Archives for October 18, 2018

If there’s one tool that financial experts seem to unanimously love, it’s the Roth IRA. It’s often touted as the hands-down best way to save for retirement, even inspiring a full-blown movement to encourage more people to contribute.

Is this retirement account really the slam-dunk experts make it out to be? Not exactly.

Most people would be better off not having mortgages in retirement. Relatively few will get any tax benefit from this debt, and the payments can get more difficult to manage on fixed incomes.

But retiring a mortgage before you retire isn’t always possible. Financial planners recommend creating a Plan B to ensure you don’t wind up house rich and cash poor.

A mortgage-free retirement is usually best. Mortgage interest is technically tax-deductible, but taxpayers must itemize to get the break — and fewer will, now that Congress has nearly doubled the standard deduction. Congress’ Joint Committee on Taxation estimates that 13.8 million households will benefit from the mortgage interest deduction this year, compared with more than 32 million last year.

Even before tax reform, people approaching retirement often got less benefit from their mortgages over time as payments switched from being mostly interest to being mostly principal.

To cover mortgage payments, retirees frequently have to withdraw more from their retirement funds than they would if the mortgage were paid off. Those withdrawals typically trigger more taxes while reducing the pool of money that retirees have to live on.

That’s why many financial planners recommend that their clients pay down mortgages while they’re still working so they’re debt-free when they retire.

Increasingly, though, people retire owing money on their homes. Thirty-five percent of households headed by people ages 65 to 74 have a mortgage, according to the Federal Reserve’s Survey of Consumer Finances. So do 23 percent of those 75 and older. In 1989, the proportions were 21 percent and 6 percent, respectively.

But rushing to pay off those mortgages may not be a good idea, either.

Don’t make yourself poorer. Some people have enough money in savings, investments or retirement funds to pay off their loans. But many would have to take a sizable chunk of those assets, which could leave them short of cash for emergencies or future living expenses.

“While there are certainly psychological benefits related to being mortgage-free, financially, it is one of the last places I would direct a client to pay off early,” says certified financial planner Michael Ciccone of Summit, N.J.

Such big withdrawals also can shove people into much higher tax brackets and trigger whopping tax bills. When a client is wealthy enough to pay off a mortgage and wants to do so, CFP Chris Chen of Waltham, Mass., still recommends spreading the payments over time to keep the taxes down.

Often, though, people in the best position to pay off mortgages may decide not to do so because they can get a better return on their money elsewhere, planners say. Also, they’re often the ones who are rich enough to have big mortgages that still qualify for tax deductions.

“Mortgages many times have cheap interest rates that are deductible and thus may not be worth paying off if your portfolio after taxes can outpace it,” says CFP Scott A. Bishop of Houston.

When a payoff isn’t possible, minimize the mortgage. For many retirees, paying off the house simply isn’t possible.

“The best case ‘wishful thinking’ scenario is that they’ll have a cash windfall via an inheritance or the like that can be used to pay off the debt,” says CFP Rebecca L. Kennedy of Denver.

In pricey Los Angeles, CFP David Rae suggests that mortgage-burdened clients refinance before they retire to lower their payments. (Refinancing is generally easier before retirement than after.)

“Refinancing can spread your remaining mortgage balance out over 30 years, greatly reducing the portion of your budget it eats up,” Rae says.

People who have substantial equity built up in their homes could consider a reverse mortgage, planners say. These loans can be used to pay off the existing mortgage, but no payments are required and the reverse mortgage doesn’t have to be paid off until the owner sells, moves out or dies.

Another solution: Downsize to eliminate or at least reduce mortgage debt. CFP Kristin C. Sullivan, also of Denver, encourages her clients to consider this option.

“Don’t fool yourself that your grown kids will be back visiting all the time,” Sullivan says. “Certainly don’t keep enough space and comfort for them to move back in with you!”

Saving up an emergency fund is a well-trodden piece of personal finance advice. Having a cushion in place when things get tough can mean the difference between a catastrophe and a mere setback.

