Paying off my mortgage question

Factual Questions
61

There’s a nice dodge in Canada with an RRSP (like an IRA - conributions are limited and tax deductible, withdrawals are taxed - presumably when you retire and your income bracket is lower). You can “self-direct” and use your fund to invest in many publicly traded assets, like stocks, bonds, etc. instead of the usual mutal funds (restrictions and fees apply) If you have a big retirement savings account, you could use it to hold the mortgage on your house. (Big trouble if you don’t make the payments, the CRA thinks you’re trying to make tax free withdrawals on the installment plan.)

I wonder if that can be done in the Land of the Free?

62

IRAs can invest in nearly anything. Certainly stocks and bonds; it’s definitely not limited to mutual funds only. Including even collectibles, rare art, etc.

IANA expert on these more esoteric uses of IRAs. ISTM there were some restrictions on IRAs owning real estate but I don’t know the details. They can certainly invest in PTPs and REITs which are the two common investment vehicles that are sorta kinda mutual funds for real estate investments specifically.

63

That’s exactly what happened with us. When we paid off our not very large mortgage the amount of our deduction was unchanged. The deduction on mortgage interest was a significant benefit back when the standard deduction was smaller.

64

I know the CRA with RRSP’s was most concerned with avoiding dodges where a person effectively used the untaxed money in the account tax-free; i.e. you couldn’t buy a car for your persona use if it was paid for by a savings account. I assume US rules are similar. The transactions had to be arms’ length.

So i assume you could not buy art and hang it in your home or business, it would have to be properly stored and insured as if it was not you who owned it - or you pay your savings plan a fair market rental rate to hang it. Here (and I assume USA) the savings account has to be held and managed by licensed financial institution. (In the case of self-managed, they charge a fee for holding and overseeing the activities and ensuring the rules are followed). You could invest in publicly traded stocks, but not in shares of your brother Bob’s trucking company.

The advantage of using your saving plan to mortgage your home was a guarantee of a decent interest income (standard market rate was a requirement) at a time when cash deposits paid almost no interest, and the stock market could be unreliable.

65

If you can pay extra on your principal each month, that too will speed up your payoff time and reduce your interest payments in the long run.

66

Interesting article in NYTimes (probably paywalled?) about people whose accounts were closed randomly. For example, the people who ran a couple of bars in the NYC area, but rounded deposits to even thousands, kept the rest as flaot. The student from Nigeria who got money transfers from his family while waiting for a work visa. The guy whose company is owned (and he is therefore paid) by a a cannabis company.

Basically, suggests that a computer is flagging people with too many SARS (over 2 million filed last year) and the bank simply cuts off their accounts rather that keep dealing with it.

67

What you can’t invest in with an IRA is anything that is run by you, the beneficiary of the IRA. You can find IRA trustees that will hold real estate in an IRA account for you, but in that case, you have to hire someone to do any work at all on it. That means you need to hire a management company to do that, which is fine, but you need to be careful to tell all your close relatives which property you have in your IRA on the off chance that they might decide to rent it, because if they do, then theoretically the asset would need to be distributed out of the IRA. I doubt the IRS would notice, but that’s what would theoretically happen.

I’m fairly sure having the IRA hold the mortgage on your home would similarly be a transaction that would not be allowed and cause the asset in the IRA to be distributed to you by force of law. Canada has a specific thing going on with their plan, and as noted there are heavy restrictions on you having to make payments on that loan, or else effectively you’re distributing the money from the RRSP by holding onto it.

For completeness, IRAs can also not invest in life insurance (they’re a retirement plan, not an estate plan), nor can they enter into contracts in which they are assuming potentially unlimited risk (writing naked call options for example). They also can’t “invest” in things valuable as collectibles, regardless of form; there is a specific law allowing them to invest in coins that have all of their value from their metal content, which is how there are “Gold IRAs” that you might see advertised. The reason for the collectible prohibition apparently is the potential for lawsuits from prior owners of the collectibles, spurred on specifically due to Nazi-looted artwork showing up in IRAs.

68

Awesome info. Thank you. Always great to hear from an actual professional.

The restrictions on self-dealing in real estate make lots of sense. Many ways for that to turn more-or-less fraudulent. Shame they didn’t include any restrictions on insider stock deals. Otherwise Romney wouldn’t have a $20M IRA when you can only deposit a few grand per year.

69

The same restrictions on self-dealing are a similar big deal in split interest trusts. I get a handful of trustees each year who ask if they can put their home in a Charitable Remainder Trust and live in it (or have a family member live there).

70

Now to get back to the topic…

As indicated previously, you should consider not paying off your mortgage faster if there is a potential need for emergency cash. I don’t know your living situation, but if you own your own home or are otherwise responsible for your heating situation, you will want to have enough on hand to handle any maintenance or replacement of your heat system. At least, if you live somewhere it gets cold. If you don’t, then maybe the same could be said for your cooling system.

If you do decide you need some of this money on hand, definitely take all that you need for months beyond the current one and put it into a money market mutual fund at a discount brokerage. Vanguard has the best rates out of the big three players in that space. Schwab is slightly lower but is a bit more risky, while Fidelity is significantly lower; Vanguard simply has a lower expense ratio on their money market funds. If you go with Vanguard (or Fidelity), you automatically have your excess cash invested in their money market funds. With Schwab, you have to manually buy and sell SWVXX, which isn’t a huge deal but is inconvenient. Because the income you earn on this fund is taxable and it’s unlikely that you can deduct your mortgage interest, despite the nominal return of these funds being higher than your mortgage rate, it’s probably not a +EV option to intentionally not pay off the mortgage instead of just having the money there to cover emergencies.

