Dragging debt? You’re not ready to retire

Dear Liz: I just turned 65 and had planned to wait until 70 to retire. I love the actual work I do but my boss is very challenging. I’m starting to question whether working here another five years is really how I want to spend my days at this point in my life. I have about $175,000 in my 401(k), about $35,000 in an IRA and $1,500 in a single stock that’s not in a retirement account. I have two years left on my primary mortgage and a $17,000 balance on my second mortgage, plus I owe $3,500 on a line of credit and $2,000 on credit cards. I was starting to take money out of my IRA to pay down my mortgage early but the taxes at the end of the year were so much that I stopped that distribution. (I still owe $500 to the state tax agency.) I have also had trouble keeping up with my property taxes and owe about $3,500. I live in a 900-square-foot home which I love and live a fairly simple life. I’m wondering about cashing in the stock and some of my IRA to pay down my debt, then using my 401(k) for living expenses until I actually draw from Social Security. As I’m typing this out I’m thinking, “Are you crazy?” I’d love your thoughts.

Answer: One definition of insanity is doing the same thing over and over again, expecting different results.

Tapping your IRA incurred a big tax bill that you’ve yet to fully repay. You also lost all the future tax-deferred gains that money could have earned. Why would you consider doing that again?

You may long for retirement, but it’s pretty clear you aren’t ready. You don’t have a lot of savings, given how long retirement can last, and you’re dragging a lot of debt. The type of debt you have — second mortgages, credit lines, credit cards — is an indicator you’re regularly spending beyond your means. If you can’t live within your income now, you’ll have a terrible time when it drops in retirement.

So instead of bailing on work, take retirement for a test drive instead. Figure out how much you’d get from Social Security at your full retirement age next year (you can get an estimate at http://www.ssa.gov.) Add $700 a month to that figure, since that’s what you could withdraw from your current retirement account balances without too great a risk of running out of money. Once you figure out how to live on that amount, you can put the rest of your income toward paying off debt (starting with your overdue taxes), building up your retirement accounts and creating an emergency fund. It’s OK to cash out the stock to pay off debt, since it’s not in a retirement account, but make sure you set aside enough of the proceeds to cover the resulting tax bill.

Don’t forget to budget for medical expenses, including Medicare premiums and out-of-pocket costs. Fidelity estimates a typical couple retiring in 2013 should have $220,000 to pay out-of-pocket medical expenses that aren’t covered by Medicare. That doesn’t include long-term-care costs. Your costs may be lower, but you’ll want to budget conservatively. Spend some time with the Nolo Press book “Social Security, Medicare & Government Pensions: Get the Most out of Your Retirement & Medical Benefits.”

You’ll be ready to retire when you’re debt-free and able to live on your expected income without leaning on credit.

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Reverse mortgage: what to consider

Dear Liz: All my friends have said I should get a reverse mortgage to be able to live more comfortably and still stay in my house. I would think our greedy banking system would give you only 50% of value and have a high interest rate that would chew up the remaining value. What is your advice on the merits of this option?

Answer: A reverse mortgage program that lets you tap too much of your home equity wouldn’t be in business very long.

Reverse mortgages allow people 62 and older to borrow against the value of their homes without having to make payments on the debt. Instead, the amount they owe typically increases over time because interest is charged on the loan, and that adds up. Lenders get paid back when the owner moves out, sells the house or dies. If the house is worth less than the debt, the lender (or more often the insurer) suffers a loss.

Too-generous lending standards have already caused trouble for previous iterations of the Home Equity Conversion Mortgage, the federally insured option most often used by borrowers. Too many borrowers grabbed big lump sums up front, straining the program’s reserves and leaving the borrowers with few options if they ran into hard times later. Defaults rose as borrowers failed to pay their property taxes and insurance premiums as required.

The Federal Housing Administration, which insures HECMs, has tightened the rules so that borrowers can access less of their equity upfront. Fees also have increased.

How much you can borrow using a HECM depends on your age, the home’s value and current interest rates. Interest rates for lump-sum withdrawals are fixed, while those for lines of credit you can tap over time are variable.

You’ll certainly get a better (or at least less expensive) deal if you borrow 60% or less of your home’s value. The mortgage insurance premium for loans below that level is 0.5% of the home’s appraised worth under the new federal government rules that go into effect Monday. Those borrowing more than 60% face a premium equal to 2.5% of the home’s value. That’s in addition to a 1.25% annual mortgage insurance premium.

There’s no getting around the fact that these are expensive and complex loans. They’re usually not a great choice for people who have other assets to tap. They also can prove a land mine for people who drain their home equity too early and wind up with no resources later in life. On the other hand, they can provide a more comfortable retirement for those who would otherwise be strapped for cash, particularly if the borrowers opt for a steady stream of monthly payments rather than the upfront lump sum.

