To reduce retirement risk, reduce debt

Q: We are a retired couple. We have two debts that we have not paid off. One is a Sallie Mae student loan at 3.875 percent. We are making payments of $500 monthly.

We also have a 30-year home mortgage at 3.5 percent that has 27 years remaining. We owe $147,000 on the home with a monthly payment of $685. We are in our early 60s.

Our current retirement income, including income from investments, is about $87,000. Without the investment income, the yearly income would be about $67,000.

We have $560,000 in an IRA and $304,000 in cash. We are currently investing the $304,000 cash in first lien short-term mortgage investments through an individual lending corporation - not a bank. These investments

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Se pay at a 7 percent annual interest rate. So far, this has been a reliable source of monthly income. The loan-to-value of the short-term mortgages is 25 to 50 percent. Most of those mortgage investments are two years in duration. As they come due, the invested money rolls into new projects.

With the banks relaxing their lending policies now and funding easier to get through conventional banks, there is less guarantee that new projects will be available and our invested money may sit idle for a while. We feel this source of investment may dry up eventually as banking regulations for loans loosen. We will not use IRA money to pay off our remaining debts.

Question: Should we use the $304,000 cash to pay off both the college loan and our home mortgage? The monthly loan obligations would go down if loans were paid off - in effect, a monthly raise.

- C.P., by email

A: It makes sense to pay off both loans. The reason is simple. You will reduce your risk and maybe your taxes at the same time. You have $177,000 in debt. It takes almost the same amount, committed to what most would consider a risky investment, to earn the interest income needed to make the payments.

Worse, it's very likely that you don't have enough in mortgage interest payments or real estate taxes to itemize deductions on your tax return. As a result, you get taxable interest income that may not be offset by your mortgage interest payments. You can check this by visiting with a tax preparer or CPA who can show you the tax difference between having the debt and not having it.

While rolling short-term first lien mortgages at 7 percent may seem safe, the reality is that anything that pays 7 percent in today's market is a risky investment. One clue is that the yield is right up there with the yield on typical junk bonds.

So if you want to have a safer and more relaxed retirement, pay off the debt. You'll still have a cash cushion left and you'll still have the entire IRA account.

Q: I just saw an article of yours mentioning withdrawing from one's bond allocation when stocks are down. Doing this prevents the selling of stocks at depressed prices. I don't think you can choose what assets to sell in the Federal Thrift Savings Plan. Is this your understanding as well? If that is the case, would you recommend leaving the TSP in retirement for something like Vanguard?

- G.G., Sanger, Texas

A: The Federal Thrift Savings Plan offers the lowest cost of money management available, but it isn't particularly flexible when it comes to making withdrawals. If you have made arrangements for a regular monthly distribution, that money will come from your whole portfolio, not a single asset such as your equity fund or your bond fund. So you are correct, you can't choose what assets to sell when making regular monthly distributions from the TSP.

The only way you could sell from an individual fund would be to move your money. Even then, you'd most likely have to make distributions manually, each month, from the chosen fund.

Should you move your money? I don't think so. You'll never beat the low cost of the TSP funds, for one thing. And there is nothing like the riskless government bond fund -- the "G" fund -- available elsewhere, for another. Those benefits offset some loss of flexibility.

• Scott Burns is a principal of the Plano, Texas-based investment firm AssetBuilder Inc., a registered investment adviser. Questions about personal finance and investments may be sent by email to scott@scottburns.com.

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