Tax Free Wealth

At least 4 million Americans are wasting money by accelerating their mortgage payments instead of investing in retirement accounts, according to a paper published by the Federal Reserve Bank of Chicago.

The money you use to pay off your mortgage has been taxed, which means, depending on your tax bracket and your state tax hit, you have only about 60 to 70 cents to show for every buck your employer paid you. Better to divert that dollar into your 401(k), because the full 100 cents goes into the account.

Let's say you and your significant other bring home $200,000 a year in a high-tax state and you are just starting to pay off a 30 year $400,000 mortgage at 6.5%. If you paid an extra $300 each per month toward those mortgage payments, you could pay off your loan nearly 12 years early. Sounds great, until you see Huang's math (UT professor who co-wrote the paper).

By diverting that $600 a month into your 401(k), you'd come out $44,000 ahead, she says. And that might even be lowballing it: for the purposes of their study, the researchers assumed you'd invest the money in bonds. A couple investing in stocks might see an even bigger gain.

Most of us, the authors suggest, worry too little about bad debt (e.g., credit card balances) and too much about the most benign (e.g., mortgages with tax-deductible interest). And this goes double for the surprisingly large number of people who don't take full advantage of their employer's 401(k) contribution matching programs.

Hey, it's Free Money!

this article was adapted based on the original article by David Owen, published in BestLife Online, September 21, 2007.