The Money Class
Page 21
I am here to tell you that the choices you make in this decade will have a tremendous impact on whether you will be able to retire with the money and security you desire. It is your willingness to face those decisions today—and adjust your retirement plan as needed—that will allow you a decade from now to look back and say with pride, “I am glad I did,” rather than be filled with the regret of “I wish I hadn’t.” I realize it is easy to be paralyzed by what you think is an insurmountable task, but please listen to me: You are still plenty young and in a position to make sure your retirement dreams can be realized.
Every year the Employee Benefits Research Institute (EBRI) publishes its retirement readiness report; it’s a detailed statistical look at how many of us are on pace to have enough money in retirement to meet our basic living needs. What grabs the headlines is that nearly one-half of us are currently at risk of not having enough in retirement to pay the basic bills such as housing, food, and utility costs, as well as paying for out-of-pocket healthcare expenses not covered by Medicare and private insurance. But here’s what was deeper down in the study: The majority of that group who are at risk are within 20% of having what they need to be okay in retirement. That is, right now they have 80% of the savings and access to retirement income (pensions, Social Security, etc.) that EBRI estimates they will need to support themselves in retirement. Yes, that’s a shortfall, but it’s not nearly as dire as the headlines would suggest. Stand in your truth at this stage in your life and you can surely close a gap of that size.
For those of you who are more than 20% away, now is not the time to give up. I learned a saying from a teacher many years ago that I have often recalled to help me get through tough times in my life, and it goes like this: Be a warrior and don’t turn your back on the battlefield.
Obviously the ability to save more at this juncture is a huge part of the puzzle we need to put together between now and retirement. But it’s far from the only piece on the table. Reducing your expenses before you reach retirement is a very important strategic move that is often overlooked. We think we have to save, and save, and then save even more so we can “afford” to retire, yet we don’t realize that what we need to save is a function of what we expect our expenses to be in retirement. If you can arrange your financial life so you will have lower expenses in retirement, then you don’t need to save as much.
Of course, it is impossible to sit down and do a line-item run-through of what you think your living costs might be 20 or 30 years from now. But there are in fact some obvious big-ticket items we can move off your balance sheet. Pay off your mortgage before you retire and you have just wiped out what for most of us is our largest monthly expense. Another big expense center in your 40s and 50s is college costs. For years I have implored parents not to put paying for college ahead of retirement savings. That’s become even more important today. I am not just talking about redirecting money you wanted to put into a college 529 plan into your own retirement accounts. Parents must also not overburden themselves with loans to pay for their children’s college costs if it means they will still be paying off those loans in retirement. (In the Family Class, I explain a college tuition strategy for parents and children ready to stand in the truth of their New American Dream.)
We also need to embrace the changing nature of what it means to be retired. The classic notion of retirement is that you walked away from your job sometime around age 62–65, never worked another day, and lived for another 10 years or so. But if you retire in your early 60s today, the odds are you will live a lot longer than your grandparents did at the same age. Consider that in 1940 the average life expectancy for a 65-year-old man was just 12 years, meaning that just half of the 65-year-old men in 1940 would still be alive at age 77. Today a 65-year-old man has a life expectancy of 16.7 years. That’s four more years of needing to support yourself in retirement. Women’s life expectancy has increased from 13.4 years to 19 years over the same stretch. Half of today’s 65-year-old women will still be alive into their mid-80s! And I want to make sure you grasp the fact that this means 50% will still be living past their mid-80s. In fact, among women who are 85 today, their average life expectancy stretches into their 90s!
In terms of how we view our retirement years, the impact of these numbers is really significant. Because our life expectancy has expanded, we must consider stretching our work years beyond the traditional 62–65 time frame. Unlike past generations of retirees, many of whom could rely on a lifetime pension annuity from their job, most of us retiring in the coming decades will be relying on our own 401(k) and IRA savings. So it’s on us to make the money last longer given the likelihood of our longer life spans.
As I will explain in greater detail in this class, devising a strategy for extending your income-earning years through your 60s will help to ensure that your retirement savings can support you throughout your longer life. Don’t worry, the advice is not that you must keep working 40-plus hours a week at a high-powered job. The goal will be to find some part-time work that can generate enough current income that it enables you to delay when you start drawing money from Social Security and your own retirement savings, or at the very least reduces what you need to spend of your own savings in your early 60s.
Here are some of the actions to take in your 40s and 50s that we’ll cover in great depth in this class:
Deciding When It Makes Sense to Pay Off Your Mortgage
Have a Realistic Plan for Working Until Age 66–67
Delay Your Social Security Benefit
Estimate Your Retirement Income: How Are You Doing?
