Debt Paydown vs. Investing

Some folks who have a mortgage, student loans and/or car loans are in the enviable position to consider paying down or paying off that debt from their cash or investment accounts. If a person I’m meeting with has that option, then here’s how I approach the issue:

Financing a big purchase isn’t a bad thing, despite the stories of family members from the past who “only paid cash for everything.” For our purposes, let’s assume a client named John asks for my advice on his $50,000 mortgage balance with 8 years of payments remaining. He has $75,000 in a bank or investment account and wonders whether he should just pay off the mortgage and be done with it. Three factors need to be considered:

1.  Emergency Money. If John pays off the mortgage, will he still have sufficient funds for an emergency? Everyone should always have easy access to cash that will cover 6-12 months of recurring expenses. Paying off debt is not recommended if it minimizes or eliminates your emergency fund.

2.  Rate Comparison. If the emergency fund is covered, then the next question I ask is the rate of interest John is paying on the debt (in this example, a mortgage). If it is equal to or greater than 6%, then I recommend he seriously consider paying down the debt as quickly as possible while still having an ample emergency fund. Why 6%? Because if your debt interest rate is less than 6%, and you are willing to invest your money appropriately, then you will likely get more bang for your buck by investing and paying the debt in installments.

Here’s an example: Let’ say John’s mortgage interest rate in the above example is 4%. Let’s further assume John’s investments are in a diversified low-cost index portfolio with an average annual return of 5.75% – a very reasonable assumption. While invested for the year, the $50,000 John is considering paying off the mortgage with is making $2,875 (5.75% of $50,000). At 4% interest, John’s annual interest payment on his mortgage is $2,000 (4% of $50,000). By keeping the mortgage and investing the balance, he can make $2,875 and owe $2,000 for a net gain of $875. If he cashes in the investment and pays off the mortgage, he is saving $2,000 in mortgage payments but losing out on the $2,875 gain on his investments. The net loss is $875.

Realistic returns on a well-diversified and moderately aggressive investment portfolio are around 7%-10%, but they don’t produce that every year, so I err on the conservative side by using the 6% rule in debt repayment analysis. If John was a more aggressive investor, he may consider keeping debt with an interest rate of 7%; or only 5% if he is a very conservative investor.

If John’s money isn’t really working for him because it is just sitting in a checking account making 1%-2%, then his money can work much harder for him by paying off that 4% mortgage. But before I would tell John to take that cash from the bank account to pay off the mortgage, I would gauge his comfort in investing it. If he can’t stomach the market volatility, then debt repayment makes better sense than a low interest checking account. If he can take the volatility, then I usually recommend he keep paying on the mortgage and invest the money.

3.  Peace of Mind. Finally, John can’t forget the intangible component that is peace of mind. How you sleep at night should always be a factor in your financial decisions because your money is there to make you feel protected. If paying off the mortgage just makes John feel better and he doesn’t want his loved ones to worry about the debt if he dies unexpectedly, then debt repayment makes sense despite the numbers we looked at above. This same analysis applies to any debt – student loans, car loans and the like.

As you can see, there is no absolute objective answer to the debt vs. investing question. But there is a methodology that can certainly help you make an informed decision. Feel free to call my office if you have any questions because every situation is unique.

Personally, I paid off my mortgage sooner than I needed to because I wanted the peace of mind. However, I financed my last car that I could have paid cash for because the dealership offered a 60-month 3.9% rate. I jumped at that rate because I’m confident I can make my money work harder through my investment portfolio.

Fun Fact: For those of you old enough to remember, CD rates in the 1970s were almost unfathomable today. In 1979 the average 3-month CD rate was 11.2%, but before you long for those days gone by, remember that inflation in 1979 was at 11.3%, so that CD was really producing a net loss in purchasing power of .1% annually. Today 3-month CD rates are closer to 4%, and with inflation currently around 2.67%, your current CD is gaining purchasing power each year despite the much lower rate. The “good old days” weren’t necessarily that good on the CD front.

A Follow-Up to the Big Beautiful Bill: Investment Accounts for Children

As a follow-up to last week’s Up Early, a thoughtful client of mine inquired about the “Trump Account” created under the new tax bill. At its simplest terms it’s an IRA for children. At its more complicated terms it’s, well, fairly complicated. Here’s what I’ve been able to figure out so far:

The new tax bill creates what are called “Trump Accounts” for children who are US citizens with Social Security numbers. For children born from January 1, 2025, through December 31, 2028, the Federal government will contribute $1,000 to start. Parents of children born before 2025 can also open a “Trump Account” but that account is not eligible for the initial $1,000 government seed money.

Once open Trump Accounts can be funded by parents or others through a contribution of up to $5,000 annually until the child’s 18th birthday. Companies can contribute up to $2,500 annually for an employee’s eligible child and that contribution won’t apply toward the employee’s taxable income. These contribution limits will be indexed for inflation annually as well.

All families with children born during the eligibility dates can receive the $1,000 seed money regardless of income or net worth. The accounts are supposed to open mid-2026 with the $1,000 seed money available at that time.

