A house shouldn't be a priority

By which I mean: A house should not be a priority above funding your retirement!





Look, I used to own a house. I miss it. I really miss having a garden -- especially the free and tasty raspberries and plums. But even after we pay off the debt, I refuse to sacrifice our retirement savings for a house.





And it seems like I may be one of the only ones who thinks this.





Over and over, I hear about houses. How people are saving up for one. How they're putting other items on hold.





Folks, they are nice, but they are not a necessity. Not even when you have kids. They are a luxury. In the midst of all these subprime loans, we seem to have forgotten that.

**People talk about how they are stretched thin so that they could afford a house. Well, then clearly you can't afford a house.

**People talk about how hard it was to find a place so that the kids could have separate bedrooms, so they ended up with a tiny house they don't like. Since when do kids have to have separate bedrooms? (Yes, I understand puberty may eventually force this issue if you have a boy and a girl. But I don't think that's the main reason most folks decide their kids each need a bedroom.)

**People talk about how they have to put retirement savings on hold for awhile, so that they can get a house. Or they put money toward a down payment while they still have interest-bearing debt. Folks: Do some math and reassess your priorities.

First, you're losing money by keeping the interest-bearing debt -- at least, when you look at the savings rate for that down-payment account. I can sort of understand some people's rationalization about saving for an emergency fund while still paying down debt. I get that, to an an extent.





But I cannot, for the life of me, understand why you'd continue to ding yourself for longer than was absolutely necessary. Don't forget: Your debt-to-credit ratio (and debt vs income) are taken into account when you apply for a loan. So you're making things harder on yourself -- as if the new, saner mortgage guidelines weren't enough of a hurdle for most people.







**Finally, people talk about putting retirement on hold to get a downpayment. Since when is it financially sound to put off future security for more immediate gratification?





Because "immediate gratification" is exactly what you're doing. I'm sorry if you folks don't want to hear it. But once again, a house is not a necessity. So ranking a luxury (house) over a necessity (retirement funds) is pretty much the antithesis of all PF advice.





Sure, back when house prices were going up, up, up -- and real estate was disappearing days after being listed -- PF experts advised us to make the leap. But that was then. How many experts are still saying you should make it a priority? And of those, how many are simply catering to what they know the audience wants? (You can only force so many unpleasant truths down people's throats. And if you're taking away their lattes, you may have to concede that a house is important.)





Just remember, you might own a house. But the house owns you, right back. It's the same reason that I don't want to get a car before we pay off our debt: Both create a new drain on your finances. (And now you can't even argue that houses will definitely appreciate, at least in the short-term.) There will be repair costs, property taxes, homeowner's insurance and all sorts of other unexpected liabilities.





And, when you're figuring out your maximum mortgage, can you guarantee that you'll remember to factor in the retirement contributions you want to restart? I doubt I would. I'd figure out how to make it all work. Then I'd realize that I needed an extra couple hundred each month to go toward retirement. That'd pinch the budget even further.





This whole subject arose over on Sense to Save, when Kacie asked her readers what they thought about postponing retirement savings in order to save for a downpayment. She was taking a page out of the oh-so-hallowed Dave Ramsey book. (Sorry to all the Ramsey followers for the sarcasm. He has some good ideas, but it scares me how blindly folks sometimes follow him.) He suggests that it makes sense to put it off -- though for no longer tahn 18-24 months.





To give props to Kacie, she and her husband will apparently take the middle road: Save for both. It won't get them to a house as quickly as they would like, but it also won't leave their retirement accounts destitute.





So why am I so violently against saving for a downpayment rather than retirement? Oh, where to begin...





First, if you put money in your 401(k), you do have the option of borrowing it for a downpayment at a later date. (Don't forget, this whole thing could also be avoided simply by contributing to a Roth IRA, which allows you to take any invested funds back out penalty-free.)Of course, this comes with caveats. You want to be in a much more stable economy than we currently are. There are very strict repayment rules, and if you become unemployed (through your own volition or not) you are expected to pay it back pretty much immediately. Still, by putting money into your 401(k) you are keeping your housing option open, while still securing your future.