But debt repayment can also do wonders for your financial health. And it’s hard to get serious about saving cash when you’re constantly bleeding it in the form of interest payments.

So which of these two important budgeting objectives comes first: getting out of debt or saving up a few months’ worth of living expenses?

Save it up or pay it off?

If you have absolutely no emergency savings — like the majority of Americans — most advisors would counsel you to build at least a small buffer before you go all out on debt repayment. Financial advisor Dave Ramsey famously tells people to save up a $1,000 “baby” emergency fund before paying off a single cent of debt, even if they’re drowning in it. This is life, after all; something is bound to go wrong.

But other advisors suggest a bilateral approach in which you contribute as much as possible to both goals. That way, you can start chipping away at that towering debt while still working toward an emergency cushion.

It can be difficult to decide how to allocate your funds, particularly if they’re limited. So if you’re stuck in this conundrum yourself, we suggest you consider the following factors.

What kind of debt is it?

While it’s never an ideal scenario to owe money, certain types of debt are more harmful than others.

For example, credit card debt is pretty much always terrible. Most consumer cards come with high interest rates, and carrying a revolving balance offers you no real benefit. Auto loans are another not-so-nice form of debt, thanks to vehicles’ tendency to rapidly depreciate. (Yes, you may need a way to get around, but from a financial standpoint, a paid-off beater is the way to go.)

On the other hand, a home loan can help you build equity while keeping a roof over your head, and even a so-so mortgage usually carries less than 5% interest. There are also reasons to consider taking your student loan payoff strategy slowly. For one, most of us have five-digit educational debt totals — and if you prioritize paying off every cent of it before you invest, you’ll miss out on valuable years of compound interest.

So while repaying any debt is a commendable goal, it’s worth taking a moment to assess what kind of debt you’re carrying and how harmful it really is to your financial health and future. (Hint: If it’s credit card debt, get on it.)

What’s your current income — and how can you make more?
Naturally, your ability to work toward any financial goal is profoundly influenced by your cash flow. If nearly every cent you earn is tied up in necessary expenses, you won’t get far toward either objective, no matter how diligent you are.

The first step is to honestly analyze not only how much you’re earning, but where exactly it’s all going. If you don’t have a line-by-line budget, creating one can be a real eye-opener — and it may help you discover expenses ripe for cutting.

But in the end, you can only skip so many caramel macchiatos or after-work beers. Finding ways to increase your income will make your quest for financial independence a whole lot easier, as will diversifying it (i.e., finding new income streams so you’re not completely reliant on just one). For example, you could try picking up a part-time job. Some side hustles can actually earn you a lot of money.

How stable is your lifestyle?

Nobody can predict the future, but chances are you have some idea of your overall level of financial risk.

Are you young and in good health, or do you think you may someday need costly drugs and/or medical operations? Have you been with the same company for decades, or are you a fresh new face at a bootstrapped start-up? While emergencies can happen to anyone at any time, you might want to prioritize your savings goal if you’re in a financially precarious situation.

While your exact ratio of saving to debt repayment should depend on your personal lifestyle and financial choices, it’s always a good idea to have at least a little cash on hand for life’s inevitable surprises. And it’s easier to repay your debts with gusto when you’re not scraping by, paycheck to paycheck.

Want to get a better idea of exactly how big an emergency fund you need? Try this handy calculator. And if you’re looking for ways to pay off your credit card debt in a hurry, check out these tips.

And don’t forget: Whether it’s debt repayment, saving up an emergency fund, or stashing cash for retirement, every penny you can put toward your goal helps — so no matter what you decide, get busy.

With the Mega Millions jackpot at an estimated record high of $868 million ahead of Friday’s drawing, many are dreaming of what they would do with life-changing money.

Neighbors of lottery winners may want to mentally prepare themselves, too. They’re more likely to go bankrupt, a 2016 study by the Federal Reserve Bank of Philadelphia found. Researchers theorized that neighbors of lottery winners were unconsciously trying to match their spending and going broke in the process.

But there are better ways to compare yourself to others. It all depends on who you choose to compare yourself to, and which direction you look when comparing yourself to others.

