The Money Class

by Suze Orman

  • Reduce your monthly expenses so you can add more to your mortgage payment. If you are ready to stand in the truth that paying off your mortgage before retirement is the best way to ensure a secure retirement, then you must also stand in the truth that having more income available at the end of the month to add to your mortgage payment is how you make this particular dream come true.

  After taking those steps, if you are still looking for more money to use to pay off your mortgage, you can carefully consider scaling back contributions to your retirement funds. Here is a game plan:

  • If you contribute to a 401(k) up to the point of the match: Keep contributing enough to continue to get the match. But if you have been contributing more than that to your 401(k), redirect anything beyond what’s needed to get the match toward paying off your mortgage.

  • If you have less than $100,000 in your traditional IRA: Keep investing in your IRA, but once you get within 10 years of retirement, consider reducing your IRA contribution by 50% and use that money to pay down your mortgage. For example, let’s say you are contributing $500 a month to your IRA. My advice is to reduce that to $250 a month and then put the remaining $250 into accelerating your mortgage payments.

  • If you have less than $100,000 in a Roth IRA: Same advice as with the traditional IRA, above.

  • If you have more than $100,000 in a Roth IRA: Figure out how much you need to accelerate your mortgage payments to get it paid off by your expected retirement date. If that monthly sum is more than your current monthly Roth IRA contributions (or the annual equivalent), stop the Roth contributions and use the money to pay down the mortgage. If the amount you want to use for your accelerated mortgage payment is less than your current Roth contributions, great. You can put more money into paying off the mortgage and still continue to make smaller Roth contributions. Let me illustrate that with an example: If all you need is $300 more a month to pay off your mortgage by the time you retire, and you are depositing $500 a month into your Roth, continue to deposit $200 a month into your Roth and add $300 to your mortgage payments. However, if you need all $500 to pay off your mortgage before retirement, stop the contributions altogether and put all that money toward paying down your mortgage.

  • Use money from a Roth IRA. Money you invested in a Roth IRA—your contributions—can always be withdrawn in any amount at any time without a penalty or tax. And your earnings on those contributions can be withdrawn tax- and penalty-free once you are at least 59½ and have had the account for at least 5 years. If you converted a traditional IRA to a Roth IRA and paid the tax, you need to leave the amount you originally converted inside the account for at least 5 years or until you turn 59½—whichever occurs first—to avoid all tax and penalty. The earnings on your converted money must stay untouched until you are 59½ to avoid tax and penalty.

  In any case, I strongly recommend that you do not touch any retirement savings before age 59½. You want that money to grow as long as possible. It is better to aim to get your mortgage paid off by using other income sources while you are working. Once you are within a few years of retirement, tapping your Roth is fine. But please think carefully about how much you can truly afford to withdraw. If you will need income from your Roth to help pay your ongoing expenses in retirement, then it makes no sense to deplete the account. This goes back to my stand-in-the-truth challenge: You are only to pay off the mortgage if you can truly afford to stay in the home.

  Later on in this class I am going to ask you to work through an exercise that will give you an estimate of what your monthly retirement income sources may be—from Social Security, from a responsible rate of withdrawal from your 401(k)s and IRAs, and perhaps from a pension. When you go through that exercise, I want you to run the estimates based on a few different scenarios for your Roth IRA: if you don’t touch it at all right now, if you were to use 20% of it to pay off your mortgage, if you were to use 40%, etc. The challenge here is to not use so much of your Roth IRA today that it reduces your potential income in retirement to a level that makes you nervous. It’s a balancing act. If you have a big pension or you are confident that your Social Security and 401(k) assets will provide plenty of retirement income, then you can afford to tap more of your Roth IRA today.

  • Under no circumstances are you to take an early withdrawal from a traditional 401(k) or IRA. It makes no sense to withdraw money if you will have to pay the 10% early-withdrawal penalty. Moreover, remember that withdrawals from these traditional accounts count as income in the year you make the withdrawal. A large lump sum withdrawal could put you in a higher income tax bracket for the year. That is not a wise move. Even once you turn 59½ I do not recommend you make large lump sum withdrawals simply to pay off your mortgage. The tax hit will invariably bump you into a higher tax bracket. My advice is to start today with the intention of finding extra monthly income or focus on reducing your expenses so the income you do have can be put toward accelerating your mortgage payment so the mortgage will be paid off before you retire.