And, yes, I know that naysayers will insist that it's not that simple. You could put money in and your 401(k) could lose value. That's money you could have been putting in something secure like a savings account or CD. This is a valid point to consider. But also a valid point: If you invest carefully and/or conservatively, your stocks will be lower risk. And, technically, your "losses" are not real until you sell the stock. So if you buy shares, which lose value in the short-term, you still have the chance to make money in the long-term by holding on to them. History has shown that the market does inevitably rebound. While we may not see the heydays of the last decade or so, I feel confident that we will, in fact, see people make money on stocks again. (And not through short selling.)





Arguably, a dropping value does it make it harder to borrow from your 401(k), but then again dropping house price can be a huge problem as well, if circumstances change and you need to sell. Nothing right now is a certain investment.





Speaking of selling your house, what if circumstances force a move? And what if that move is to an area with substantially higher housing costs? Did you put off your retirement savings for nothing? Will you have to do it again to amass enough for another downpayment? How long are you willing to stave off investing in your future?





Finally, I have to use my favorite example from Deal With Your Debt by Liz Pulliam Weston:





A woman starts investing in retirement at age 22 and stops at age 32. Each of those years, she contributes $3,000. After this, she never puts in another dime.



Her twin, however, contributes starting at age 32 and continuing through age 62. She, too, contributes an annual $3,000.



At retirement, the first twin will have around $200,000 more in her retirement fund, despite having contributed 1/3 the amount of her late-to-the-game sister.





Naturally, this example is based on average returns that may no longer be applicable. But I do feel certain that the market will, in time, inch back up to something approaching bearable. (No pun intended.) And, either way, these twins would have withstood mostly the same market forces. So while the difference might be smaller in today's conditions, it would still exist and be notable.





I love this example because it truly drives home the fact that compound interest is completely undervalued by most Americans. I was certainly shocked to read this example. It seems so impossible that a 10 year head start (especially compared to an extra 2 decades' contributions) would lead to such a marked difference in funds.





So, given how powerful compound interest can be, I don't understand how anyone could rationalize saving for a house over paying into a retirement fund. You're getting what you want now, but at the expense of your future security.



Let's recap:





I know no one wants to hear it, but here's the thing: A house is not a necessity. No matter how badly you want it; no matter how much it pains you not to have it. It is never a necessity. It is a wonderful luxury that I hope everyone gets to experience (with financially prudent saving). But it is simply not indispensable. Funds for retirement, however, are absolutely integral. Take it from someone who receives $883 each month from the government. In a city where 1 BR apartments are $700.





Even assuming phenomenal changes are made and Social Security stands for our retirement (and I know plenty of you doubt that will happen), could you live on $1,500 a month in retirement?





If you said yes, remember:

• Inflation for cost of living, but not necessarily reflected in SSA payments.


• Medicare coverage is not free. Part B (non-hospitalized medical care) is $96.40 a month.


• If you want better coverage, that will cost you, too.


• Want decent precription drug coverage (Part D)? More money.


• You still have the "donut hole" to worry about. Once your Part D coverage company has paid $2,700 (your deductible, oddly, is included in that amount, despite sometimes being more than $200) you are responsible for 100% of the costs for the next $4,350. Then, your coverage kicks in again -- at a higher rate than before. (Isn't that sweet?)


• You can get a supplemental plan that avoids the donut hole (technically called the coverage gap) but it'll cost you. Surprise, surprise.

Of course, if you're pretty broke, Medicaid will take pity on you and help you pay some of the premiums and will lower your co-pays. But that's only in specific cases.

Still think retirement can be put off for awhile?

Traditional IRA or Roth?

Readers: This is the second part of a two-part article. The first piece, Retirement on $20 a week, is a guest post featured over at Ms. Money Savvy.


