Save the difference in a tax deferred vehicle. The previous options dealt with keeping all money liquid and using after tax dollars. In this option we will discuss tax deferred accounts. The best tax deferred vehicle is the Roth IRA. Everyone needs and should have a Roth IRA. The contributions are made with after tax dollars but all the growth is tax deferred and distributions after age 59 ½ are tax free. Everyone with W2 or Schedule C earnings can contribute to the Roth IRA. Contributions are limited to W2 earning or $5500 below 50. An additional contribution of $1000 is allowed at 50 and above. This is not a discussion on IRA but just know this is truly a gift from the govt. don’t know how long they will allow this to continue so take full advantage of it while you can.
After the Roth IRA comes qualified plans at work. 401(k) and 403(b) are great tax deferred accounts and have much higher limits. Another feature that employers can do is give a matching contribution. For example, you decide to put all $507.25 into your 401(k) at work and the employer matches 100% up to 6%. The 507.25 is not more than the 6% of your earnings so they just doubled your contribution. Instead of paying a mandatory 15yr high minimum payment, you took the 30yr and saved the difference in your own retirement account and your boss is matching your contribution. What a win, win, win scenario. Not all employers match but even if they don’t you still get the tax deduction on your contributions. Some employer sponsored plans offer a Roth version which has all the features in the individual Roth IRA described above with some added bonuses.
As I finish this tax strategies involving mortgages let me summarize the main decision points.
- Is the reduction in the interest rate worth refinancing? Ask for a proposal with the new mortgage with the same number of months left on your present mortgage. If the refinanced payment is less than what you are paying now it should be cost effective. If not then look at other factors that will benefit you.
- If you want to go to a shorter mortgage can you afford the higher payment.
- What is the interest rate? Can you get saving rates of return equal to or higher than the mortgage rate.
- Do you need to accelerate other debt (bad debt) and you want can free up money with a refinance?
- Are you saving enough for retirement? Does your company offer a retirement plan and do they match?
- Finally, what is most important to you being totally debt free or having enough money to pay you an income equal to or greater than you make now.