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Can I withdraw money from my retirement accounts without being penalized?
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Q: I'm 56 years old and was laid off from my job two months
ago. Can I take money from my retirement accounts without incurring
the 10 percent tax penalty on early withdrawals?—Patrick,
Missouri
Lynn Brenner replies:
Yes. In fact, if your money is in your former employer's 401(k)
plan, this isn't treated as early withdrawal. When you leave a job
after your 55th birthday, you can take withdrawals from your 401(k)
plan without incurring an early withdrawal penalty. Of course, the
withdrawals are still subject to income taxes.
The penalty usually does apply to IRA withdrawals you take before
you're 59 and a half. Penalties are waived if you're in truly
dire straits—totally disabled, for example, or deeply in debt
because of medical expenses. There is also one relatively painless way
around the penalty, and your age makes you a good candidate for it.
It's called a 72(t) distribution, after the section of the law
that established it, and here's how it works:
You must agree to take a series of "substantially equal"
annual distributions from your account for at least five years or
until you turn 59 and a half, whichever takes longer. But you
don't get to simply pick an amount. The size of your distribution
is based on your life expectancy, and you have a choice of three life
expectancy tables from the IRS, and three different formulas to
calculate your 72(t) schedule.
Ask a tax accountant to do the calculations for you. The distribution
amount can vary dramatically depending on which method you use to
compute it, and the calculations can be complex. Moreover, the
agreement you make is a contract with the IRS: if you withdraw more or
less than the right amount, you're hit with retroactive penalties,
plus interest.
A 72(t) rarely works for young people because they have longer life
expectancies and smaller retirement accounts. That typically results
in a 72(t) distribution that's too small to be of much financial
help, and a distribution schedule that lasts so long that the account
may be empty before they retire.
But the same set of facts works in your favor when you're in your
late 50s: Your annual 72(t) distributions may be big enough to meet
your present needs, yet you'll only be required to take them for
five years. If your situation has by then improved, you can stop
taking taxable withdrawals and let your account continue growing
tax-deferred.
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- What will it cost me to convert to a Roth IRA?
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Q: I'm thinking of converting my traditional IRA to a Roth IRA. What fees are incurred and what surprises may pop up if I do?—Al, New York
Lynn Brenner replies:
Your question is timely. Roth IRA conversions are in the news these days because in 2010 they'll become available to everyone, thanks to a change in the tax law. Currently, you can convert a traditional IRA to a Roth IRA only if your household's modified adjusted gross income (income minus deductions) is under $100,000.
Why consider a conversion? In a traditional IRA, your earnings are tax-deferred; you'll owe taxes on all your eventual withdrawals. In a Roth IRA, your earnings are tax-free, and so are withdrawals after you're 59 and a half and have owned the account for five years. Also, Roth IRAs don't require minimum withdrawals after age 70 and a half, the way traditional IRAs do. If you think you're headed for a higher bracket in retirement, you might prefer to pay the tax on at least part of your retirement savings now.
The price of conversion is the income taxes you'll owe on the amount you convert. Let's say you move $100,000 from a traditional IRA to a Roth. If you're in a 25 percent tax bracket, you'll pay $25,000 in taxes on the conversion. You will, however, be allowed to spread over two years the tax liability for a 2010 conversion—a one-time goodie that's sure to get brokers beating the drum for conversions.
The potential surprise: even if the IRA's value drops after you do the conversion, your tax bill doesn't. For example, let's say you convert $100,000 next June—and then the market tanks. By the following April 15, you would still owe taxes on $100,000 no matter how low the account may have dipped.
One saving grace is that you have a window when you can beat a retreat: you have until October 15 of the year after you do the conversion to undo it. This is called recharacterization; if you've already paid the taxes, you'll need to file an amended tax return to get your refund.
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- How can my wife inherit my share of a rental property?
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Q: My sisters and I own a rental property together. The deed is in all our names, but not our spouses' names. If one of us dies, would the spouse automatically inherit that person's share? If not, how can we rectify this?—David, New York
Lynn Brenner replies:
First, check the deed to find out if you own the house as tenants in common or as joint tenants with right of survivorship. Tenants in common can leave their respective shares to anyone they wish via a will, and that's usually a better way for siblings or friends to own property together. But if you own the property as joint tenants and one of you dies, the surviving owners automatically inherit the deceased's share.
To change the deed from one type of tenancy to the other, all the owners need to be in agreement. Just have a lawyer prepare a new deed, and file it in the county where the house is located. Then you can leave your shares in your wills to your respective spouses.
That's that for investment properties. When the house in question is your residence, there's an additional wrinkle: let's say you and a good friend buy a house to inhabit together in retirement. As tenants in common, you can leave your shares to your respective children. But you also want to make sure neither of you loses a place to live when the other dies. To protect each other, each of you can leave the other a lifetime occupancy right—or, in legal jargon, a life estate in the house.
