Coffee heat rising

Is it time to punt?

This month’s statement from Fidelity shows another $10,000 loss in my big IRA, despite my financial advisors’ having moved as much as possible into conservative investments, gold, and cash.

At the age of 63—damn! soon to be 64!—I’m watching my retirement investments melt away. That IRA has dropped in value from a high of $326,000 to $193,000. Total savings have dropped from over $600,000 to less than $420,000. Meanwhile, we owe $23,000 more than the Investment House is presently worth, and I took out a second on my own house to renovate said investment.

I’m wondering if it’s time to do something completely, utterly, totally contrarian. Hang onto your hats, folks, because this is one scary idea:

Maybe I should cash out that big IRA before it’s all gone. I have enough set aside in savings to pay off the small second mortgage on my house; if instead I combined that with the amount remaining in the IRA, I could use the money to pay off the loan on the Investment House. My son could then continue to pay me the amount he’s been paying toward the mortgage as a variety of “rent.”

I would repay him his share of our combined investment in the house so far. This would provide him enough to go back to school, which he would like to do.

If he decides to go to the University of Arizona, which has a better graduateprogram inpublic administration than the Great Desert University’s, I could either rent his house, providing a nice bit of cash flow, or I could rent mine for even more, move into his, use the rental on my house to cherry out the little house downtown, and collect a ton of money.

Because I no longer have enough in savings to support me in old age, I’m going to have to work until I drop. When the deans physically throw me out of the place (assuming I haven’t died before then), I would have the rental income from one house, Social Security, and income from taking out a reverse mortgage on whichever house I’m living in.

Hm. I wonder what that would look like?

Let’s assume a miracle happens and the Obamaites succeed in turning the economy around. Let’s assume that starts to happen in, say, three months, during which I continue to lose at the rate of 10 grand a month.

Several options present themselves:
1. Stay the course. Change nothing in the investment strategy
2. Pay off the house; have my son pay the amount he’s been paying, only to me.
3. Pay off the house; my son goes to school elsewhere and I rent his house.
4. Pay off the house; my son leaves for graduate school; I move into his place and rent my house.

I ran some figures in Excel. My math is not very good, so these prognostications may be out in left field. But if I’m right, it looks like I would be better off to pay the mortgage and have M’hijito pay me a monthly “rental” in the amount that he’s now paying the mortgage company. I’d still have enough to refund him his investment in the house, which would pay a big chunk of his graduate school tuition, or at least revive his Roth IRA.

I posited three mortgage-payoff scenarios and estimated my net income if I retired at age 66 (which ain’t gunna happen) or at age 70 (the earliest I can imagine being able to afford retirement). I assumed equity investments would continue to drop 10% a month for the next three months and then begin to rise at about 3% a year from now forward. In scenario 1, M’hijito stays in the house and pays me rent of $600 a month. In scenario 2, he goes to graduate school in Tucson and I rent his house for $950/month. In scenario 3, he goes to Tucson, I move into his house, and I rent my house for $1,000/month.

I listed all the bottom lines in Excel and then sorted to show the numbers ranging from least income to most income.

Compared with staying the course (leaving my investments where they are and continuing to pay the mortgage), all three pay-off-the-mortgage scenarios seem to look better, unlessM’hijito stays in the house and I’m forced to retire or am laid off at age 66.

payoffhouse

The big unknown is whether I will keep my job. If I’m canned before I reach age 70, we lose a very big bet. But if I can hang on until age 70 and I’m not purely raped by the taxman, then I end up with a net income fairly close to my present net.

On the other hand, if I’m canned, we’re screwed anyway.

My son would get back the money he put into the down payment. He could continue to live in the house as long as he pleased, but he would no longer be chained to the thing: he would be free to go to school or take a better job elsewhere.If I moved to his house, when I really get desperate for money (which will inevitably happen as my health starts to fail and medical care costs soar), I could take out a reverse mortgage on the place. M’hijito would then lose that house after I die, unless he wanted to pay off the reverse mortgage, but he would inherit my paid-off house, which by then would be making a nice rental income for him, or (with some fix-up) would be a good place for him to live.

