Roth IRA vs. mortgage

Mom987 · December 2013

So I mentioned to DH that I wanted to start maxing out my Roth IRA and open one for him to start working on [I make 6% work 401(k) and he makes 9% work 401(k), these include the employer contribution], which comes out to a very similar dollar amount/year. He tends to think we should either increase our 401(k) or pay down the mortgage, rather than increasing the Roth IRA. This is the first night I've mentioned it, and he said he wants to do more research (we're both very math-oriented), but just thought I'd see your thoughts? Thanks!!!

maple2 · December 2013

I think the common advice for retirement is to first invest in your 401k at the level necessary to get any employer match then switch to Roth IRAs then consider doing more in your 401k if you still have money left to invest. Roth investments are usually considered a better option for young people because all the interest you earn grows tax free. For a Roth, you pay taxes on the money you earn and invest in the year you earn it, but you never have to pay taxes on the interest that accrues. Non-Roth 401ks allow you claim a tax deduction on the money you earn and invest in a given year, which gives you a tax break at that point in time. When you withdraw funds, however, you have to pay interest on both the principle and the interest.

In terms of retirement versus mortgage, this is going to depend on your personal philosophy about debt and comfort with market volatility as well as your mortgage rate. Our mortgage currently has around a 4% interest rate, which is lower than the returns the market has historically produced. We have decided to focus on retirement and other investments rather than paying extra toward the mortgage because we believe we will get more than a 4% return on that investment, which makes it a better use of our money in the long run. Lots of other people prefer to focus on paying off a mortgage because they feel more comfortable without debt or because they believe money invested in their house will be more secure than money invested in the market.

YellowTulips521 · December 2013

We are having a similar discussion right now. I believe (but am not sure) that there are maximum income requirements for having both a Roth 401k and Roth IRA. I am waiting to hear back from our tax accountant on this, so you might check with yours as well. If you are maxing out your employer contributions and want to diversify even more, I see no harm in putting more in your IRA.

As far as paying down on the mortgage instead of contributing more to your retirement - that is up to you, but I would focus more on retirement, especially if your mortgage rate is low. The more you invest at a younger age, the higher your returns will be.

maple2 · December 2013

Here is information on the income limits and contribution limits for for Roth IRAs
http://www.irs.gov/publications/p590/ch02.html

As pp alluded to, you cannot make a Roth IRA contribution if your joint income exceeds $183,000. I assumed that was not the case in making my previous recommendation, but if you do make that much or more then a Roth IRA is not for you. You could still make contributions to a traditional IRA, but I am not as clear on the tradeoffs between a traditional IRA and a non-Roth 401k.

Here is information on the contribution limits for 401ks
http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics---401(k)-and-Profit-Sharing-Plan-Contribution-Limits

This does not specifically address Roth 401k plans, but since you did not mention that your 401k had a Roth option, I assumed it did not.

jtmh2012 · December 2013

Also, remember that IRA/401k vs mortgage isn't an all or either proposition. If you have extra money, you can put part of it toward the mortgage and part of it toward the 401k/Roth.

My financial advisor told me the following:

401k up to your employeer match

Roth IRA after that

My "extra" mortgage payment actually goes into a mutual fund. The market is returning more than the interest rate I'm paying on the loan. When the mortgage payoff meets the amount in the account, I can just keep paying the mortgage, use it to payoff the mortgage, or use the money to make the payments.

Ducktale · December 2013

maple2 said:

In terms of retirement versus mortgage, this is going to depend on your personal philosophy about debt and comfort with market volatility as well as your mortgage rate.

This exactly. Depending on your interest rate (which is hopefully pretty low considering where they've been at the last few years), your retirement will most likely earn more in the long run than you will pay interest on your mortgage. So as long as you have comfortable payments and are okay with that debt, I'd say go with retirement. We currently have a 15 year, and we're not overpaying a dime on our mortgage because we think that money can be more useful in other ways, like retirement.

That said, we threw tons of extra money towards our student loans, although in theory we should have gone with this same concept (the interest rate was lower than the gains we could make elsewhere) but getting rid of that monthly payment altogether was important for our goal of me being a SAHM. We needed our monthly expenses reduced when that time comes. So that's where the personal comfort/preference may override the math for some.

Mom987 · December 2013

Thanks for your responses, everyone! We are 26 and 28, so young, IMO. 4.5% mortgage interest rate, we are 3 years into our 30 year, but we've been really paying down principal so we've paid down about 9 years worth so far.

hoffse · December 2013

I agree with Maple:

1) 401(k) up to employer match - and see if your employer will match a Roth 401(k) - because some will.

2) Roth IRA until they are maxed out

3) Then everything else in a 401(k).

If you have a low interest rate mortgage, you really shouldn't pay it off early mathematically - but some people have bad feelings about all kinds of debt. Student loans are the same way. I will say that generally I'm much more inclined to pre-pay student loans because they can't be discharged in bankruptcy. H and I also have student loans that will probably be twice as much as any mortgage we acquire in the next year, so we will pre-pay those just to get them out of our lives. H jokes that after our loans are done is when we should buy a vacation house - since it would probably be less than our student loans as well.

hoffse · December 2013

OP, the reason you want to do Roth accounts instead of regular 401(k) accounts (after the employer match) is because of taxes.

You do get a deduction for a regular 401(k) contribution, but that's not a dollar-for-dollar savings... and then when you retire you have to pay taxes on both your initial 401(k) contribution AND any gain it has earned in the 40 years it's been growing. That's a ton of money that will go to taxes, and you can't avoid it if you live long enough - withdrawals are mandatory at a certain age (I think it's age 70). You will also be taxed using the tax bracket you are in during retirement... and for most 20 and 30 somethings your tax bracket will be higher in retirement than it is currently.

For Roth accounts you pay the taxes now, and you don't get the deduction - but then when you take money out in retirement, EVERYTHING is tax-free, including your 40 years of gains. That's a huge tax savings.

Granted, the tax law could change for Roth accounts, but the longer they are around the less likely they are to change. Eventually they will be mainstream enough that changing that rule would get every member of Congress voted out, and they know it.

Mom987 · December 2013

Thank you everyone for the very helpful responses!

Roth IRA vs. mortgage

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