Whether or not they live together, tenants in common should have a written agreement that if one tenant wants to sell his or her share, the others have the option of buying it at fair market value, says Eric Kramer, an estate lawyer in Uniondale, New York. The agreement should also say how fair market value will be determined. (For example, you could agree to hire two real estate appraisers, and use the average of their appraisals as the buyout price.)
Kramer also recommends keeping a record of your respective contributions to the mortgage, property taxes, capital improvements, and maintenance expenses. If you decide to sell the house together, that record will make it easier to agree on how to divide the sale proceeds.
- Can my creditors seize my Social Security benefit?
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Lynn Brenner replies:
In theory, not very often. In reality, more often than they should.
Federal law generally prohibits creditors from seizing Social Security benefits, with a few notable exceptions: they can be taken to pay child support, alimony, student loans, and taxes.
Nevertheless, creditors often seize Social Security benefits unlawfully, says Robert Hobbs of the National Consumer Law Center. A typical scenario: Mary Smith's creditors obtain a judgment against her and notify her bank that it must freeze her funds. Mary's Social Security benefit is legally exempt from such orders, says Hobbs, yet many banks freeze accounts without even checking whether the money in them is exempt.
In most states, it's up to the account holder to assert the Social Security exemption, a process that often involves going to court and filing an order to show cause to vacate the judgment. In some states, you have a limited time in which to assert your exemption. (For more information, see MFY Legal Services' Get the Facts page and click on "My Bank Account Is Frozen. What Do I Do?")
In another common scenario, banks take Social Security benefits out of customer accounts to recoup unpaid overdraft fees. In those cases, asserting the federal exemption may not work: In June, California's Supreme Court said the exemption doesn't apply to bank overdraft fees. Other states may follow California's lead, and that's sure to affect people who are heavily dependent on Social Security. They incur about $1 billion a year in bank overdraft fees, according to the Center for Responsible Lending, a consumer advocacy group.
But this hazard may be short-lived. For one thing, the Treasury Department is expected to issue new rules prohibiting banks from freezing Social Security funds on behalf of third-party creditors. For another, you can protect your Social Security benefits from seizure starting today by getting a Direct Express Card from Social Security instead of having your benefit deposited in a bank. You won't be able to write checks on it or earn interest— and you'll have to plan well to avoid all transaction fees—but you can use the card at most ATMs, at all stores that accept MasterCard debit cards, and to pay bills online. Perhaps best of all, you can't overdraw a Direct Express card.
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- What are the dangers of cosigning a loan?
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Q: My father-in-law, who has cosigned on a mortgage for a friend, is leaving his estate to his two sons. When he passes away, will his estate be responsible for that mortgage if the primary borrower defaults on his payments?—Grace, New York
Lynn Brenner replies:
In a word, yes. If you cosign a loan, you are as liable as the primary borrower—the loan appears as an outstanding debt on your credit report, the lender can sue you to collect, and after your death your estate can become responsible for the debt.
The situation you describe is a reminder of the perils of cosigning. The mortgage your father-in-law cosigned is a potential claim against the estate. If the primary borrower's finances don't inspire confidence, your father-in-law's executor may want to keep enough assets in the estate to cover the mortgage until it's paid off. That's because it's an executor's duty to settle any debts before distributing assets to the heirs—the executor is personally liable if creditors later come to collect.
So your father-in-law's heirs might have to wait for their inheritance. If the property has accumulated equity, a straightforward way out of the situation would be for your father-in-law (or his executor) to ask the primary borrower to refinance the mortgage alone.
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- My annuities are losing money. What are my options?
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Q: My husband is 65 and I am 58. We have almost 85 percent of our savings in five variable guaranteed annuities, which our adviser recommended to us because our risk tolerance is low. She estimated they'd earn a 9 percent annual return. Instead, they've lost almost 30 percent of their value in the past year. Must I just sit and watch my investments dwindle? I'm told that if I withdraw money before I'm 59 and a half, I must pay a 10 percent penalty plus taxes.—Elaine, South Carolina
Lynn Brenner replies:
You have some choices that won't trigger taxes or penalties, but let's start by clearing up a common misunderstanding. Each annuity withdrawal includes some return of principal and some investment growth. Only the investment growth is subject to taxes and a 10 percent early withdrawal penalty. If your annuity has lost money, taking withdrawals or cashing out of the annuity won't incur a tax or a tax penalty. However, cashing out can trigger surrender charges from the insurer who sold you the annuity, depending on how long you've owned it.
