I'm retired and would like to use my 401(k) funds to buy a home. Will I incur penalties?
First, I think home ownership can make a lot of sense for retirees. In addition to the tax deductions for property taxes and mortgage interest, owning a home can help you control your housing costs as opposed to being subject to the whims—financial and otherwise—of a landlord. As you probably know, this is a good time to be a home buyer, since housing prices and mortgage interest rates are both very attractive right now.
But tapping into a 401(k) or other retirement plan to pay for a home can be problematic, because you'll have to pay income taxes on the amount withdrawn (but not a penalty if you are over age 59 1/2). The taxes can be burdensome.
For example, if you need $25,000 to fund the down payment, closing costs, and moving expenses, and you withdraw the money from a retirement plan, you'll probably need to take out about $35,000 in order to pay the taxes due on the withdrawal. But don't necessarily let this discourage you. Instead, look for ways to get into a home at a low cost. Your state government may have programs that help low- and moderate-income home buyers with limited resources.
All in all, I encourage you to pursue your dreams. Here are some other issues to consider:
• Do older home owners have any local tax breaks?
• Does the community offer public programs that you may want to use?
• Is the home convenient to transportation, shopping, and recreation?
• Is the general neighborhood declining or improving?
• How expensive are property taxes, and have they been rising at a rapid rate?
• What advantages and disadvantages would the type of housing you're considering give you? Old houses may be less energy-efficient and may require ongoing maintenance. Newer homes may be expensive and of inferior construction. Condos and co-ops may have less storage space, and some have inadequate soundproofing.
• Do you plan to live in a home for the rest of your life or only for the next few years? If you anticipate spending only a few years in the neighborhood, try to pick a home that will be easy to resell.
• Most important, compare the cost of a new home (after deducting the income taxes you'd save) with your current rental cost. You may be pleasantly surprised to find that home ownership doesn't cost a whole lot more. But if it does, you need to realistically assess whether you can indeed afford to buy a home.
I have $2,000 to spend/save. Should I put it into my IRA or pay down on my credit card balance?
– John, Florida
Conventional wisdom suggests that paying off high-interest credit cards should be your number-one priority, before putting any money away for the future in retirement accounts. The reasoning for this guideline is financially sound. Why put money into an account that will probably earn less than 10 percent when you're paying interest on a credit card that's approaching 20 percent or perhaps even more?
I often encourage a somewhat different and controversial approach to the pay-off-the-credit-card-versus-save dilemma. Do some of both.
Here's my reasoning: First, there is a no joy forthcoming from making payments against outstanding credit card loans. It is often a monthly reminder of past spending sprees. Depending on the extent of the indebtedness, you might be looking forward to years of paying down the loans without making much, if any, progress toward a brighter financial future. On the other hand, putting some money, even a little bit of money, away for the future is always good for the soul, particularly for those souls who don't yet have much in savings.
So here's my strategy for paying off your credit cards later, rather than sooner: Depending on how much you owe on the cards, plan to put 50 to 75 percent of your available (and any future extra money) against the loans. The more debt you have, the more I advise you put toward reducing the loans. One thing you want to avoid like the plague is simply making the minimum required payments each month. Here's the fun part: The remaining portion of your "extra money" you can contribute to your IRA or a savings account at your bank or credit union, if you need to build up a small cushion for any financial emergency that might arise.
If you conclude that my suggestion of paying off your credit cards later rather than sooner is a crazy idea, you're in good company. After all, this strategy results in higher interest charges and increases the time it takes to pay off your debts. But there's more to creating a wonderful financial future than simply making loan payments. People who have followed my strategy have told me that doing so has given them a more optimistic outlook. They know that they're creating a future in addition to paying for the past.
I am presently collecting unemployment benefits and short each month. Should I take money from my retirement fund or start collecting Social Security at age 65 next year?
–Richard, New Jersey
In this era of high unemployment, you face a common dilemma: Taking money from retirement funds will require that you pay taxes on all or most of the money withdrawn. This may not necessarily be a bad outcome, particularly if you are in a low tax bracket.
On the other hand, while full Social Security retirement age is now 66, collecting at age 65 will allow you to postpone tapping into your retirement funds. But there are a couple of matters to consider first:
1. If there's a possibility that you may return to the workforce, whether full- or part-time, collecting Social Security before full retirement age may subject you to a reduction in benefits, depending upon how much you earn. This is not necessarily a bad thing, either, but it is something to consider.
2. Since Social Security benefits rise by 6 percent per year until age 66, commencing benefits at age 65 will result in a small reduction in your lifetime benefits. Again, this may not be a big financial deal. Since Social Security benefits are calculated based on the month you retire, waiting a few months after your 65th birthday to apply for benefits will result in a somewhat higher benefit.
Finally, this is one of those common financial dilemmas that is not necessarily an "either/or" decision. In your situation, you may want to tap into your retirement funds until you reach full retirement age and then be able to enjoy a full, lifetime Social Security benefit.
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