If you are considering a reverse mortgage, you should talk to a fee-only financial planner who is familiar with the program and who can review your other alternatives.

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Are retirements really longer these days?

One of the “givens” I often see in discussions about retirement is the idea that previous generations didn’t have much of one. Great-grandpa got to the end of his working life, got his gold watch and keeled over.

Short or non-existent retirements certainly were the rule before the 20th century. People usually worked until they died or until they were physically unable to continue. There were some exceptions; Civil War pensions allowed older veterans to leave the workforce earlier and some companies launched mandatory retirement policies in the late 1800s. The fact remains, though, that many people ended their lives in abject poverty because they could no longer work. That was what prompted the creation of Social Security in the 1930s.

It’s not true, though, that people in the 20th century died shortly after turning 65. That’s obvious from this table of historical life expectancies compiled by the Social Security Administration.

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Check out the last two columns. Even in 1940, men could expect to nearly 13 more years and women nearly 15. Life expectancies at age 65 have certainly gotten longer (20% longer for men, 33% for women) since 1940. The bigger change has been in the percentage of people making it to 65. Improving safety standards and better health care meant a whole lot more people got a shot at having a retirement.

(And these figures don’t account for reductions in infant and childhood mortality, since the numbers in the second two columns reflect adult survival rates from age 21 to 65.)

Another big change came in 1961, when the earliest age for collecting Social Security benefits dropped to age 62. That plus longer life expectancies contributed to lengthier retirements.

The trend seems to be reversing. The average retirement age for men has risen in the past 20 years from 62 to 64. The average retirement age for women also increased from 59 to 62.

That still leaves a lot of years to support yourself, which is why delaying retirement and working part-time in retirement are often good strategies for making your savings last.

 

64 and broke: what now?

Dear Liz: I’m 64 and lost my last full-time job a year ago. I have since exhausted my unemployment benefits and been on and off food stamps. (I’m waiting to get back on them right now because my temporary-to-permanent job didn’t become permanent after all.) Fortunately I almost never need to go to a doctor, or if I do, I don’t know that I do and can’t afford to find out. I have about $3,000 in emergency savings, and my IRA is about $15,000. I was fortunate enough to sell a home in Hawaii 20 years ago, but I managed to run through all the money. My income when I was working full time was only $26,000 a year. I don’t know what to do, and I don’t know why I listen to all these financial programs that seem to target twentysomethings or people with retirement savings and comfortable incomes. They do not speak to my situation. My priority isn’t saving for retirement. It’s paying the bills.

Answer: Financial programs are, at least to some extent, concerned about the entertainment value of their programming. They often focus on people who fit their audience demographics and whose problems have satisfying solutions. That’s why the people featured tend to be younger or to have resources, because those are the ones who typically can recover from past mistakes and get their finances on track.

When people have no income, there’s not much financial advice to give. And when they’re in their 60s and have virtually no retirement savings, there’s no way to “catch up.”

That doesn’t mean your situation is hopeless, but it does mean you’ll have to hustle to stay afloat.

Finding a full-time job at this point is a long shot, so part-time work and Social Security probably will provide your income in the coming years. Social Security might replace as much as 40% of your previous low income (the replacement rate is lower for higher earners), but that still leaves you with a substantial gap to fill.

Ideally, you would hold out until age 66 before applying so you can get your full Social Security benefit. You’re eligible for benefits now, but your checks will be permanently reduced if you start early and your earnings could potentially reduce your check further under the earnings test (which you can learn more about at http://www.ssa.gov/oact/cola/rtea.html). The benefits that are withheld aren’t lost, because at full retirement age your monthly check would be increased to account for the withholdings. You’ll have to balance whether those disadvantages outweigh the upside of starting a guaranteed income now.

By the way, if you’ve ever been married and the marriage lasted at least 10 years, you may qualify for spousal or survivor benefits (even if the marriage ended in divorce) that could exceed the benefit you’ve earned on your own record. You can discuss your options by calling the Social Security Administration at (800) 772-1213.

You’ll need to look for ways to reduce your expenses so that you can get by on whatever income you receive. If you qualify, the federal Section 8 program could help pay for housing (start at Benefits.gov to see what programs are available). Some of the other ways to reduce housing costs — the biggest expense for most people — include getting a roommate, becoming a live-in caregiver for an older person or a family with kids, or becoming an apartment manager or the caretaker of a property.

At 65, you’ll qualify for Medicare. Although this government health insurance program for older Americans doesn’t cover everything, you will have access to healthcare again.

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