A better choice may be to keep the annuities but change what they're invested in. It sounds as if your annuities are more aggressively invested than you realize. "A 9 percent annual return isn't a conservative projection, especially if that's the after-expense projection," says Michael Kitces, director of research at Pinnacle Advisory Group, a Columbia, Maryland, money management firm. "A guaranteed annuity can cost 2 percent to 2.5 percent a year—so to net 9 percent, you must earn 11.5 percent." But such annuities generally give you many investment options. You can switch to more conservative investments without incurring taxes or penalties.
Or, if you don't like any of the available investment options, you can exchange your annuity for an annuity from another insurer. This transaction, called a 1035 exchange, doesn't trigger taxes or a tax penalty, but bear in mind a new annuity comes with a new surrender charge period. (Almost all annuities carry them.)
Annuity guarantees typically promise to return your original investment, either through a minimum income stream while you're alive or in a lump-sum payment to your survivors. But no two companies' guarantees work the same way. Your first move should be to ask your adviser to explain exactly how your five annuities work. Make sure she studies the fine print. In some annuities, it's possible to inadvertently terminate a guarantee simply by taking too big a withdrawal!
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- Should I consider a self-directed IRA?
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Q: I'm thinking of rolling my 401(k) into a self-directed IRA, but I have questions about where to set it up. Can I do so at a bank?—Kat, Virginia
Lynn Brenner replies:
I think you should reconsider your plan. For the average investor, a so-called "self-directed" IRA is a recipe for disaster.
You can roll your 401(k) into a regular IRA at any bank, stock brokerage, mutual fund, or insurance company. They all act as IRA custodians. Some of them only let you invest your IRA in their own products, but others provide you with an unlimited selection of stocks, bonds, mutual funds, annuities, and CDs.
But self-directed IRAs (a misleading term, since in any IRA you choose the investments you make) aren't limited to these investments. They're set up to let you invest in assets that aren't sold by any IRA custodian—assets that can range from rental properties and private partnerships to cattle ranches and gold mines.
When ordinary investments perform badly, as they have in the last year, it makes sense that more people consider self-directed IRAs. But picking less-conventional investments wisely takes time, attention, and expertise. They typically require a hefty upfront investment. And they're illiquid. It's much easier to sell mutual fund shares than a cattle ranch.
Only a few companies act as custodians for self-directed IRAs—among them, PENSCO Trust, The Entrust Group, and Sterling Trust. Not surprisingly, they charge much higher maintenance fees than you'd pay for a conventional IRA. You may also have to pay fees for research, legal advice, and expert appraisals by third parties. The bottom line: A self-directed IRA can cost thousands of dollars a year.
You must also take care to avoid legally prohibited transactions that would terminate your IRA, triggering taxes on its entire value. For example, you can't invest your IRA in anything you use personally—like your house, a business owned or controlled by you or a member of your family, or even a vacation property that you rent to a friend who invites you to spend weekends there.
Finally, following IRA rules can be cumbersome in this kind of account. If you invest in a rental property, for example, all money for repairs and maintenance must come from inside your IRA. And of course, as you get older, you need enough cash in the account to be able to take required distributions.
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- Are annuities that guarantee a certain return still reliable?
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Q: Several years ago my wife and I invested in three "guaranteed" variable annuities from two very large insurance companies. But how safe are these annuities if the financial markets keep losing money? My financial planner says there are funds set aside to ensure the payouts. Is this true?—Dennis, Georgia
Lynn Brenner replies:
Guaranteed annuities, like anything else that insurance companies sell, ultimately depend on the insurers' prudent management of their money. A guaranteed annuity may not be as safe as a bank account backed by federal deposit insurance, but investments in a variable annuity—typically stock and bond mutual funds—are indeed held in a segregated account, so they're fully protected from the insurer's creditors.
Annuity guarantees vary from one company to another, but here's an example of the way they work:
Let's say you invest $100,000 in an annuity with a 5 percent guarantee. That means the insurer guarantees that the stream of income you'll receive (which depends in part on your age when you start receiving it) is based on a figure that's at least as much as your balance would be if your $100,000 had grown 5 percent a year. For example, in eight years you could start getting lifetime income based on an account balance of $147,745 even if your investments are really worth much less because of declines in the market. You could not, however, get a check for $147,745 if you cashed out.
So what can go wrong? Insurers invest their reserves—and in a bear market their investments perform badly, just like yours. Companies that sold a lot of guaranteed annuities are vulnerable to a double whammy: a bear market that forces them to make good on the guarantees will also hurt their ability to do so.
In the worst-case scenario, an insurer may fail. If that happens you're protected in two ways: First, every state has a fund to protect life insurance policyholders and annuity owners. Each state sets its own limits, but these funds typically cover up to at least $100,000 of annuity withdrawal value. Second, regulators find a healthy insurer to take over the failed company. The new company usually honors the guarantees of the old one, but it can modify them, subject to regulatory approval, says Michael Kitces, director of research at Pinnacle Advisory Group, a Columbia, Maryland, money manager. The last major life insurance company to fail was Executive Life in 1991.