The words IRA make a lot of people freeze up. In fact, they're not nearly as intimidating as you might think. Here, we'll cover the basics of the two main type of IRAS -- traditional and Roth. Then we'll take a look at what these differences mean for people in terms of their goals. That will help you figure out which one will work best for you.


So, since we're reviewing the whole subject, I'd like to start with the most basic item. Most of you probably know it already, but why not cover all our bases?


The basic basics


What does IRA stand for?


C'mon... You know this.


The answer was "Individual Retirement Account." (We would also have accepted "Individual Retirement Arrangement.")


We all know vaguely that IRAs are for retirement. But what are they, exactly?


You might think of a deduction from your paycheck, which is actually only for traditional IRAs. You might know vaguely that some tax benefits are involved. Mostly, though, the majority of us just create the account, throw money into it and hope that the fund managers know what they're doing.


It's actually not that bad. There are a few things you should know about IRAs in general:


• The soonest you can withdraw money free of penalty is age 59 ½
• There is a 10% tax penalty for early withdrawal
• The current limit is $5,000 for individuals under 50
• People 50 and over can deposit up to $6,000



Getting started


The problem with a lot of IRA explanations is that they focus mainly on the end product. That's important, obviously. But most people are scared of the stuff that comes at the beginning.


You might start to sweat when you think about visiting various brokerage firms. Or perhaps you get a headache just thinking about reading a prospectus.


Breathe deeply. It will be okay.


If you go with a traditional IRA, your company will already have a brokerage firm selected. That is certainly one benefit. Otherwise, you are on your own to a certain extent. But always feel free to ask friends and family who they use and how their experiences have been.


Also, remember that you can get your IRA through your bank. That's what my husband and I did. It was relatively simple. There was a lot of paperwork to sign, but it was pretty standard. And we were out the door no more than a half hour after we sat down.


It is true, we should have done more homework, read a prospectus or two. But we needed to get our feet wet, and we had a lot of other stuff on our plate. Sometimes there is value in keeping things simple, just to get started. If you're very panicky about IRAs, this is something to bear in mind.


So, once you're seated in the bank or brokerage firm, now what? Now you'll sign a lot of paperwork. But first you have to decide what level of risk you are comfortable with. You can specify, you see. And in this sort of economy, it is vital that you do. Younger people tend to be more comfortable with higher risk, since they can afford some reversals of fortune along the way. Tim and I, however, have an uncertain future when it comes to earnings. So we will probably stay with low risk, since we might be more affected by losses.


Whatever you choose is okay, and the broker will help you decide. Just be sure you don't get pressured into something you aren't comfortable with. Once you've invested, switching to a higher- or lower-risk fun will involve trading fees.


Okay, now there's just the main question: Traditional IRA or Roth?



Everything you ever wanted to know about IRAs (but were afraid to ask)


You can't know which is right for you without knowing what each has going for it. So I've made a nice, simple, bulleted overview. (You'll probably notice that these are very different. They are made to appeal to different situations, different populations. It actually makes choosing much easier.)




Highlights of a traditional IRA:

• Taken out pre-tax
• Contributions may be tax deductible
• Cannot contribute past age 70 ½
• Taxes are paid at the time of withdrawal
• Must start to withdraw by age 70 ½
• You must withdraw a certain amount, as dictated by the IRS.


Highlights of a Roth IRA:

• Taken out post-tax
• Contributions are never tax deductible
• No taxes paid upon withdrawal
• No mandatory withdrawal age
• Contributions are allowed throughout your life
• Principal can be withdrawn without penalty




Which one is right for you?


Okay, you read the bulleted stuff. And you still have no idea what that means for you. Don't feel bad. I had to have this stuff explained and re-explained to me.


Let's look at the implications of the IRAs' characteristics:


Traditional IRAs


Traditional IRAs have more restrictions than a Roth: an RMD (required minimum disbursement), which you have to start taking by age 70 ½, and past that age, you can no longer make contributions. (It’s worth noting that Congress suspended the mandatory withdrawal rule for 2009, given the depressed stock market.)