Whaddaya think? Crazy? Or not crazy?

11 thoughts on “Is it time to punt?”

  1. Wow.

    I read through that entire post but I am still working my brain around your neatness of numbers 🙂

    I don’t think you can really make a true decision until you figure out how much you’re going to have to pay in penalty taxes first.

    There’s a lot to take in, and a lot of scenarios. Might I suggest just running 1 scenario for now? Going ahead with the situation (taxes and all), and losing your job.

    Then factor in that amount and see what you get net out of it then run the rest of your #s and then look at the CNL (Cumulative net loss) of taxation, loss in market, etc.. then run one single simulation for the worst case scenario of losing your job etc, and seeing if you could survive and/or what the bare minimum is required for you to continue living.

    If you cannot, then tweak the numbers until you get to something reasonable, like maybe take out 50%, clear most of the mortgage, etc etc.. play around with ONE scenario until it fits, but start with the worst scenario imaginable first.

    Hard decisions especially since you are nearing retirement.

  2. It’s hard for me to get inside your numbers, but, basically, paying off investment house would give you guaranteed return of whatever your mortgage rate is.

    I don’t think your plan is truly contrarian–that is what everyone who is panicking (i.e. most people) want to do: get out of equities.

    When you retire, you can take cash first out of whatever investments you want–in other words, I would not take out of equities now.

    I have no idea if any of this makes sense.

    I am luckier than you are only because I’m 9 years younger.

  3. You know Funny, I like your thinking. Your proposal makes a whole lot of sense. I say go for it and pay it off.

  4. Let me just preface this: I’m not knowledgeable about stocks/bonds/etc. But I do know something (as in, far from professionally but enough to give friends and family some help) about taxes. So I’ll start with why the IRA withdrawal is a bad idea tax-wise.

    1. You’ll be taxing yourself at 10% (penalty for early withdrawal) — so right off the bat that $190,000 becomes $171,000.

    2. If your IRA isn’t a Roth, your tax bracket will ratchet up skyward. The IRA will be taxed at over 33% and your deductions will be limited because you’re in a high tax bracket.

    Now, let’s look at it from an inveestment standpoint:

    1. You’re 64 (almost) and the earliest you could even CONSIDER retiring is 70. That’s SIX YEARS for the stock market to turn around.

    2. Actually, it’s more because generally speaking you don’t take the whole IRA out at once. You take out a percentage of the whole. So if the value doesn’t increase by age 70, take out as little as you can, because I’d be pretty shocked if the market hadn’t recovered by the time you were 75! (I’m basing this on overall cycles of boom/bust.)

    Also, you don’t mention SSA and I’ve only been reading for about a month. So I don’t know if you’ve already taken it. I’m assuming not, since your projected income if you do nothing is $18,000.

    So consider your options on SSA. Yes, your benefit rises pretty decently for each year (up to 70) you don’t take it. But at the very least, it’s a good safety net to know about.

    Now you also didn’t really mention (again, I’m a newbie) why your “savings” is fluctuating. I would take the bulk of that and put it some place a little less scary! Yeah CD rates/internet bank rates are awful but at least they’re assured growth.

    Also, I’m not sure why you’d raid your IRA to pay down that debt, but not your savings, which has over twice the value. Since it’s obviously in an investment vehicle, you might have to pay a small penalty. But nothing like the 10% on your IRA.

    I think you really need to figure out what you want your retirement income to be. I recently read (and will be reviewing) “Spend to the End” which is really helpful in that regard. The idea being that you should be using your savings and income so that your standard of living doesn’t drop dramatically.

    I’m going to take a random guess at some figures because I don’t know how much your son put into the house. Given that your home equity loan plus your IRA would about cover the rest of the mortgage, that makes it under $250,000. So let’s go with that.