Readers who are thinking of buying an annuity should know that they have other drawbacks: They usually have high fees and substantial surrender charges if you cash out within seven years of purchase.
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- Can a debt elimination company really wipe out my credit card bills?
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Q: I have $21,000 in credit card debt. I'm considering a debt elimination program from a company that says it uses contract law against card issuers. This company assumes your debt and knowingly sends your payment late, inserting new terms in the envelope telling the credit card company that if it cashes the check, it is agreeing to those terms. Then it charges the card companies violation fees that eventually wipe out your debt. Is that legitimate?—Rose, Tennessee
Lynn Brenner replies:
No! You've described a blatant scam. Unfortunately, it's one of many—the debt settlement business is riddled with shady operators who leave consumers in worse shape than before.
Typically, you're told to stop making even minimum payments and instead put money into an account that pays the debt settlement firm while the firm tries to persuade your creditors to accept less than you owe. Meanwhile, your interest charges and late payment fees keep rising, and collection agencies keep calling you.
In the end, your creditors may not agree to settle; some of them may even sue you. And even if they do accept less than you owe, your unpaid balance doesn't vanish. It's reported as bad debt. That hurts your credit score—and may boost your taxes because the law treats forgiven debt as taxable income.
You're better off with a debt management plan, in which you gradually pay off your full balances at lower interest rates. You can negotiate such a plan yourself by calling your creditors, explaining your situation, and asking for a lower rate and easier repayment schedule. But if you decide you need help, shop for it very carefully. Go to the National Foundation for Credit Counseling's website. It provides debt management advice and the names of nonprofit counseling agencies that don't charge hefty fees. Focus on agencies that offer savings and debt management education as well as repayment plans. Call to ask them about their services and fees, which they should describe to you before getting your financial information.
A legitimate agency will give you a one-hour consultation, by phone or in person, before making any recommendation. Be wary of anyone who promises instant relief, "debt rescue," or "debt elimination." And don't sign up with any company before checking with both the Better Business Bureau and your state attorney general's office to find out what complaints have been made against the company.
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- Is there a penalty for moving an IRA?
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Q: My father has money invested in an IRA. How can he transfer his money
into a mutual fund or into bonds without being penalized?—Leon, Oklahoma
Lynn Brenner replies:
It sounds as if you think of an IRA, or individual retirement account, as an investment, which is a common misconception. In
reality, an IRA is just a place to keep investments. (Imagine the IRA as a bookcase and the different investments as books you've purchased at
different stores.) As far as the Internal Revenue Service is concerned, you have only one IRA even if it includes multiple accounts at many different
financial companies. You can make as many transfers among these accounts as you want; for tax purposes, the money has never left your IRA.
However, if you're shifting money, the institution from which you're withdrawing funds can sometimes impose a surrender fee. For example, if your
IRA funds are in a CD—certificate of deposit—you'll owe the bank an early withdrawal penalty if you transfer money out of it before it matures. (Some banks waive this penalty if you're taking a required minimum distribution from your IRA.) But there's no tax or government penalty when
you transfer money within your IRA, just as you might sell some books to buy others.
Let's say you have an IRA at ABC Bank, and you want to move the money into a different financial institution, a mutual fund company called XYZ. One
option is simply to ask the bank to give you a check for your money. In that case, you'll have just 60 days to deposit it in a new IRA. If you miss that
deadline, you'll owe income taxes on the whole amount, plus a 10 percent early withdrawal penalty if you're under age 59 1/2.
A better choice is a trustee-to-trustee transfer: Fill out XYZ's IRA application, saying you want to open a new IRA account with money that's
currently in your IRA at ABC Bank. The mutual fund company will ask the bank to transfer the money directly into your new account. If the bank requires
anything more to complete the transaction—your notarized signature authorizing the transfer, for example—the mutual fund company will tell
you. In a trustee-to-trustee transfer, there's no 60-day deadline to worry about.
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- Was it a mistake to have a joint account with my mother?
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Q: Was it a mistake to have joint bank accounts with my mother? My father died 20 years ago,
she died in February, and now my accountant says I have to have my Social Security number put on every
account and report income from them on my taxes.—Anne, New York
Lynn Brenner replies:
Your accountant is right, but you've done nothing wrong. On the contrary, it sounds as if you've been quite responsible. A
joint account can be a mistake, but the danger typically is to the parent, because the child doesn't need the parent's signature to tap the account;
and even if the child is scrupulously honest, the account is vulnerable to claims from his or her creditors in a divorce or a lawsuit.
