Thursday, June 18, 2015

Sea Change - Perpetual Debt and the 401(k) Generation

Retirement for many will be a series of increasingly unpleasant financial decisions to make.

I received an e-mail from a reader who is in a bit of a pickle.  Forced to retire early (actually, into their second career) they have a mortgage to pay off while in their 60's.   Should they cash in their 401(k) to pay off the mortgage? 

Tough question.   And questions like this illustrate why it is best not to put yourself into tough situations where you have to make hard choices.

There are, of course other options.   First, you could sell the house, if there is any equity in it, and then buy a smaller house, preferably paying cash from the sale of the first house, and then live mortgage-free in a smaller, easier-to-care-for house with lower utility bills, lower taxes, lower insurance, and lower upkeep.    That would be my choice, because at age 55, I am already sick of mowing lawns and scrubbing toilets, and less space, less land, less expense would seem to me to be an advantage.

But a lot of folks immediately disregard this option - even if it were feasible.   They don't want to be seen as "giving up" by their neighbors and friends.   For us here on retirement island, the choice is to sell here and move to the mainland.    A typical house on this island may sell for about $380,000 in average condition (a house without a beach view or whatnot).   On the mainland, a very nice house in a suburban development can be had for about $175,000 or about half the price of living here.

And yet many, when faced with financial stress, would not even consider this option, as pride prevents them from doing so.   To sell here and move elsewhere would be seen as an admission of poverty and shame.   And folks worry what other people think of them - people they hardly know.  And that's pretty stupid.

Others will use the gambit of "I'm moving away to be closer to my grandchildren!" which puts a spin on it that they are not just selling for financial reasons.   Hey, if that gets you through the night, do it.

But of course, I do not know the reader's full financial situation, so I cannot give him advice.  And as I have noted before, I am not Dear Abby.   I started this blog to figure out my own finances.   And my solution was to downsize - albeit on a larger scale.

For example, I have no idea what housing prices are like where he lives, what equity he has in his home, what his sources of income are, and what his other monthly expenses are.  He says he has a "negative cash flow" and is tapping into emergency funds.   But he is paying for Cable TV and a Smart Phone?  Because if so, I can tell him where to find $200 a month in a real hurry.

And what some consider "necessities" others consider "luxuries."  I recounted a friend of mine who wanted "help with their finances" and I went through their budget, and showed them where they could easily cut $250 a month.    They were paying $100 for cable TV, $65 for internet service, and so on.   And they were going to the most expensive restaurant on the island, regularly, and buying $12 drinks.   But what I found out, after doing this analysis was what they wanted wasn't my advice so much as a loan of $5000. I'm not in that business either.

Another option our reader could take is to refinance.   This is, in a way, rearranging the deck chairs on the Titanic.   However, we are all on the Titanic as we approach retirement age.   Life has an end point.   If he refinances the house at a lower (fixed) rate, the monthly payment might go down and be within his affordability.   A neighbor of mine did just that, at the ripe old age of 78 - taking out a 30-year mortgage.  Not my first choice, of course, but it works for him, or at least it appears to be doing so.   But in a few years, he won't have to worry about the mortgage.  But his wife will, and she's a lot younger.  I hope she has the income to service the mortgage once he's dead!

A reverse mortgage is another option (and we are really working our way down the food chain here!) but I am not sure if that would work with an existing mortgage on the property.  And it would depend on how much equity is in the house.   A $500,000 house with a $60,000 mortgage is a far different scenario than a $80,000 house with a $60,000 mortgage.  Like I said, without knowing all the details, it is hard to even start to guess at what to do.

And speaking of reverse mortgages - which I think are a very, very bad idea - there was another article in the news the other day about a woman whose husband died, and without telling her, took out a reverse mortgage in his name only and as a result, is facing foreclosure.  Men can be so nice to their spouses, no?  This is called financial abuse and it goes on a lot more than you think.  My Grandfather, for example, died at age 55 and left his wife with nothing.

But this conundrum illustrates why it is important to think about retirement and old age and "owning yourself" when you are 30, not 50.  By age 50, your career may last only another five years, and it is far too late to "save up for retirement" at that point.    Far too many people today are living for today only and making no plans for the future.  And when the future comes - at a time when the mind and body are failing and life is far harder to live - you don't want to be forced into a situation where you have to make hard choices like this.

It is not impossible to pay off a mortgage over 30 years, if you get it at age 30 and work until age 60.   But many folks chose instead to do other things with their money - and we see this all the time at the local boat ramp or at the RV campground.   People want to impress others with their fancy new toys - as if they actually made these things instead of merely signing loan papers on them.   Folks want to take fabulous vacations and then post the pictures on Facebook.   These are all choices we make.

The problem for our generation is that we don't have the luxury of a pension to look forward to.    I know people here on our island who are making in the six figures (as a couple) on pension income alone.  A retired school teacher from New York can easily make $50,000 a year in pension, if not more.   Good for them.  Bad for the taxpayers.   One reason I no longer pay property taxes in New York State.   But that is another issue that you will hear a lot about in the coming months.   And I suspect the teacher's unions are going to take it on the chin pretty soon.   But I digress.

The rest of us have to live on our accumulated savings - which is one reason most of us have less and less sympathy for people with cushy pension plans that we have to pay for.   And most folks today have very little saved for retirement.   Maybe a hundred thousand or so - which is not a lot of money.

To have the same $50,000 annual pension as our NYS school teacher (as an example), one would have to save up a cool million dollars using the 5% rule of withdrawal.   And yet, if you asked these pensioners if they were millionaires, they would cry out, "I'm not rich!  I don't have a lot of money!" and they don't - in terms of cash on the table.  They have only a pension check and nothing more.   And I know pensioners like this, who confess they have a mortgage, car payments, and whatnot, but only $10,000 in savings.   So long as their pension holds up, they are set.   Better pray Mitt Romney doesn't buy the company you retired from.   Oh, right, these are the same idiots who voted for him.  No sympathy.

So when people say to me that "You're lucky, you're rich!" I have the same reaction as our schoolteacher pensioner.   A million dollars isn't a lot of money today - it is barely enough to retire on in any sort of middle-class lifestyle.

And to retire on your savings, a mortgage is out of the question.   You have to live on your savings, which means paying taxes on your IRA/401(k) as you take the money out.   So the name of the game is to minimize the amount you take out (those with a Roth IRA don't have to worry as much).  If you have to take out $2000 a month just to pay a mortgage, that means not only paying more taxes, but probably pushing you into a higher tax bracket.

So what does this mean?   Well the best decision to make is to not place yourself in a situation where you have to make such dire decisions.  Sadly, a lot of people will be in these bad places, in large numbers, and very soon.  And many will do very odd things, too, like cashing in a 401(k) so they can "own a house" or whatever.   It happens all the time - it is already happening.

On the news the other day, a sad story of a retired Navy war vet.  For some odd reason, he decided that taking his pension in monthly payments wasn't good enough, and a helpful company in the Navy Times offered to give him a "lump sum" payout, in exchange for his pension payments for the next ten years.  What he needed the money for is unknown (conveniently - was it gambling, stocks, housing, drugs, what?).

Anyway, he now needs money to live on, and he won't see a pension payment until 2025 if he lives that long.  And yea, the "lump sum" payout people basically loaned him money at 30-40% interest or more,

Just don't do shit like that.  Don't buy a jet ski when you haven't funded your IRA.  Don't take out yet another home equity loan to pay off credit cards, while at the same time having 500 channels of cable and a smart phone.

But alas, most folks think cable television is like oxygen ("everyone has it, right?") and not having the latest smart phone would be like living in a 3rd world country.

Choices, Choices!