Got extra cash? Boost your retirement contributions
Dear Liz: My husband and I are in our late 40s. My husband is the sole provider. We have $200,000 equity in our home and a 5.875% interest on our mortgage. We have nine months’ worth of expenses saved in an emergency fund, plus we contribute $100 a month to our son’s college fund and 6% to my husband’s 401(k). We make regular monthly payments on a student loan balance of $12,000 (at 4.167% interest) and a personal loan balance of $12,000 (at 0%). My husband has had two stretches of unemployment over the last five years, each lasting for about six months. We have begun saving in a secondary account and are uncertain how to best use that money. Should we pay off the student loan? The mortgage? Invest in a CD or IRA? Or consider some other investment strategy?
Answer: You don’t say how much is in your husband’s 401(k), but a 6% contribution rate when you’re in your late 40s is unlikely to generate a big-enough nest egg to retire. Boosting that contribution rate should be your priority, and you should consider contributing to a Roth IRA for each of you.
Likewise, saving anything for your child’s college education is smart, but $100 a month won’t get you far. Just for comparison, consider that parents of newborns need to save around $600 a month to pay the full cost of a public college. Those who start later or want to cover a private college have to contribute much more.
Most families aren’t able to save that much, so the next best thing is to simply save what you can — after you’re fully on track with your retirement savings.
You shouldn’t prioritize paying down your relatively low-rate debts over these two far more important goals. But you may want to consider refinancing your mortgage to dramatically lower your rate and perhaps free up more cash for your goals. Just try to make sure the loan will be paid off by the time you plan to retire. A 15-year loan, in other words, might make more sense than refinancing into another 30-year mortgage.
Raiding retirement funds could deplete them
Dear Liz: I retired two years ago at age 60 and draw $5,525 a month from two pensions, which covers our necessary expenses. What it doesn’t cover is travel, which we enjoy. To pay for our trips, I’ve been withdrawing $10,000 a year from my 401(k). So far, the account has grown enough to offset these withdrawals. I’d like to wait to start claiming Social Security, since I know that will increase my benefit. Should I continue my annual withdrawal from my 401(k) for the next couple of years and not start Social Security, or apply for Social Security and not touch the 401(k) so it can keep growing?
Answer: You’ve been lucky the past two years, but your luck may soon run out.
Favorable market conditions allowed your 401(k) to make up for your withdrawals, but there’s no guarantee that will continue. Bad markets dramatically increase the chances a retiree will run out of money, since withdrawals are being made from a shrinking account. The money taken out isn’t there to benefit from the inevitable rebound.
That doesn’t necessarily mean your withdrawals, or your travel, has to stop. But you need to have a better handle on how much you can withdraw each year without running a big risk of running out of money. You can get a rough idea by using mutual fund company T. Rowe Price’s retirement income calculator at www.troweprice.com/ric. For the best results, however, you should hire a fee-only financial planner to review your situation and make suggestions about how to make your money last.
Don’t tap retirement funds for a bigger down payment
Dear Liz: My husband is 30 and I’m 28. We were told the importance of contributing to our retirements and so now have $58,000 saved. We have an additional $65,000 saved for a down payment. Due to my son’s recent liver transplant, I won’t be able to work for an indefinite amount of time, so we are reduced to one income of about $60,000. We have to move to get into a better school district and can’t decide what to do. We’re currently looking at homes in the $200,000-to-$250,000 range. My husband wants to use my $38,000 retirement savings (which would be $30,000 once taxed) to get into a home with a lower payment that will not require me to work. I’m scared to do this since everyone preaches retirement, but at this rate we won’t have a mortgage when we retire. Plus, who wants to be a millionaire at 60! I want to enjoy life while we’re young and our kids are young. We are very disciplined but just don’t know what to do. Thanks!
Answer: You can enjoy life and still refrain from doing stupid things that will jeopardize your retirement.
And tapping retirement funds early is typically pretty stupid. You’re giving up all the future tax-deferred returns that money could have earned. By the time you’re 60, that $38,000 could have grown to nearly $450,000.
You also may be underestimating the tax bite. You can withdraw up to $10,000 from an individual retirement account for a first-time home purchase, but the remainder of the withdrawal will be penalized at a 10% federal rate, plus whatever penalty your state assesses. The entire withdrawal will be taxed at your current income tax rates.
The taxes and penalties are substantial for a reason: You’re supposed to leave this money alone. Since you probably won’t be able to contribute to a retirement account for a while, it’s even more important not to squander these funds.
Besides, the extra $30,000 would lower your monthly payment by about $160 on a 30-year fixed-rate mortgage at 5%. That doesn’t seem like much of a payoff considering what you’d be giving up.
Do your research before relocating
Dear Liz: I’m 55 and single with no dependents. I have about $250,000 invested. I rent an apartment in Los Angeles. I work in sales, which I can do anywhere. Would I be better off buying a house for about $150,000 now (somewhere in the middle of the country), thus reducing my living expenses (property tax and insurance will cost much less than rent) and leaving me with about $100,000 left for retirement, or just continuing to invest the entire $250,000 for retirement?
Answer: Moving to a less costly part of the country is a time-honored way to make your money stretch further in retirement. It also can help you save more for retirement if you dramatically lower your living expenses.
What you don’t want to do, though, is incur all the expenses of moving and buying a new home only to discover you hate where you’re living. Do substantial research and visit your targeted communities at different times of year before you commit.
Also, tying up 60% of your portfolio in a single, illiquid asset such as a home is risky. You may well be better off moving to a cheaper area and continuing to rent until you’ve built up a bigger nest egg.
Ducking payroll taxes in retirement
Dear Liz: I am 66 and receive Social Security benefits in addition to working part time. I’m covered by Medicare. My employer deducts payroll taxes for Social Security and Medicare from my paycheck. Since I get no benefit from these taxes, do I have any recourse to recovering what amounts to $100 a month? My employer says the payroll service it subscribes to automatically makes these deductions.
Answer: The short answer is no. If you work, you typically have to pay into the Medicare and Social Security systems. Console yourself with the fact that you’re at least receiving the benefits for which you paid earlier. Younger workers typically pay in much more each month with no assurance they’ll get the full benefits they’ve been promised. As currently structured, Social Security will be able to pay just 75% of promised benefits after 2036, and Medicare is scheduled to run into the red several years earlier.