If these accounts were jointly held with right of survivorship—that's the legal terminology—you automatically became
their sole owner when your mother died. But it's the Social Security number on the accounts, not the name, that tells the Internal Revenue
Service who's responsible for paying taxes on any accrued interest. Even a jointly owned account never carries more than one Social Security
number, says Alan E. Weiner, partner emeritus of Holtz Rubenstein Reminick, an accounting firm in New York.
You're responsible for taxes on any 2009 interest earned in the accounts since your mother's death. You'll be solely responsible for taxes on the
2010 interest. No later than January 1, 2010, the accounts must carry your Social Security number.
Your mother's estate is responsible for taxes on any 2009 interest earned before she died. If her total 2009 income was more
than $9,350 ($10,750 if she was over 65 years old), whoever handles her estate must file a 2009 tax return for her next year.
Let's say these bank accounts earned $200 in interest in 2009 before your mother died and $1,000 afterwards. If they still carry her Social Security
number, the bank will report the entire $1,200 to the IRS as her income. In that case, her 2009 tax return must also report $1,200, Weiner says. "But
then you'll subtract $1,000 and write an explanation on her tax return—or in a note you include with the return—that this $1,000 of
interest was earned after her death, and is reported on your own tax return," he adds. And of course, be sure you do report it on your tax return.
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- I just turned 70 and am still working. Must I start tapping my 401(k)?
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Q: I turned 70 in February. With recent stock losses, my 401(k) account is much diminished, so I'm still working. In August, at age 70 1/2, must I start making withdrawals from my 401(k)? I don't want to have to pay a large penalty!—Carol, New York
Lynn Brenner replies:
You may be eligible for a break if you have a 401(k) with your current employer: Regardless of age, you don't have to take distributions from that plan unless you own 5 percent or more of the company.
But the government doesn't want to wait forever to take its cut of your nest egg. You must start taking minimum distributions from any other tax-deferred retirement account—including IRAs and 401(k) accounts you leave with former employers—by April 1 of the year after you turn 70 1/2. For you, that's 2010. If you don't take required distributions, the penalty is substantial: 50 percent of the amount you should have taken.
(Other readers take note: In response to the nation's economic difficulties, the government is letting you skip taking 2009 required distributions from retirement accounts, if you wish.)
How much you'll need to withdraw is based on your life expectancy. To illustrate how this works, let's assume that your 401(k) is with a former employer and so you must start emptying it next year.
To determine your required minimum distribution for 2010, you'll need to divide your account balance on December 31, 2009, by your life expectancy, which you'll find in the Uniform Lifetime Table located on page 110 of IRS Publication 590. For 70-year-olds the IRS pegs life expectancy at 27.4 years. Let's say your 401(k) balance next December 31 is $69,000; your 2010 minimum distribution is $69,000 divided by 27.4, or $2,518.25. (These distributions are taxable, but the balance remains tax-deferred.)
Each 401(k) you have requires a separate distribution calculation, but people with several IRAs can generally do a single calculation based on the total balance in all the accounts and take the distribution from any one of them, says Ed Slott, a Rockville Centre, New York, tax accountant and IRA expert. Moreover, when you retire it's smart to transfer any 401(k)s to an IRA. IRAs give you total access to your money—you can take withdrawals as needed. By contrast, some employers will distribute a 401(k) only in a lump sum; others limit you to annual, quarterly, or monthly withdrawals.
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- Should I refinance my mortgage?
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Q: My wife and I want to lower our monthly housing cost. We pay 6.75 percent interest on a 30-year mortgage with 13 years to go. But we'll move in about seven years, and we don't want to be saddled with another 30-year mortgage. Does it pay for us to refinance?—Barry, Virginia
Lynn Brenner replies:
It certainly sounds as if you'd save money with a new 15-year mortgage, as long as you qualify for a low rate. But many homeowners aren't so lucky.
The cost of refinancing depends on the size of the loan and on how much equity you have in the house, as well as on your credit score. Even if your score is pretty good (680 or better), rates on "jumbo" mortgages—loans of more than $417,000 ($729,750 in high-cost areas)—are still above 6 percent. But rates for non-jumbo (also known as conforming) mortgages have fallen dramatically. In recent weeks homeowners have been getting rates in the neighborhood of 4.75 percent for a 15-year fixed rate non-jumbo mortgage, says Greg McBride, a senior analyst at Bankrate.com.
But to qualify for the best rate, you must have at least 20 percent equity in the house. That rules out many people whose home equity has plummeted with the value of their property. If you owe $350,000 on the mortgage and your house is worth $500,000, for example, you have 30 percent equity. If the value of the house falls to $400,000, your equity drops to 12.5 percent. (Who decides what your house is now worth? The bank's appraiser—and these days you can be sure the appraisal will err on the conservative side!)
