Dear Liz: My in-laws just informed us that they have gone through their retirement fund and soon won’t be able to pay their mortgage. They borrowed against the house they’ve lived in for 30 years and currently owe $325,000. They are devastated, so I am trying to figure out the best way for them to stay in their house in their final years, as they are both 73. They have about $300,000 in equity but do not want to sell. They are willing to sell the house to my wife and me at their current balance. We would make the payments and they remain in the house. When they pass, the house would be ours. They looked into a reverse mortgage but this would cover only the payments, not taxes, insurance or maintenance. What is the best way to do this? Do I get a loan and purchase outright? Do I contact their bank and see if I can assume their loan? Do they quit-claim the home to my wife and me? My wife and I can afford to do this, but we want to make the right financial decision.
Answer: Before you do anything, please consult a tax professional and an attorney with experience in estate and elder law.
It’s unlikely the lender will allow you to assume the loan, so you probably would need to set this up as a sale of the home with you and your wife obtaining a new mortgage.
But their plan to sell the house to you at a below-market value could create gift tax issues and could delay their eligibility for Medicaid, should they need help paying for nursing home care.
There are other risks to your in-laws. Your creditors could come after the home if you lose a lawsuit, for example. You could sell the home without their consent, and you would have a claim on the property if you and your wife split up.
Then there are the risks to you. You say you can afford to make the payments (and presumably pay the taxes, insurance and maintenance as well), but what happens if you lose a job or suffer another financial setback?
All of you need to understand the risks involved, and your alternatives, before proceeding.
A sale of the home or a reverse mortgage may well prove to be a better choice. A reverse mortgage wouldn’t completely eliminate their home costs, but would substantially lower them — whoever winds up paying the bill.
Dear Liz: My husband works for the government and will be receiving a pension when he retires. Am I still supposed to save the recommended amount for retirement from my income or can that amount be reduced since we know we have the pension? We are starting a family and could use any extra money we can get right now.
Answer: If your husband is just a few years away from collecting that pension, counting on it to be there is reasonable. Since you’re just starting a family, though, it’s much more likely that retirement is decades away, and a lot can happen in that time.
Your husband could be laid off or fired, or he could quit. Even if he sticks it out, the government could change the way his pension is accrued to make it less generous. (The rising cost of public employee pensions concerns many lawmakers and taxpayers.) Even if he gets what he expects, his pension may not be enough to support the two of you in old age.
So yes, you should be saving for retirement. A cautious person would save as if no pension existed. Someone who’s comfortable with risk might simply aim to fill the gap between the expected pension and future living costs. Others might find a comfortable saving rate between those two points. You can use AARP’s retirement calculator to help you create a plan that allows you to take care of your family today without depriving yourselves in the future.
Dear Liz: I am 54 and considering retiring in three or four years. I have been fortunate to work at a Fortune 100 company for 30-plus years and have both a defined benefit pension plan and a 401(k). When I retire, we have the option of taking a lump sum or an annuity. Most financial people I talk to strongly recommend taking the lump sum, though I wonder if it is not just so there is more money to manage? My current inclination is to take the annuity (with survivor benefit for my wife). I think we can live off the annuity alone and use the 401(k) for emergency/fun/help-the-kids money, etc. I think if I took the lump sum and invested it, I’d always worry about what the market was doing. Am I off base?
Answer: Not at all.
Theoretically, you often can make more money by taking a lump sum and investing it than by accepting the annuity, which offers a lifetime stream of payments. But perhaps you’ve heard the quote “In theory, theory and practice are the same; in practice, they are not.” Anyone who knows much about behavioral finance knows there are many, many ways such a plan can go wrong.
You could pick the wrong investments, take too much or too little risk, trade too much or spend too much, and wind up much worse off than if you’d chosen the annuity. You could turn over the investing decisions to a pro, but there’s no guarantee that person won’t make mistakes. Even if he or she chooses great investments and allocates your assets well, your nest egg could still take a hit from the market.
If you were comfortable taking that extra risk to get the extra possible reward of more cash, accepting the lump sum would be the way to go. Since you’re not, there’s nothing wrong with taking the annuity. Opting for a survivor’s benefit means your wife will have guaranteed income should you die first.
Before you pull the plug at work, though, make sure you talk to a fee-only planner who charges by the hour to make sure your retirement plan makes sense. (Planners paid by the hour won’t have a vested interest in how you opt to manage your retirement funds.) Your assets probably will have to last 30 or 40 years, and you’ll have to figure out how to pay for the ever-escalating cost of health insurance. This can be a tricky process, so you’ll want expert, unconflicted help.
Dear Liz: I don’t know where to turn. My husband is 76. He has a federal government pension and collects Social Security but he has only a $17,000 life insurance policy. We still have a $229,000 mortgage and no savings other than my small 401(k). I am 59 and also a federal worker. Do you have any suggestions or guidance for me? Is there such a thing as an insurance policy that could pay off the mortgage if he passes before me?
Answer: Buying a life insurance policy on your husband that would pay off your mortgage isn’t necessarily impossible, but it would be expensive and might not be the best use of your funds. You can explore that option, of course, but you also should research your own retirement resources and what’s likely to remain after he’s gone.
Will your husband’s pension make payments to his survivor or will it end when he dies? How much will your own federal pension pay you when you retire? How much will Social Security pay you, and how does that compare with your survivor’s benefit (which is essentially equal to what your husband is receiving when he dies)? What are your options for maximizing those benefits?
You also need to know if your Social Security benefits could be reduced because of your public pensions. Some federal employees and employees of state or local governments receive pensions based on earnings that were not subject to Social Security taxes. When that’s the case, their benefits could be reduced by the Windfall Elimination Provision or the Government Pension Offset. Most federal employees hired after 1983 are covered by Social Security, but just in case you should check out the information at http://www.ssa.gov/gpo-wep/.
Once you have an idea of your income as a widow, you can compare that with your expected expenses and see whether continuing to pay your mortgage will pose a burden. If that’s the case, you might consider downsizing now to a place you could afford to buy with cash or a much smaller mortgage. Reducing your expenses also could help you build up that 401(k), which will help provide you with a more comfortable retirement.
Establishing a relationship with a fee-only planner now will help you prepare for the future and give you someone to turn to for financial advice should you be left on your own.
Dear Liz: I have quite a bit invested in stocks in a regular brokerage account. I’ve held them for many years, and to sell them would mean huge capital gains taxes. I’d like to move some of these into a Roth IRA, so that I can avoid paying taxes on their appreciation and dividends, since I plan to hold these for quite some time. Is it possible to move these stocks into a Roth IRA without selling and repurchasing?
Answer: Nope. Uncle Sam typically gets his due, with one major exception.
Roths have to be funded with cash, and direct contributions are limited to $5,500 per person per year, plus a $1,000 catch-up contribution for those 50 and over. Your contributions would be further limited once your modified adjusted gross income exceeds $181,000 for married couples and $114,000 for singles, said Mark Luscombe, principal analyst for tax research firm CCH Tax & Accounting North America. A big-enough capital gain, on top of your regular income, could push you over those limits.
If you want to avoid paying capital gains, just hold the investments until your death. Your heirs will get the investments at their market value and can sell them immediately without owing any capital gains. There may be other taxes involved, however. If your estate is worth more than $5 million, it may owe estate taxes, and a few states levy inheritance taxes on heirs.