How To Pay Off Your Mortgage Using Pre-Tax Money – About Your Online Magazine


Retirement funds are useful to support us in old age, providing income beyond Social Security. But they can also be exploited before you leave the workforce. The idea is to use that money for something that will benefit you economically in the long run. How to get rid of your home mortgage, which depletes you over the decades with interest rates. Stephen Nelson, the president of Birchwood Capital in North County San Diego.

Larry Light: Is there a way to use retirement funds, such as an IRA, funds to pay the bank without having to make a taxable distribution? This money, of course, is invested before taxes and is only taxed when it is withdrawn.

Stephen Nelson: Unfortunately not. But with a little tax planning and a strategy using Roth conversions, you can save a huge tax bill and pay your home. Now, does that avoid taxes altogether? Certainly not. There is no free lunch. But it can reduce the taxes you would pay by up to 50%.

Light: What can you tell me about Roth’s conversion strategy?

Nelson: This is a process that deliberately moves money from a pre-tax account, such as a 401 (k) or a traditional IRA, to an after-tax account. The benefit is that any distributions and any increase in that money are tax-free. So you can do anything with the money you want, like using it to pay your mortgage.

The trick is to manage the tax liability, since any amount taken from an account before taxes will be taxed based on normal income rates. But the good news is that this is a piece that is under your control.

Light: OK, show me some examples of how this would work.

Nelson: I will present two examples to show you the power of Roth’s conversion strategy to pay off your mortgage. One shows the wrong way to do it, another shows the right way. For the sake of simplicity, let’s assume that the current taxable profit is zero and a joint tax return.

Light: Hit us the wrong way.

Nelson: You do everything at once. Let’s say you converted $ 1 million in pre-tax money to after-tax money. You would pay approximately $ 300,000 in federal taxes. There! The conversion moves you from the lowest tax bracket to the highest tax bracket, which is 37%. Therefore, each marginal dollar you withdraw is taxed at the maximum rate. You would earn $ 700,000 net that could be used to pay your mortgage.

Light: But the other method makes even more money, since there is less impact on taxes, right?

Nelson: Right. You extend withdrawals over time. In our second scenario, if you spread Roth’s conversions over five years, making a conversion of $ 200,000 each year, you will reduce your tax range from 37% to 24%. This cuts your effective rate basically in half.

The net result is to have $ 847,500 available for mortgage payment or 21% more money compared to the first example. Due to our progressive tax system, money is first converted at the lowest possible rates. The more you fill the lower tax brackets without overflowing to the higher tax brackets each year, the more taxes you will save.

Light: If a couple was looking to pay off their mortgage on retirement, this seems like an excellent strategy to help them avoid dying from taxes.

Nelson: Precisely. The strategy can be adapted to suit someone’s exact situation. With a little planning, you can save hundreds of thousands of dollars and pay off your mortgage in a few years.

Paula Fonseca