Let's assume you originally borrowed $250,000 at 6.75 percent for that 30-year mortgage. Your monthly payment is $1,621.50. After 17 years, your loan balance is $168,102. If you can get a 15-year mortgage for $168,102 at 4.75 percent, your monthly payment will fall to $1,307.55.
To determine whether it pays, add up the total cost of refinancing—points, fees, and all—and divide it by what you'd save each month. If the total refinancing cost is $3,000, for example, and you save $313 a month with the new mortgage, you'll recover your expenses in under ten months. If you move in seven years, you'll have saved about $23,000.
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- I have to hire care for my mother—or else quit my job. What should I do?
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Quitting your job has tremendous ramifications. If you can't bring in income and produce savings, how will you take care of yourself in your own old age? Sheryl Garrett suggests that you tap local social service agencies for help.
First, contact your local agency on aging and find out how you can get an assessment of the care your mother needs and any aid for which she may qualify. You may even want to hire a social worker to do the assessment. The point is to know your mother's options before you make any change in your work. Click here for the U.S. Department of Health & Human Services Eldercare Locator and enter your mother's town or Zip Code, or call 800-677-1116.
It's possible that your mom does not need full-time care but only a few hours of help each day. Another option is adult daycare, an arrangement where you could drop her off on your way to work and pick her up afterward. The Eldercare Locator leads to a database of practically all caregiving agencies, including adult daycare. If you have siblings, ask them to share in the care of your mother. Finally, says Garrett, you may be able to tailor your job to fit your needs. Perhaps your employer will allow you to work from home or allow you to shift your hours.
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- I need to tighten my belt. Where do I start?
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Whether you’re cutting back out of dire necessity or to save more for a future goal, start by knowing exactly where you stand.
How much do
you spend? Does your outgo exceed your income? How much are you putting away in savings?
If you don’t know the answers to these questions, making an itemized monthly budget should help. “You have to
prioritize
what’s necessary to sustain life,” says financial expert Sheryl Garrett, which is why she divides spending into needs (Required Monthly Spending) and wants (Desired Monthly
Spending) and looks to cut wants first. That may mean jettisoning the extra phone, the second car, restaurant meals, or all of the above,
depending on
the size of your budget gap.
Spending on food, clothing, shelter, insurance, and debt payments may not be optional, but here, too, you may be able to wring out
significant
savings by comparison shopping to find everything from lower auto premiums to a cheaper place to call home.
Financial adviser Spencer Sherman offers this exercise: “Ask yourself what you could live without for a year.” With
everyone feeling
the pinch these days, friends may be able to help. “People can come up with pretty creative solutions,” he says. Sherman knows of some
women who,
instead of paying for gym memberships, exercise together, acting as each other’s coaches. Another woman he knows teams up with a friend to clean
each
other’s houses, saving on cleaning services and, in the process, easing the lonely burden that money worries can bring.
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- How much money will I need to retire?
-
“Less than you may think,” says financial adviser Jonathan Pond. “Everybody says that you need a million
dollars, but
don’t believe that. If you are a homeowner and your mortgage will be all paid up, for example, you may need just 50 or 60 percent of your prior
income.”
As retirement nears, try to project how much you’ll need to spend each year. Pond recommends making a ten-year plan and
including in the
yearly budget one-tenth of predictable but infrequent expenses, such as a new roof or car. Subtract from that spending total what you’ll get from
Social Security (if
you’re applying for benefits right away) and any other pension you stand to collect. You’ll have to pay for the remainder of your spending
from your
savings.
Say your pretax income is now $76,000 a year. You might need $46,000 to live on in retirement. If your Social Security checks
amount to $24,000 a
year, you’ll need to have enough invested to give you a yearly income stream of another $22,000. Spencer Sherman says that if you’re the
average retiree,
you should plan to withdraw only about 3 percent to 5 percent of your capital in any year. That way your savings will last as long as you do. If $22,000 is 3
percent to 5
percent of your nest egg, you’d need a total of $440,000 to $733,000—not a million, but an impressive number nonetheless.
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- I’m underwater on my mortgage. Should I walk away?
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No way, say Jonathan Pond and Spencer Sherman. If you owe more on your mortgage than the house is worth—which is what
being
underwater means—simply abandoning the property and mailing the keys to your lender is to be avoided even when your prospects are bleak.
“You will ruin
your credit,” says Jonathan Pond. “Even worse, the bank could sue you.”
For example, say your mortgage is $250,000, you walk away, and the lender sells the property for $200,000. A court might decide that you have to make up the $50,000 loss to the bank. There are better, more orderly ways to get out from under, including, in the worst case, bankruptcy.
But things may not be that bad. If you can stay put and manage to make your mortgage payments, do. The new Obama
administration program would allow some homeowners who aren’t behind on payments to refinance at low rates as long as their mortgages don’t exceed 105 percent of current property values. You can find out if you qualify at FinancialStability.gov.