    So you take out the $410,000 (assuming 2% penalty for early withdrawal from whatever you have it in). You use $250,000 to pay off the mortgage. Now you have $160,000.

    Not sure how much your son gave you to help with the mortgage. I’ll just assume enough for a couple years of grad school, so let’s say $60,000.

    So you have $100,000 left of savings. Not great but better than a sharp stick to the eye. Parceled out over the next 30 years — with absolutely 0% — that’s an extra $3,000+ dollars a year.

    So how much do you need to live on? Let’s fast forward to 70, assuming you don’t change anything.

    I’m guessing by that time, your son will have moved on or at least paying you a more fair amount of rent. (I mean, he’ll be working rather than being a student and will be able to afford it.) So let’s assume you get $950 for the place. That’s $11,400 in rental income. Add in another $1000/month for SSA, that’s $23,400 a year. All that without touching your IRA.

    So let’s assume that magically, when your IRA does recover a bit, it hovers right at $150,000 for the next 30 years. That’s another $5,000 a year, bringing your total up to $28,400 (minimum) all without any of your future savings or IRA contributions taken into account.

    I just think you’re really jumping the gun. I think you need to figure out how long before you quit working and what standard of living you’re hoping to achieve. Obviously, inflation will change things. But then your rental income will probably increase over the years, as well, because of that same process. And your IRA will probably get back up above $150,000 before you even get to 75. Finally, I just chose the $1,000 in SSA because most people make more than that, so it’s a safe worst-case-scenario.

    So if, in a worst-case scenario, you are making $28,000 and own two houses, just how bad off are you? (And yes, I know you still have the HELOC to pay down but I’m assuming in this scenario you make monthly payments along with other bills.)

    If you want to clear some of these issues up a bit, and let me know what yearly income you’re shooting for, I might be able to get you a slightly more firm answer. But then again, you seem pretty handy with spreadsheets, so I imagine you could do that yourself.

    My point is, as I was just reading in a PF book, the old adage is buy low, sell high. But people panic and do the exact opposite. They jump on the bandwagon (so the price is already up) and then, when the price starts falling, they sell and lose a ton. Yes, right now your IRA is bad. And will probably get worse. But for how long, really? And is it worthwhile to take that tax penalty AND potentially mess up tax brackets rather than use your more accessible savings?

    I think you may be reacting out of fear rather than logic. It’s understandable. Money fears are overwhelmingly strong. But that doesn’t make them right.

  5. I’m over 59 1/2, and so I won’t have early withdrawal fees. I’m already withdrawing $800/month to pay my share of the mortgage, most of which is going down the toilet in the form of interest. Because the money goes directly into an investment with all sorts of write-offs and deductions, the taxes are to some degree washed. I do not know what would happen, though, if I yanked out $183,000 to put into the mortgage: that might trigger a large tax bill.

    The amount in that IRA is now less than it contained at the time I came into the money, almost 20 years ago. You see the problem: it took TWENTY YEARS for it to grow to the point where I thought I could live on the proceeds of my investments (tax-deferred and nondeferred) plus Social Security. Seven years will not be long enough to recover enough in those funds to help me with retirement.

    Each scenario given in my li’l Excel chart includes Social Security, which changes according to when you decide to begin drawing down benefits. At age 66, the combined net income from Social Security and 4% of my total savings (assuming the various savings instruments begin to grow and do so at about 3% per annum from now on, which is a very big assumption) will be $18,028. If I waited til age 70 to start collecting SS, my net income would be $27,148.

    The present base cost of running my house, property taxes (which will go up), and home and auto insurance is presently $14,280. Medicare will cost 12 times what I’m paying for health insurance now, adding another $3,600 to the basic cost of living, for a total of $17,880. That’s BEFORE I’ve paid for food, clothing, maintenance on my house, and maintenance on my car.

    While I just MIGHT get by on $27,148, it would be very, very close. Remember, the cost of everything will have gone up by then, and so $27,000 won’t go as far as it does today.