The finite window on contributions means that traditional IRAs probably won’t work for people who are getting a late start on saving for retirement.


Similarly, if you plan on working past age 70 ½, a traditional IRA may be a problem. It would mean you are still drawing an income when you start to receive IRA funds. This will probably raise your tax bracket to a much higher level -- which is a problem since traditional IRAs are taxed at the time of withdrawal.


I mentioned RMD before, but it’s important that you understand how it is calculated. The IRS takes the value of your IRA on the last day of the year, divided it by the number of years left, based on life expectancy tables.


Why does this matter? Well, if people in your family tend to live long lives, this IRA may not be for you. Since life expectancy is calculated with averages, you may outlive the agency’s expectation. In that case, your funds will be gone.


So those are the drawbacks to traditional IRAs. But this type of plan can have plenty of benefits for middle- and upper-class workers – especially those without many tax deductions.


Workers who don’t have many deductions to lower their taxable incomes can rely on traditional IRAs to do this. When the contributions are taken out of pay, they are removed before taxes are applied. This means that your contributions to a traditional IRA lower your taxable income. Depending on your income, you may also qualify for a tax deduction, lowering that amount further.


The real value, though, comes in retirement. If the money hadn’t been taken out as contributions, it would have been taxed at your current tax rates. But with traditional IRAs, you don’t receive the funds until you’re retired and, presumably, in a lower tax bracket. So, while you pay taxes on the profits, you're also paying a much lower rate on the original funds than if you had received them in a normal paycheck.


All in all, traditional IRAs will work best for people who:


• Plan on retiring before age 70 ½
• Don’t plan on working after retirement
• Can get a timely start on IRA contributions
• Are currently in higher tax brackets
• Need the tax deductions



Roth IRAs


Roth IRAs, on the other hand, are more lax. You can contribute for as long as you like, and you don’t have to touch a cent until you want to. When you do dip into the funds, there are no rules about how much you have to take. So if you’re not sure how late in life you’ll need to work, a Roth IRA may be best for you.


A Roth IRA is also best for people who plan on having alternate streams of income, such as pensions or real estate investments. They can dip into the funds as necessary, or keep the money earning interest in the IRA.


If your career is uncertain, or you are simply worried that you may need the money later, a Roth is a good fit. With this type of IRA, you can withdraw any and all contributions without any penalties or taxes. (However, if you also withdraw the profits, they will be subject to taxes and to a 10% penalty.)


Finally – and perhaps most importantly – Roth qualified disbursements (taken out under proper conditions) are not taxable income. See, you already paid taxes on this money, before you put it into the Roth IRA. So any profits are completely tax free. This allows you to stay in a low tax bracket, even in retirement, but still have some financial help beyond Social Security.


While there are many benefits to a Roth IRA, it’s important to note one major drawback: There are no immediate tax benefits for contributing to a Roth IRA. Your taxable income won’t be lowered, and you get no tax deductions. So if you are looking to decrease your present tax burden, this is not the IRA for you.


The traditional IRA postpones taxation until the person is retired and, presumably, in a lower tax bracket. If, however, you already pay a low amount of taxes, it makes more sense for you to use a Roth IRA. You pay taxes now, and get tax-free profits later.



All in all, a Roth IRA works best for people who:

• Have lower incomes (unmarried people, single-income families)
• Have plenty of tax deductions already
• Want access to their contributions, if needed
• Want to (or have to) work later in life than 70 ½
• Start saving for retirement later in life
• Prefer to let their profits grow tax free




What did we learn today?


So which category did you fall under? Are you clear which IRA will benefit you most? If you're still not sure, review your last few tax returns (and your goals for the future) and you should have a fairly simple choice on your hands.


Once you've decided which one works best for you, go find a brokerage firm or bank and start an IRA. Now. Even if it’s only $20 a week.