“If you have to move right away or can’t afford the mortgage, ask the bank if it will permit a so-called short
sale,” says Pond.
“That means the lender accepts less than the full amount you owe.” In the example above, say you sell the house for $225,000. The bank
may forgive the deficiency to avoid the cost and hassle of a foreclosure. Not all banks are eager to take the loss, however, so call your lender immediately, or talk to a government-approved housing counselor about your options. To find a counselor, call 800-569-4287 or go to hud.gov and, under the heading At Your Service, choose Talk to a Housing Counselor. You may also need legal guidance. For inexpensive assistance, try your local Legal Aid Society.
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- Do I save for the kids’ college or for retirement? I can’t swing both.
-
“There’s no financial aid for retirement, so you’ve got to save for it,” Sheryl Garrett observes. “If
you spend all
your money on the kids and fail to save, you could wind up moving into their den.”
Don’t promise your kids that you’ll pay for the entire expense of their education, Garrett warns, because there is sure
to be
disappointment down the line if you can’t. Before even discussing the choice of school, you should talk to your teens about how much you can put
toward college
and whether you’re willing to take on any debt on their behalf. That may guide their choices, not only for an undergraduate institution but also for
graduate or
professional training. And they will understand that they’ll have to pitch in by winning scholarships, taking out loans, and working along the
way.
Jonathan Pond adds that employers usually look most closely at the last school a person attends. So spending a couple of years in a
community
college or at a state school, then spending more money to polish off a bachelor’s or graduate degree at a prestigious institution could be a better
investment than,
say, attending an expensive undergraduate institution and then having to take out loans for any further education. Says Garrett, “It’s not so
important where
you went to school as that you went to school.”
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- Should I get a reverse mortgage?
-
A forward mortgage lets you live in a home as you buy it over time. A reverse mortgage lets you stay put even as you cash out some
of your home
equity. It doesn’t need to be repaid until you sell the home, move away permanently, or pass away. Sounds good, huh? But don’t be too
eager.
“A reverse mortgage is best for older retirees—people in their late 70s or 80s who want to stay in their homes,”
says Jonathan
Pond. “The younger you are when you take out a reverse mortgage, the less you’ll have later when you might really need it.”
You can qualify for a reverse mortgage starting at 62, but if you’re entertaining the idea at that age, you should also consider
whether
selling your house and moving into a smaller place would get you more cash. With a reverse mortgage, you still bear the expenses of property taxes,
insurance, and
upkeep, and as loans go, reverse mortgages are quite expensive, especially for small amounts or short periods of time. Upfront and monthly costs can run
as high as 10
percent of the home’s value—and that doesn’t include interest, which is often the largest cost of these loans.
To be eligible for a federally insured reverse mortgage, you must consult a reverse mortgage counselor who works for a nonprofit or
public agency
approved by the U.S. Department of Housing and Urban Development (HUD). You can find a list of qualified counselors at hecmresources.org/network.cfm. A counselor can walk you through other less costly alternatives (a
home equity
loan, home repair loans or grants, or energy assistance) and the technicalities of loan caps and payouts. For all the details on reverse mortgages, read or download AARP’s free 45 page guide at aarp.org/revmort.
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- My investments shrank 35 percent last year. What now?
-
“If you have lost that much, you probably have too much stock and not enough bonds and cash,” says Jonathan Pond,
“because
35 percent was almost exactly what the Standard & Poor’s 500 index of stocks lost in 2008.”
If 60 percent of your funds had been invested in bonds last year, you would have lost only 12 percent overall—a poor result by
any measure,
but not a horror. Generally, says Pond, “you can subtract your age from 100 to get the rule-of-thumb percentage of your savings you should have in
stocks. If
you’re 60, that means 40 percent.” The rest of your invested savings should be arrayed in a range of bond and money market funds. And
perhaps once a
year, after bonds grow and stocks shrink, or vice versa, it’s good to return your mix of investments to their original proportions—no matter
how bad it may
feel. “Rebalancing your portfolio lets you buy low and sell high,” notes Sheryl Garrett.
Now that the value of your stocks has shrunk in the market selloff, says Spencer Sherman, you could rebalance merely by leaving
every investment
where it is and making any new investments in stocks, scary as that may seem. For the bond/cash part of your portfolio, Sherman likes the safety and
diversification of
domestic and international government bonds, as well as tax-free municipal bonds. He recommends Treasury Inflation-Protected Securities, generally
known as TIPS,
which have been cheap recently as inflation fears have been replaced by deflation fears. You can buy them from a broker or a commercial bank, or from the
government
at Treasury Direct. As for municipal bonds, Sherman says that
purchasing a
national, short-term municipal bond fund that charges no load (commission) and has an annual expense ratio below 0.4 percent is the easiest way to
invest.