Saving More, and Investing Strategies in Your 50s
Plan for Long-Term Care Costs
LESSON 1. DECIDING WHEN IT MAKES SENSE TO PAY OFF YOUR MORTGAGE
Are you surprised that the first lesson is about paying off your mortgage? You probably expected me to jump into a lecture of how you need to really get serious about saving much more in your 401(k) and IRA. There is no question that continuing to build your retirement savings is important—you will surely need that money to support you in retirement. But at the same time thinking about the savings side of the retirement challenge is only half the picture. What about reducing your expenses? If you have lower living expenses in retirement you will need less savings to cover your needs, right?
In terms of your ongoing monthly expenses, your mortgage is probably your biggest bill. A troubling trend is that more people are still paying off their mortgage in their 60s. To be sure, the vast majority of older homeowners in fact are mortgage-free, but between 1999 and 2007 (the latest year data is available) the percentage of people age 65 and older with a mortgage rose from 24% to 32%. And I am concerned that many of you in your 50s today will still be carrying a mortgage into retirement.
Many of you, over the past few years, wanted to take advantage of low interest rates and refinanced from rates above 6.5% to rates around 5% or lower. While that move made sense financially, for many it also reset the clock on your 30-year mortgage, extending your total payback time. Or maybe you traded up during the housing bubble—complete with a new 30-year mortgage. Or perhaps you decided the time was right to take advantage of some of the bargains to be had out there and you became a homeowner for the first time. All these scenarios point up the fact that we now have a generation of 50-somethings who will still be paying off a mortgage well into their 70s or possibly their 80s, if they stick to their current payment schedule. That could create tremendous financial stress if you are living on a fixed income. You may well find yourself struggling to cover your other costs, to say nothing of having the ability to spend money on the things you dreamed your retirement would hold, such as travel and spending time with—and money on—your grandchildren.
Continuing to carry a mortgage once you stop working puts your retirement dream at risk. That is why I am starting this Money Class with a lesson on how to get your mortgage paid off before retirement.
Now, I want to be clear, this strategy only
makes sense if you can answer yes to these two essential questions:
Do you absolutely intend to stay in this house forever? If you have any doubts about whether you will continue to live in your house after you retire, I wouldn’t rush to pay off the mortgage.
Can you afford to stay in the house? Please stand in the truth here: Even if you pay off the mortgage, will your retirement income be enough to cover property tax, insurance, and maintenance costs? I know it is hard to contemplate moving from a home you love and have put so much into, but what would be even more heartbreaking would be to realize at age 75 or 80 that you really can’t afford the upkeep of your home and then be forced to uproot yourself at a time when moving may be more trying, both physically and emotionally. If your taxes and maintenance costs are eating up a significant portion of your income today, you have to question how you will be able to handle the payments when you retire; unless you have a big inheritance or have been squirreling away tons of money, it’s likely you will have less income in retirement, not more. If that is your truth, please stand tall and be realistic. Rather than worrying about your mortgage in retirement, you should think about downsizing to a less expensive home sooner rather than later. The faster you get into a less expensive living situation, the more time you give yourself to save more because of your reduced expenses.
THE BENEFITS OF PAYING OFF YOUR MORTGAGE
If you answered an emphatic yes to both of the questions above, then I have to tell you that paying off your mortgage is an especially smart move in today’s investing environment. Right now safe bank and credit union accounts such as certificates of deposit aren’t paying more than 1% or so. If you were to use savings to pay off a mortgage that is costing you 5% or 6% (the mortgage interest rate) you would have just earned a higher return on your money: You wiped out owing that 5% or 6% with money that was sitting around earning just 1%. Now, of course you could also use your bank CD for other investments that you think could earn you 5%, or 6% or even more. But let’s stand in the truth here: There is no investment in today’s market that can give you a risk-free guaranteed 5–6% return. A dividend-paying stock or ETF might earn that much might, but it could also fall in value too, right? There’s no such risk when you pay off your mortgage.
I also need you to tune out any naysayers who tell you it never makes sense to pay off a mortgage ahead of schedule because you will lose the valuable mortgage interest tax deduction. Be smart here: In the early years of a mortgage it is true that the bulk of your monthly mortgage payments go toward paying the interest on your loan, and those interest payments are what is tax-deductible. But as the years go by your payments pay off more principal than interest, so the value of that deduction gets smaller and smaller.
For example, let’s say you are 50 years old and you just bought a home or refinanced with a $200,000 mortgage. Let’s say your interest rate is 4.5% on a 30-year fixed-rate mortgage. That means your monthly payment is $1,013, or $12,156 a year.
If you just keep up with the monthly payment for 20 years, you will reach age 70 still having 10 years of payments left to make. And even though you are two-thirds of the way into paying off the mortgage, your remaining balance is still nearly $100,000, because your payments in the early years mostly went toward paying interest, not principal.
So here you are at age 70, ready to retire. Your plan is that you will just make annual withdrawals from your 401(k) to cover the mortgage. To generate the $12,156 you will need each year requires that you start with a 401(k) balance of at least $500,000. That in itself is a tall order.