Once you’ve got that money market account set up, you can consider also buying short-term CDs that have slightly better rates than the money market, and at those brokerages, they offer the best rates that banks anywhere are paying. You just have to buy in even $1,000 increments. Fidelity does offer slices of CDs in $100 increments, but they’ll have a worse rate.

If you have no other investments though, assuming you don’t make too much money to be eligible, you should be maxing out an IRA of some sort with all that extra money you earn and don’t need right now. Whether a Roth or traditional is better depends on what your tax bracket that you anticipate being in during retirement will be compared to now. Most people in their peak earning years will have lower marginal tax rates in retirement, which makes traditional IRAs good. If you’re just starting out though, you might not be at that point yet. I hit that point last year, and will likely continue hitting that point if I get a similar-sized year-end bonus each year. You do have the option of recharacterizing your IRA contribution type until the due date of your tax return, which I took advantage of when I ended up making more money than I anticipated in 2022.

Note that if you expect your marginal tax rate to be the same in retirement as now, a Roth is better; they are not equal. In fact, the tax bracket difference needs to be substantial and not just 12% → 10% or similar, because with a Roth IRA contribution, you are also effectively getting to contribute the taxes that you would have paid on that money into the IRA compared to a contribution made to a traditional IRA where the money in the IRA is worth slightly less since you will be taxed on it when it’s withdrawn. If the difference is 22% → 12% as I anticipate for myself, the traditional is generally better, but for smaller jumps in tax rate the advantage of the Roth contributions being effectively greater can win out over a long enough period of time.

71

Multiplication is associative. For a given amount of pre-tax money, if you assume you will be paying the same tax rate now and in retirement, Traditional or Roth makes no difference. It doesn’t matter if you pay the taxes now or later, it multiplies out exactly the same.

It’s not valid to compare (for 2023) $6500 into a Traditional account to $6500 into a Roth account - the Roth amount needs to be lowered to account for the taxes (e.g. $6500 Traditional vs. $5070 Roth for someone in the 22% tax bracket).

It’s true that if you can afford to make the maximum contribution to a Roth account, that will be worth more than the same number of dollars into a Traditional account. But if you assume contributing the maximum to a Roth account, you need to also assume saving the “extra” in the Traditional scenario. For someone in the 22% tax bracket, making a $6500 Roth contribution requires $7930 in pre-tax income. So the $6500 Roth contribution must be compared to a $6500 Traditional contribution plus that extra $1430 pre-tax / $1115 post-tax also invested elsewhere.

72

For most investments in Canada, your RRSP must invest in market-traded securities. I.e. stocks listed on the exchange, not Bob’s Trucking, and not your uncle’s grocery store. Bonds from the bond market, not personal loans. Mortgages managed by a licensed financial institution are included.

I’ve never heard of an RRSP account holding actual real estate. It can hold a mortgage - anyone’s, including your own. But the management company will oversee that, and it will be a standard mortgage with all the regular terms, and at a fair market rate to avoid self dealing. Also, presumably the management company will quickly report if mortgage fails to make payments. Canada has mortgage insurance, so that a mortgage provider gets paid by the insurance company if the mortgage defaults. One provision for mortgages in RRSPs is that the mortgage must be insured, which is a percentage of the mortgage added on to the principal. (Includes assorted terms, like minimum 5% down, meet income levels etc.; banks aren’t stupid, if the mortgage isn’t insured, why would they lend to you?) Usually if you put more than 25% down payment the insurance is optional, but for RRSP held mortgages it is required.

By the time you pay that insurance, odds are you are better off investing elsewhere instead of holding a mortgage. Who lives in the house is irrelevant, as long as the mortgage is fair market rate and paid.

I guess the calculation with a tax-free savings account is that it will accumulate through compounding much fastter than if it pays taxes as it goes along. So $1,000 invested with no taxes to pay until you withdraw, is going to get larger than $1,000 that is then taxes and the remainder invested, and then taxes paid each year as you go along - even if your marginal rate never drops at retirement.

The only “gotcha” I see is that some investments produce capital gains that typically are taxed at a lower rate than income. When I withdraw from my account, it is considered “income” and taxed at that rate, regardless of how it was compounded. I’m sure there are asorted math tricks to determine what is better in which scenario, but to me it seems not having to manage that sort of detail year after year may be worth the extra taxes. After all, I haven’t reached the level where the income can also profitably pay for an acountant.

73

Yes, and that money won’t be in your IRA, and thus the investment returns will be subject to tax, so you will have a drag on that return of traditional IRA + taxable account vs. a Roth. The net effect is that you are effectively contributing more into your IRA, so you have more money earning income not subject to tax. There shouldn’t be a question as to which is better if your tax rates will be the same. You’re right that due to associativity of multiplication that if you were to be able to invest the same effective amount in both if wouldn’t matter, but you get more tax-free growth if you invest in a Roth IRA than if you put into a traditional and put the tax savings in a taxable account.

There can be an issue of just how much of a marginal tax rate difference there can be and still prefer a Roth. Over a long enough period of time, getting more effective money into your IRA can be better than a small increase in tax rate (some tax brackets right now only differ by 2%) paid when you contribute it. It depends over what time scale you’re talking, what the actual tax rate is, and what your investment return assumptions are.