No withdrawals are allowed until the child reaches the age of 18, and at that point for all intents and purposes the Trump Account is an IRA for the child. As such, IRA rules will apply, including additional contribution limits for IRAs that are currently $7,000 per year and, importantly, a 10% withdrawal penalty for distributions made before age 59 1/2, with some exceptions as noted below.

Investment options will be limited to low-cost index funds, but they have to track “primarily United States companies.” There is no clear understanding yet of where or who will be offering these eligible investment accounts so stay tuned.

The taxation of these Trump Accounts is where things are really complicated. Contributions made to the Trump Account do not count as taxable income to the child (even if they are made by the parent’s employer). The accounts will grow with all taxes deferred until withdrawal after age 18, and then any withdrawals made will be taxable.

How the funds are used will dictate how they are taxed. If the funds are withdrawn for school tuition, a first-time home purchase or small business expenses they are penalty free and will be taxed at capital gains tax rates. Funds withdrawn for other purposes (like a new car the 18-year-old may be eyeing) will be taxed at ordinary income tax rates which start at 10%, and they will also be subject to a 10% penalty if withdrawn before age 59 1/2.

Are Trump Accounts worth it? Yes, if the child is eligible for the $1,000 seed money. After that, I’m not so sure. The most power tool in investing is time, so starting an investment account for an infant allows for powerful compounding… at least until 18. Then, the 18-year-old is in charge (!). Will they continue the compounding, or buy a new car, taxes and penalty be damned. No way to know. Investments limited to only American companies doesn’t sit well with me either.

Like everything in this massive tax bill there’s a little bit more to clean up and learn about but I’m glad my client brought this issue up because I think it’s worth following carefully. I wouldn’t blink at opening the account if you can get the “free” $1,000. I would think twice before adding additional funds except those that your employer might be willing to contribute. Finally, I don’t think we’ve seen the last in terms of rule changes to the Trump Accounts. Stay tuned.

Fun fact: Amaze your friends and relatives by understanding the Rule of 72: That is an easy way to estimate how long it takes for any investment to double in value based on a given interest rate. Simply divide 72 by the interest rate. For example, with an 8.5% annual return it takes 8.47 years for the money to double. (72÷8.5). At a 6% annual interest rate it takes 12 years.

Understanding the One Big Beautiful Bill (So Far)

The “One Big Beautiful Bill” was signed into effect on July 4, 2025, after months of intense negotiations in both the House and Senate. The law is 870 pages long so there’s a lot to digest but here are some key elements that are worth knowing about in the financial planning area:

1. On the Medicaid eligibility side there is a “community engagement” requirement. Able-bodied adults must affirm on a monthly basis that they spend no less than 80 hours per month working, participating in a work program, completing community service, participating in education programs or doing a combination of all of the above. There are exceptions for those under 19 years of age and individuals with certain identifiable hardships.
2. There are state requirements for quarterly reviews of records to verify deceased beneficiaries so they don’t remain on the Medicaid program after death.
3. There is a newly created Rural Health Transformation Program that will provide $50 billion over five years to hospitals and other providers for states that submit a rural health transformation plan establishing how such funding will improve access to care and patient outcomes in rural hospitals.
4. Existing tax brackets become permanent, and the standard deduction increases by $750 for single people and $1,500 for married joint filers. ($15,750 for single; $31,500 for married filing jointly)
5. State and local tax deductions are increased to a cap of $40,000 for married joint filers over the next five years.
6. There is now a deduction for tips up to $25,000 and overtime pay up to $12,500, but there is a phaseout based on income levels. This change ends after 2028.
7. It is now possible to deduct up to $10,000 for car loan interest associated with vehicles in which the final assembly occurred in the United States. This is also phased out based on income levels. This change ends after 2028.
8. Student loan repayment plans have been revamped. New borrowers going forward will choose between the following options: 1. A fixed monthly payment over 10 to 25 years based on total principal, or 2. Income-based repayment based on adjusted gross income with a minimum payment of $10 per month and payment continuing until the loan balance is zero or the borrower makes 360 qualified monthly payments, whichever is earlier. Existing borrowers will be transitioned into one of these two plans by July 2028.
9. On the estate tax front, the law puts a lot of confusion to rest. The federal estate gift and generation skipping tax exemption will increase to $15 million per person starting January 1, 2026, and for married couples the exemption will be $30 million. These amounts will then be subject to a cost-of-living adjustment on an annual basis. You should note that Michigan has no state inheritance tax so Michigan residents can rely exclusively on these exemptions to plan their estates.

As I slowly wade my way through summaries of the tax bill, I realize just how extensive it is, from oil and gas interests to farming to nuclear power, to immigration and defense spending, it is truly massive. Like any major tax bill overhaul it will need clarification as time goes on, but I think the important elements above can be relied on for planning purposes.

Fun fact: Every year thousands of hours of planning and expertise goes into the avoidance or minimizing of income taxes. Perhaps you’ll feel better knowing that while US income taxes aren’t low per se, our maximum tax rate of 37% is not at the top of the list. The Republic of Côte d’Ivoire (or the Ivory Coast) has a 60% max income tax followed by Finland at 56% and Japan at 55%. In fact, if you look at it in terms of tax revenue as a share of gross domestic product, Denmark has the highest taxes, while the US comes in at number 31 with total tax revenue being roughly 25% of GDP.