As I will explain later in this class, a solid rule of thumb is to aim to withdraw no more than 4 percent of your retirement assets in your first year of retirement. (You then adjust that for inflation in subsequent years.) So 4 percent of $500,000 is $20,000. But remember, there will be federal income tax, and possible state tax as well, if the money is withdrawn from a traditional 401(k). I am going to assume you will have no more than $15,000 left after paying the tax. Granted that’s more than your annual mortgage cost, but please realize that the $15,000 or so is probably going to need to cover not just your mortgage but also your other housing-related costs, such as property tax and insurance on the home. At the end of the day, that could be a tight squeeze—and that’s making the assumption at the outset that you have a sizable retirement fund to work with. And bear in mind that these are just costs associated with the home. We haven’t yet accounted for other living expenses, such as food, electricity, clothing, healthcare, entertainment, etc. And if you were to use most of your 401(k) to cover the mortgage, are you confident your other income sources—such as Social Security—would be enough to allow you to live comfortably in retirement?
The truth is, I know that many of you will not have ample savings in your retirement funds to cover your mortgage and other living costs, no matter how much you can manage to save between now and retirement. So that is why my advice is—if you answered an unequivocal yes to both of those major questions above—that you make it your goal to get the remainder of your mortgage paid off now. Going back to my example, I think it is more sensible to set as a goal paying off the $100,000 or so left on your mortgage before retirement, rather than hoping you will have enough income in retirement to cover the mortgage and your other living costs in retirement.
HOW TO PAY OFF YOUR MORTGAGE AHEAD OF SCHEDULE
Get a New Amortization Schedule
At what age do you think you will retire and by when would you like to pay off your home? Later in this class I will make a case that you consider working at least until age 66 or 67 in order to maximize your other retirement benefits, including Social Security. I recommend you use that as a general target. But if you think you may need or want to retire earlier, or you know enough about your industry that it is unlikely you will be able to stay at your current job—and your current salary—all the way until 67, then please stand in the truth and aim to have your mortgage paid off even earlier.
The next step is to call your mortgage company and ask them to send you a new schedule of your payments—called the amortization schedule—that would allow you to have the loan paid off by the date you choose. This will tell you what you need to send in each month to get the loan paid off by that target date.
You can get an idea of what your payments would need to be to accelerate paying off your mortgage by using the mortgage payoff calculator at www.bankrate.com.
Let’s say you are 55 years old and have 25 years left on a $200,000 30-year, fixed-rate mortgage that you took out with a 6.0% interest rate. I realize interest rates as of this writing are considerably lower, but I also know that many of you who took out mortgages during the last gasp of the real estate bubble may have been unable to refinance because of lost equity or a lost job, or maybe the new tighter lending standards banks are currently imposing meant you were turned down.
EXTRA PRINCIPAL PAYMENT ADDED TO $1,200 BASE PAYMENT AGE WHEN MORTGAGE IS PAID OFF TOTAL SAVINGS (INTEREST PAYMENTS YOU AVOID)
$0 a month 80 $0
$200 a month 71 $79,800
$300 a month 69 $101,100
$500 a month 65 $129,150
If you don’t add extra payments you will have the mortgage paid off when you are 80 years old. So the question you should be asking yourself is whether you will be able to keep making that payment through your 60s and 70s, or would it make more sense to find $500 a month today while you still have a paycheck coming in, so you could be mortgage-free by age 65? Let’s really think about that: Find $500 more a month today, or else put yourself in the pressure-packed situation of needing to keep paying $1,200 a month from the age of 65 to 80—years when we both know you will not be working at all, or just working part-time—before the mortgage is fully paid off. Stand in your truth: Of course it makes sense to try to pay off the mortgage sooner rather than later. And an added benefit to keep in mind: By accelerating your payments you will avoid owing more than $100,000 in interest payments. That’s a huge sav
ings. But the real savings here in my opinion is the money (and stress!) you won’t need between the ages of 65 and 80 to keep paying off the mortgage.
How to Come Up with the Extra Money
Accelerating your mortgage payments is something to be considered only if you are in good financial shape. That means:
You have an eight-month emergency savings fund.
You do not have any credit card debt.
You own your car outright, and you are saving for when you will need to purchase another car.
I realize there may be other pressing financial needs for your dollars today, such as lending a hand to adult children who could use help paying their own mortgage as they grapple with a layoff, or assisting parents who are struggling to make ends meet when the income they can earn in this low-rate environment has been reduced so drastically from a few years ago. I am not going to tell you what takes precedence; this is your truth to work through. Instead I would suggest that you spend time in the Family Class, where I discuss how to work through the how and when of offering assistance to your loved ones.
For those of you who are able to take on the goal of paying off your mortgage ahead of schedule, here’s your game plan:
• If you have more than eight months in your emergency fund: You may use that excess amount to pay down the mortgage. Your emergency savings are likely earning just 1% or 2% these days. Using that money to retire a 5% or 6% mortgage is a great use of your money. But you must never reduce your emergency savings below eight months. You must always have eight months of liquid cash available to cover life’s surprises.