    My present net income is about $39,000. Of that, I put about $5,280 into savings for costs such as clothing, unexpected house and car repairs, vet bills, and the occasional indulgence. So presumably I could get by in moderate comfort on $33,720 net. Much less than that, and I will have to sell my home and move to Sun City, where taxes and other costs are lower… That’s an option I view with abhorrence.

    As things stand now, $33,720 ain’t gunna come out of my savings and Social Security!

    It looks suspiciously to me as though if we turned the house into an income-producing property by paying off the loan on it, at 70 I would be reasonably comfortable.

  6. Ugh! I reread this morning. Never write advice at 11 p.m. I’m so used to hearing people under 591/2 talk about raiding their IRAs I’m afraid I knee-jerked on that.

    So, okay, no tax penalty. That definitely helps the scenario.

    The main concern, then, is if the IRA is traditional, which I’m guessing it is if you’re talking about tax ramifications. If it’s a Roth, you’re safe, obviously. If it’s not, then I would really be careful about paying off the house.

    On the one hand, yes, you’ll save on interest. But you should balance that against taxes. If your income is that high, your itemized deductions are limited, as are your personal exemptions. So you’ll be taxed on over $200,000 income this year — top tax bracket — but your itemized deductions and personal exemptions will be limited because of the high income.

    Also in the future you will need to pay self-employment tax (15.3%) plus regular tax on rental income. So you may want to have the interest to balance out the money you get. On the other hand, you may make more money by simply paying it off now and just paying the self-employment taxes as they come. You’d need to run the numbers or have someone do it. I think the biggest thing is just how badly the tax bracket change would ratchet up your income.

    Just remember that at the highest tax bracket your $190,000 will evaporate down to less than $130,000. You can’t count on the tax breaks of the mortgage interest, either, since your deductions will probably be limited. So you’ll end up owing more than you’ve been having taken out on your withholding taxes at work. Of course, you have savings to cover that in a pinch.

    But your scenario (albeit miracle-based as you say) has your IRA losing $10,000 for three more months. That’s still less than you’d lose by taking it all out now.

    In short, I’d either grab some tax software and play with the numbers to get a loose idea of your tax problem or, probably smarter, go talk to a CPA about tax ramifications.

    Also, Spend til the End had a good piece of advice. It may make more sense to sign up for Medicare asap, despite technically throwing money away (though you can check with the school and if you’re paying for health care at all, they might give you the money. Just tell them you want to buy it elsewhere. Technically true.) it may save you in the long run, given the government’s weird policy about hiking medicare the longer you’re NOT using the nation as a health care provider.

    Finally, I guess I’m wondering how long you think you’ll live. Because you say it took 20 years to get up to $300,000. But there’s probably a decent chance you’ll be living 20 years. Maybe more. Of course, your IRA is invested in lower risk stuff right now. So you won’t get back to where you were. But if you’re only withdrawing 4% of the total and you are assuming 3% growth, that’s relatively sustainable as far as income goes. It won’t be as much as you would have hoped. No one’s disputing that.

    Don’t forget that, as house values do get back on their feet, you can one day consider selling one of the houses and living off those proceeds as well. (Just, of course, be sure you’ve lived there within the past 5 years for capital gains purposes.) Probably not a great idea, but another option.

  7. Funny, I have been thinking about your post in anticipation of my own worries in 10 or so years. Here is a glimpse of the finances of my parents’s retirement: They retired @ 18 years ago, with savings and social security (1990 or so). They have been living off their savings–pretty well, I might say, with a decent amount of travel, golf, etc. No real estate appreciation fueled their savings.

    Even after 2 economic downturns (end of 1990s and now), they still have more cash than they started with and they have been drawing down all this time. So I think it is important not to panic (though it is hard not to). My father was overinvested in stocks and, even so, they (now just my mother since my father died a few months ago) have more than they started with.

    My parents were middle income and my father spent the last 12 years of work as a teacher. So, no, this is not a story of a high income couple.

