between traditional and Roth.

2) After your tax-advantaged buckets have been completely filled, and if you still have leftover money to invest, still don't pay off your mortgage. Start a taxable brokerage account using the same basic index fund / low expense strategy. If you're below the 22% tax bracket, this is fairly similar to a Roth in that you won't pay taxes on dividends or long-term capital gains (should you need to pull out some money every once in a while).

3) Long in the future (talking decades), it may make sense to pay off the mortgage rather than to continue to invest. The two triggers that you should consider in this decision are 1) closing in on retirement or 2) children starting college.

Awesome stuff.

... well if you insist :-)
https://forum.mrmoneymustache.com/investor-alley/investment-order/msg1333153/#msg1333153

tagged for future.

[Calvawt]

Another thing to note is that a 457 plan, while tax advantaged, is not a retirement plan.  It is really a deferred compensation plan.  Once you leave that company (unless you go to another one with a 457 plan also) you have to choose how to get it paid out.  There are no 10% withdrawal penalties because you get access when you leave the employer.

For example, since mine is not a government 457 plan, it can't be rolled over into an IRA or anything like that.  While i paid the SS and Medicare taxes already, once it is distributed to me i pay the income tax.  In my plan, I can only get it in one lump sum (but i can at least try to push the date out a bit to another calendar year).

It still lets you delay the taxes and invest for several years.

That being said, if its a governmental 457 plan there are some differences and I don't know those very well. 

[Adam Zapple]

I get the desire to be debt free, but read the links posted above regarding which accounts to fund first.  Focus on building wealth, not some cash flow issue 15 years out.  There are several ways to pay for college... student loans, second mortgage, scholarships etc.  Don't make a poor investment choice for the next 15 years based solely on wanting to pay this expense.  Funding a 529 would be a better choice if you are hell bent on sacrificing your own financial future for the sake of your children's education.  You'd likely have double the amount saved in 15 years vs. interest savings on your mortgage going this route and earning a 7% return.