Repay Mortgage or Invest in Roth IRA?
April 17, 2006, Revised July 17, 2006, Reviewed
August 28, 2011
"I have $500 a month available for investment. Should I put it in a Roth IRA, or use it to repay principal on my 6.50% mortgage? I am 35 years old and in the 33% tax bracket."
I would put the maximum contribution (currently $4,000 a year for someone your age) in the Roth IRA, invested in a diversified portfolio of common stock, and use the remainder to pay down my mortgage balance.
Repaying a mortgage is an investment with a yield equal to the mortgage interest rate. Since you can deduct 1/3 of the interest from your taxes, you save only 2/3 of the interest when you repay the loan. Your after-tax yield is thus 6.5(1 - .33) = 4.33%.
Roth IRAs pay no taxes, but even so funds invested in low-risk assets won’t do much better than 4.33% today. At age 35, however, you should not have a conservative IRA portfolio. I would put the IRA in an indexed common stock fund, which should yield 9% or more over the next 30 years, with no taxes due on it ever. Since your contribution limit is $4,000, use the balance to pay down your mortgage.
"I have $500 a month available for investment. Should I put it in a Roth IRA, or use it to repay principal on my 6.50% mortgage? I am 35 years old and in the 33% tax bracket."
I would put the maximum contribution (currently $4,000 a year for someone your age) in the Roth IRA, invested in a diversified portfolio of common stock, and use the remainder to pay down my mortgage balance.
Repaying a mortgage is an investment with a yield equal to the mortgage interest rate. Since you can deduct 1/3 of the interest from your taxes, you save only 2/3 of the interest when you repay the loan. Your after-tax yield is thus 6.5(1 - .33) = 4.33%.
Roth IRAs pay no taxes, but even so funds invested in low-risk assets won’t do much better than 4.33% today. At age 35, however, you should not have a conservative IRA portfolio. I would put the IRA in an indexed common stock fund, which should yield 9% or more over the next 30 years, with no taxes due on it ever. Since your contribution limit is $4,000, use the balance to pay down your mortgage.
