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Dear Liz: I just turned 50. My company has an option to contribute pretax money to a regular 401(k) or after-tax money into a Roth 401(k). Should I put the maximum contribution ($17,500) plus the catch-up ($5,500) into the Roth? Or should I split my contributions?
Answer: Given that you’re close to retirement, putting most of your contributions into the traditional 401(k) is probably the way to go.
Most people’s tax brackets drop once they retire. That means you can benefit from a bigger tax break now and qualify for a lower rate on your future withdrawals.
If you had a few decades until retirement, the math might be different. Younger people with good prospects may well be in a lower tax bracket currently than they’ll eventually be in retirement. In their case, it can make sense to gamble on making after-tax contributions to a Roth 401(k), betting that their tax-free withdrawals in retirement will be worth much more.
You may want to put some money into the Roth 401(k) so you’ll have flexibility with your tax bill in retirement. Being able to choose between taxable and nontaxable options gives you what financial planners call tax diversification. But the bulk of your contributions should still go to the traditional 401(k).
Dear Liz: My husband and I lost our home because of unemployment and being underwater (the value of the house was less than the mortgage). We now both are working full time and saving to buy another home. My father-in-law offered to help us by selling us a rental he owns and giving us a loan for $150,000. We also would have to get another loan of about $100,000.
In addition to paying him principal and interest, my father-in-law also wants us to pay the $900 rent he was getting for the home. Please advise us if you think this is a good arrangement. Is it fair for him to ask for the rental money too?
Answer: Of course not. He’s essentially asking you to pay for the property twice.
Most parents instinctively want to give their offspring a better deal than they would give a stranger. Your husband’s father is the exception — he’s asking you to agree to a deal that no stranger would consider.
Given this man’s inclination, you probably don’t want him as your banker or your landlord, let alone both. Keep saving your money and improving your credit scores so you can swing a home purchase on your own.
Dear Liz: I’m 65 and my wife is 62. We recently sold a business for over $900,000 and will net somewhere between $550,000 and $600,000. Should we use the proceeds to pay off our mortgage? Our home is worth about $1.5 million with a mortgage of $390,000 at 3.586%. We contribute an extra $200 per month to reduce the principal. We have no other debt. Our savings, retirement and brokerage accounts total $1.2 million. My wife receives a pension of $483 a month and works part time as a substitute teacher. I plan to continue working until age 70 with a salary of about $170,000 per year. On retirement we should receive about $4,400 per month in Social Security benefits.
Answer: Many people feel more comfortable having their mortgages paid off by the time they reach retirement age — even when the interest rates on the loans are so low they’d almost certainly get better returns elsewhere. (The after-tax cost of your mortgage is likely less than the longtime inflation rate of about 3%.) Not having a mortgage payment can substantially reduce your monthly expenses, which means you have to take less from your retirement accounts. Such withdrawals often trigger taxes, so you essentially save twice.
Other people feel perfectly comfortable carrying a mortgage into retirement. They’re happy to take advantage of extraordinarily cheap interest rates and keep themselves more liquid by deploying their savings elsewhere. And many people have to carry debt because they can’t pay it off before they retire, or paying off the mortgage would eat up too much of their available funds.
Because you do have choices, discuss them with a fee-only financial planner. If you pay off the mortgage and invest what’s left, you could draw about $50,000 from your retirement funds the first year without a huge risk of running out of money. That plus your Social Security and your wife’s pension may give you enough to live on. If not, you may want to invest your windfall and continue paying the mortgage down over time.
Dear Liz: My credit reports don’t show any of my old unpaid collection accounts. I also have one judgment that is not showing from 2005. My wife (who has perfect credit) and I are looking to apply for a mortgage. What will the lender find? I recently applied for a credit card to start rebuilding my credit. The issuer approved me for a card with a $1,000 limit and told me my score was in the high 700s. I am so confused.
Answer: If your collection accounts are older than seven years, your lender shouldn’t see them when it reviews your credit reports. Most negative marks have to be dropped from reports seven years and six months after the date the account first went delinquent. Civil judgments also have to be dropped after seven years unless your state has a longer statute of limitations; in that case, the judgment can be reported until the statute expires. California’s statute of limitations for judgments is 10 years.