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- The company I work for is shaky. Should I take my pension as a lump sum at retirement?
-
“If this is a traditional pension—a defined benefit plan—I almost always recommend that you take a monthly
check rather than
a lump sum,” says Sheryl Garrett. Her reasoning: even if the company goes bust, you are protected by the Pension Benefit Guaranty Corporation, a
federal
insurance program. For 2009, the plan will replace up to $4,500 a month in pension payments. There are lots of exceptions and variations, so check the
website at pbgc.gov/workers-retirees/benefits-
information/content/page13181.html to know what you are entitled to.
The other basic problem with taking a lump sum is that then the risks associated with it are your problem. How will you invest it?
What if you blow
it? The best cases for taking the lump sum are always sad ones. “Poor health prompts some people to take it,” comments Jonathan Pond,
“and debt
does, too, but that is an extreme measure.” Better to move to smaller digs than use up your pension paying off a mortgage.
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- My son has a disability and is likely to outlive me. How should I provide for him?
-
“Maximize on what the government can provide,” says Gordon Homes, senior financial planner for MetLife’s
Division of Estate
Planning for Special Kids. To qualify for benefits such as Supplemental Security Income (SSI) and Medicaid, which generally provide for food, clothing, and
shelter, your
child can’t have more than $2,000 in assets. So simply bequeathing him money would jeopardize that aid. Instead, advises Homes, you should
establish a
special–needs trust to provide for the extras that the government doesn’t—generally, anything beyond the basics that preserves his
quality of life. A
trust for your child’s benefit isn’t deemed part of his assets because he doesn’t have control of the funds—that’s the
trustee’s
role.
For the trustee, consider someone close to your son, such as a sibling or other relative. If he or she has little financial experience, you
might want to
appoint a financial professional or attorney as co-trustee. Trustees are obligated to use the money to provide for the beneficiary, to avoid loss of his
government
payments, and to invest the money prudently.
Setting up a trust is not enough, of course. “You need a guaranteed and dedicated funding source,” notes Homes. One
source might
be a permanent life insurance policy that would fund the trust after the death of one or both parents. Establishing a trust requires an attorney. For help in
finding one,
you might consult The Special Needs Alliance, a nonprofit network of attorneys, at specialneedsalliance.org.
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- I’m newly alone and want advice. Who can I trust?
-
People usually find financial advisers by word of mouth. But that’s how many investors found Bernard Madoff, the New York
financial
manager who bilked customers of $50 billion.
Probably the first thing to think about when looking at an adviser, says Sheryl Garrett, is “whether you are getting expert
opinion without an
inherent conflict of interest.” How an adviser is paid tells you a lot. A stockbroker earns his keep by selling stock. An insurance salesman, no matter
what fancy
accreditations he may have after his name, mostly wants to sell you an annuity or insurance. Money managers usually take a percentage of your assets off
the top every
year. “I often think that financial planners tell people to take lump sums from their retirement plans because they want to earn commissions and fees
for
managing” the money, says Garrett.
Jonathan Pond says you should restrict your search to members of the National Association of Personal Financial Advisors. Its
members accept no
commissions from product sales. They do charge for their services in a variety of ways, including by the hour, by flat fee or annual retainer, or by a
percentage of your
assets. You can find advisers in your area at napfa.org. The first appointment is often free, so meet with two or three
advisers before
choosing.
To check for any consumer complaints about a financial professional, go to the Securities and
Exchange Commission, the Financial Industry Regulatory
Authority, or
your state’s securities commission.
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- I am trying to avoid bankruptcy, but I am losing the battle. What should I do?
-
“Bankruptcy should not be taken lightly, but this economic crisis is not going away very soon. We are going to have record
numbers of
bankruptcies,” says Jonathan Pond.
To get a realistic assessment of your situation, make an appointment at a credit counseling center, something bankruptcy law
requires you to do
before filing, anyway. You can find a reputable agency through the National Foundation for Credit Counseling.
If you qualify for the agency’s debt management program, you may avoid bankruptcy. The agency negotiates lower interest
rates or
stretched-out payment periods with your creditors, such as card companies and department stores. Then you make one monthly payment to the agency,
which distributes
it to your creditors.
If you do have to file for bankruptcy, hire a bankruptcy lawyer to help you decide whether to file under Chapter 7 or Chapter 13. In
Chapter 7, your
assets are liquidated to repay debts. In Chapter 13, you can keep your house and other possessions as long as you agree to a three- to five-year repayment
plan set by
the bankruptcy judge presiding over your case. The judge has the power to reduce some of your debts. If you stick with the plan, any remaining debts are
discharged. The
bankruptcy stays on your credit records for seven to ten years, but you may be able to get credit sooner—albeit at higher rates.
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