Those are the findings of a 2018 study by behavioral economist Sarah Newcomb at the Chicago-based investment research company Morningstar.

“Our results lead us to conclude that harnessing the power of social comparisons might be able to meaningfully improve everyone’s financial well-being, which could help us make better financial decisions,” Newcomb wrote.

She surveyed 699 people across a range of income levels to see how they felt after comparing themselves to others. The survey wasn’t nationally representative and didn’t prove a causal link, but Newcomb found strong evidence that people feel better about their own financial health when they do it in certain ways.

Here are the take-aways:

Don’t fight the urge to compare yourself to others — do it better

Humans have a natural urge to see where they rank in the pecking order, and ignoring it is nearly impossible. It’s worth learning how to do it the right way, because people’s feelings about their relative status affect their view of their financial health more so than their income level, age, gender or occupation, Newcomb found.

In fact, people’s happiness tops out when they earn about $95,000 a year, psychologists at Purdue University and University of Virginia found, and even people with six-figure incomes worry about money, according to a 2017 PricewaterhouseCoopers survey. So if want to feel better about your finances, it makes sense to explore other ways of doing so. (One note: The more often you compare yourself to others, the worse you feel about your own financial life, Newcomb found, so try not to do it too often.)

Look down instead of up, but be careful about over-analyzing

People have a tendency to look up and measure themselves against others who seem to have more money and resources than they do. This holds true across all income groups, even for people on the top rung of the income ladder, Newcomb said.

It’s easy to assume that looking up is good for us because it’s a way of challenging ourselves to do better and be aspirational. The problem: It makes us feel worse about our own financial well-being. “It backfires,” Newcomb said. “It’s not working. We may actively be participating in lowering our own financial well-being.”

The easy solution: Look down and compare yourself to people who don’t have as much as you do — it can even be yourself at an earlier time in your own life, if you don’t like the idea of looking down your nose at people. It’s a cliché, but it works, because it’s a way to be grateful for what you have, Newcomb said.

That said, choose wisely. Make sure the person is someone who’s enough like you that you can identify with them, but they shouldn’t be too similar to yourself. If they’re too much like you, you could hurt your sense of financial well-being by becoming scared that you’ll end up like them.

Find a financial role model, someone who is within reach

Participants in Newcomb’s survey felt better about their financial health when they compared themselves to role models rather than family, friends, neighbors or colleagues. A role model is someone whose behaviors and qualities you want to emulate — and someone who feels the way you want to feel about money.

“A very wealthy person who works 80 hours a week and is sick from stress may not be a good role model,” Newcomb said. “Someone who has managed to achieve the lifestyle you want while also finding balance is a more likely choice.”

Once you identify this role model, Newcomb advises, ask yourself what behaviors led them to where they are today? How long did it take them, and how long might it take me? And lastly, what is something specific I can do right now to be more like them?

Be mindful on social media when keeping up with the Kardashians

Of course, Facebook FB, +0.40% Instagram and other social media platforms make it easier than ever to “compare and despair” — and all that time scrolling can take a toll on mental health. Newcomb says it’s key to remember what you’re looking at when you see your friends’ photos.

“We have to understand that when we see someone else’s highlight reel, we’ll compare it our own blooper reel,” Newcomb says. “It’s their best most staged moments compared to our private humiliations. What we have to do is catch ourselves and add some conscious thought to unconscious thought.”

The effects of comparing our financial decisions to other people’s decisions is a growing area of study for behavioral economists. Other research by Duke University’s Center for Advanced Hindsight has suggested comparing yourself to others could help control spending. Researchers conducted an experiment last year where members of an Arizona credit union were given the chance to see how their spending on restaurant meals compared to their peers.

Many of the participants had mistakenly assumed their peers were spending more than they did, and, when they found out their peers were actually spending less than they thought, they decided to reel in their own spending.

“Something about social norms is powerful in changing behaviors, but we still have a lot to learn,” said Andrea Dinneen, a senior behavioral researcher with the Center for Advanced Hindsight. “There’s a lot of ways in which it can backfire.”