While you are saving for retirement, you get the best bang for your buck when your Thrift Savings Plan contributions occur during down markets. When you are retired and withdrawing money for living expenses, your portfolio is irreparably damaged when your withdrawals coincide with down markets.

Having the flexibility to increase your savings contributions or reduce or eliminate your withdrawals during down markets can go a long way toward protecting your financial plan during economic periods like we’ve seen over the past 18 months. The lower your necessary expenses – your nondiscretionary spending – the greater flexibility you have to increase savings to or reduce withdrawals from your investment portfolio.

One area of nondiscretionary spending is often the cost of housing – in particular, required rent or mortgage payments. Keeping these payments as low as possible in any given year helps to increase the flexibility you have to increase savings contributions or reduce withdrawals when it is to your advantage. This doesn’t mean that the traditional goal of paying off your mortgage by the time you retire isn’t a good
idea. It means that it might not be the best idea to commit yourself to the higher nondiscretionary payments of a 15-year mortgage when you could reduce your required payments by opting for a 30-year mortgage, instead.

With interest rates at historically low levels, it might pay to consider refinancing your existing mortgage or mortgages into a single fixed-rate loan over a longer term. Let’s say you’re entering retirement and you have a balance of $100,000 and 10 years remaining on your current mortgage. Your payment is $1,100 per month. If you could refinance this loan and cut your monthly payments in half by stretching them over
30 years, that’s a decrease in nondiscretionary spending of $6,600 per year, before taxes. That’s $6,600 per year you could avoid withdrawing from your retirement plan in a down market. For most retirees, this decrease in nondiscretionary spending will be enough to have a big impact on the security of their retirement plans.

Yes, you’ll probably be spending more on interest over your lifetime. Yes, you’ll be paying more for your housing in the long run. But the interest is tax deductible and there is more to the retirement game than economics. If your goal is to balance the amount that you can withdraw from your investment portfolio over your lifetime against the risk of running out of money prematurely, there is value in lowering the mandatory mortgage payment. The flexibility that the lower payment brings can reduce the investment risk you face.

Keep in mind that there is an “option value” to the mortgage, as well. You can decide to prepay the mortgage at your discretion. If your financial circumstances allow, you can pay the loan off early, either through larger monthly payments or in a lump sum. If interest rates fall further, you can refinance again. If they rise, you may be happy to have a low rate mortgage that is no longer available.

In our hypothetical example, if the markets and other factors cooperate, you could continue to make the $1,100 monthly payment against the new loan and have it paid off in the same 10-year period as your current loan. Having the ability to reduce those payments if the markets don’t cooperate, however, could be the difference between success and failure in the long run.

Written by Mike Miles
For the Federal Times
Publication May 11, 2009