    Hope this provides some perspective.

  8. Some thoughts on your situation:
    1. It sounds like you were overloaded in stocks with your IRA. You might want to adjust to a 40-60 stock/bond mix. Or less if it makes you comfortable. Gold? Maybe a sliver but not too much. Gold doesn’t throw of interest and dividends and it sounds like you could use the income.

    2. Paying off the house is usually a good idea. But not if it kills your cash flow. Rent it? Can you do home repairs yourself? If you can, it might work. But my stocks and bonds don’t call me at 3 in the morning to tell me the water heater went out. LOL!

    3. Working until you are 70 is good if you can. Hold off on collecting Social Security until then if you can. It will pay you 120% more than if you take it at your “normal” retirement age. Investigate the SS web site!

    4. Ponder converting your investments into immediate income annuities around the age of 70. See immediateannuities.com for info. Vanguard and Fidelity have low-cost choices also. Remember, cash flow is king!

    Good luck!

  9. Things have changed drastically since I wrote this. Now my job ends in December, if not sooner. The likelihood of my getting another fulltime job is nil. The $800/month coming out of the IRA to pay my share of the mortgage represents represents well over half the income from ALL my investments, traditional & Roth IRAs plus nondeferred mutual funds. The combination of what is left of my investment income plus Social Security plus part-time jobs probably will not support me, certainly not while I’m paying on that mortgage. The house is worth, at best, $23,000 less than we owe on it.

    @ Abigail: All my investments, taxable and tax-deferred, are at about 40-60 stocks/bonds, gold, & money market. My present net from my salary is about $39,000. I figure I will need at least $33,000 net if I’m to stay in my present paid-off home, maintain it, and pay the property taxes, which have nowhere to go but way, way up.

    Social Security will be $13,944, gross. Optimistically, income from investments will be $16,000; from that total, $9600 will have to go to pay that mortgage, leaving me a gross of $29,444. Optimistically estimating the income tax bite at 18%, I come up with a net of $24,554, slightly less than 75% of the bare minimum I need to live on. I might make that up with various part-time gigs, but whether I get full-time or part-time work, I can’t work forever! And therein lies the problem.

    I can’t even begin to imagine how people live on Social Security. Then we have Medicare, an 80-20 deal with a whole series of loopholes that can leave you facing vast bills if you suffer a serious illness; and in age, the operative word is “when,” not “if.” You’re required to pay for Medicare Part D, which leaves you liable for thousands of dollars in bills for prescription drugs if you suffer an expensive illness or injury, and to cover the 20%, you have to buy Medigap insurance (providers are not allowed to offer prescription drug insurance that would cover the “doughnut hole”). All told, this cobbled-together arrangement will cost TWELVE TIMES what I’m paying for health insurance now.

    So, my expenses in retirement will go UP, not down. The gas bills for my 10-year-old car may drop $15 or $25. But I don’t wear fancy clothes to the office–I live in Costco jeans and washable knit shirts, which I wear until they fall apart. I don’t eat lunch out, ever. I don’t travel. Don’t have pay TV. Don’t have a cell phone. Don’t play computer games. Have no expensive hobbies. There’s nothing left to cut except a couple hundred bucks a month that goes into savings to cover things like Costco jeans and surprise maintenance bills.

    I suppose one possibility might be to take some money out of savings to pay toward the house’s principal and then refinance. Interest rates are down a bit, but since we got a 5.3% rate, the current 4.8% rate doesn’t offer enough savings to justify the cost of a refinance.

    The remaining option, I guess, is to default. We’d lose about $60,000, not counting the amount that’s gone down the toilet in interest payments. But it may be better to cut losses now than to continue to bleed money. Housing prices have dropped 35% in this area, and they say to expect real estate to continue to fall in value indefinitely. Whether we hang onto the house or walk away from it, we lose. Right now, its sole benefit is to keep a roof over my son’s head. That’s big, but so is the cost!

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