If none of those negative marks shows on your reports and you’ve handled credit responsibly since then, your credit scores (you have more than one) may well be excellent.
Since you’ll be in the market for a major loan, you and your wife should get your FICO scores from MyFico.com. Mortgage lenders will look at all six scores (one from each of the three credit bureaus for you and your wife), basing your rate and terms on the lower of the two middle scores. If that score is 740 or above, you should get the best rate and terms the lender offers.
Your FICO scores will cost $20 each, which is a bit of an investment. You can get free scores from various online sites, but those aren’t the FICO scores that mortgage lenders use and are of limited help in understanding what rate and terms you’re likely to get.
Dear Liz: I think you were way too hard on the young man who said his 30-year-old girlfriend’s lack of retirement savings was a potential deal breaker. You told him to get off his high horse. He was just being prudent.
Answer: It would be prudent to regard massive debt, alcoholism or drug use as deal breakers for a relationship. Elevating the young woman’s lack of retirement savings to this level is just over the top. But let’s hear what the young man himself had to say:
Dear Liz: I want to say thank you for taking the time to write on my question. I was able to find a few charts online and show her [the power of compounded returns]. She got excited about it and is now putting in to get the company match (5%).
Thank you very much for putting me in my place. I did not mean to come across as if I was better. I have been very lucky to have been able to save and be taught about compounding at an early age.
Answer: One of the potential hazards of being good with money is arrogance. We can become convinced that we know better and that other people should do things our way. It takes some humility to understand that not everyone has had the advantages we’ve had or been able to take in the information as we’ve done. Understanding that makes it easier to find compromises in a relationship that work for both parties.
Good luck with your relationship. She sounds like a keeper.
Dear Liz: You’ve been writing about people who expect inheritances they don’t get. Here’s another situation. My elderly dad thought he’d tied up everything in a trust, but his surviving elderly second spouse regularly invaded the principal instead of just receiving the interest. She would simply call her broker and ask for whatever she wanted. The broker, not being a knowledgeable trust officer, would send her the money. Finally, to soothe a fretting sibling, my husband and I paid for an estate lawyer to move the trust from Stepmom’s broker to a good third-party trust institution. It took more than a year plus paying a fee (OK, a bribe) for Stepmom to relinquish her direct access to the trust. She continued to receive the interest and was quite well off. She never did understand why we thought she was doing something wrong.
Answer: People set up trusts for a variety of reasons, but the type you’re describing is usually used to preserve an inheritance for the children while allowing the surviving spouse to live off the income. These trusts typically allow the survivor to tap the principal for certain purposes (“health, education, maintenance and support” is the usual phrase used). A trustee who’s asleep at the switch may allow the spouse to dig too deep, which not only reduces the children’s inheritance but also endangers the whole structure of the trust, which is designed to save future estate taxes. Your investment in hiring a competent trustee could save a lot of expense and hassle in the long run.
Dear Liz: I am a single mom who has been renting a condo for seven years. My landlord decided to increase my rent and for two weeks I didn’t know by how much. In the meantime, I looked for a house so I would have a Plan B. I found a totally renovated foreclosure. By the time I found out what my new rental amount would be (just $46 a month more), my son and I had decided to get the house. I used my entire life’s savings of $25,000 as my down payment. Now I owe $62,000. Do you think I made the right decision to buy the house, or should I have stayed in the condo and continued renting? I am torn.
Answer: Of course you are. That’s a very common emotion after taking such a big step.
Tying up all your money in a single purchase or investment is never ideal, but what’s done is done. Focus now on rebuilding your savings (including your retirement savings) and keeping your house in good shape so that you don’t face expensive repairs down the road.
You’re unlikely to get any tax benefit from this home, given your enviably small mortgage, but you will build equity over time as you pay down the loan. You’ll quickly discover the many challenges and rewards of owning a home, which most people prefer to renting.