  STAND IN THE TRUTH

  Paying off your mortgage before you retire has an undeniable allure. What greater security is there than knowing no one can take your home from you? And if, later in retirement, you find you need more income, you will be able to take out a reverse mortgage. (See the Home Class for a lesson on reverse mortgages.) So if you are in the home you intend to retire in and your financial truth makes it possible to accelerate your mortgage payments, I think this is a great step to take, beginning in your 50s.

  But please promise me that if you reach this conclusion, you have made the decision while standing in a very real and responsible truth. I know you love your home. I appreciate that the idea of having a family home for your children and grandchildren to return to is a classic part of the American Dream. The allure of this image is incredibly powerful. So I recognize that it will take a great amount of fortitude to face up to the reality of your situation as a homeowner. And if you have to rewrite this part of the American Dream for yourself, it will no doubt be a painful and disappointing reckoning. It may be the most difficult kind of letting go to relinquish the dream of a family home and replace it with a more modest living arrangement. The consolation I can offer you in return, however, is security and peace of mind, in knowing that you have made a difficult but correct decision that is in accordance with your truth. You will know you did what was right, not what was easy.

  LESSON 2. HAVE A REALISTIC PLAN FOR WORKING UNTIL AGE 66–67

  If there has been one singular shift in America’s retirement dream since the onset of the financial crisis, it is that many of us must plan on working longer to make up for the money lost in the market crash, for the loss in home equity, or to make up for years when we may not have been saving as much as we needed.

  For those of you who fit any of these descriptions, I want to make sure you have a realistic game plan for how you will leverage working longer into a secure retirement. I realize that many of you may in fact want to work longer, for reasons that have nothing to do with finances; you want to stay engaged in work for the sense of satisfaction and vitality it provides. I think that’s great. But my lesson on delaying retirement and working longer is focused on those of you who need to work longer.

  Frankly, I am concerned that many of you may be heading for big trouble by overestimating your ability to work longer. As much as I believe that we should all plan to work longer, we also must keep saving, and saving aggressively, today in case we cannot continue to work as long as we might like.

  According to the nonpartisan Employee Benefit Research Institute, more than 40% of workers today say they expect to work past age 66—nearly double the percentage that said the same in 2000. But the reality is that 40% of people end up retiring before they expect to; the most common reasons are poor health or being laid off. It’s also interesting to see that while 70% of workers near retirement today say they intend to work in some capacity after they retire, the data shows that in fact just 23% of current
retirees continue to work. I mention all of that because it is important to recognize that even if your intention is that you will work longer, you must also plan for the possibility that you may not be able to.

  DOWNSIZING TO A LOWER-PAYING JOB IS A FACT OF LIFE

  Even if you do keep working through your 60s, it is dangerous to assume you will be working in the same high-powered job that paid you a top salary in your 50s. Downsizing is a fact of life we all must be prepared for. And if you have been with one firm for a long time, there’s a good chance that a new job in your 50s or 60s will not pay as well. And let’s be sure to stand in another important truth: Working 40, 50, 60 hours a week in your 60s may not be something you want to do. Sure, you want to work, but at a less hectic pace. You may make less in your 60s because you choose to shift to a less demanding job. A 2008 study by the Center for Retirement Research (CRR) at Boston College found that the percentage of men between the ages of 58 and 62 who were still with the same employer they worked for at age 50 had dropped from 68% in 1983 to 46% in 2006. And that was even before the economic downturn in 2008 left so many across all age brackets unemployed. Moreover, the CRR also found that those who changed jobs after age 50—whether the switch was voluntary or not—made on average about 25% less in their new job.

  Add up all those factors and the lesson here is that you cannot assume you will be able to maintain the same pay and same vigorous work schedule that you kept in your prime. You must aggressively save for retirement in your 50s so that you can afford to earn less in your 60s, and if necessary, stop working altogether at an earlier-than-expected age.

  Yet here’s what I hear so often these days from so many of you: Your plan, you say, is to never retire. I have to tell you, that is simply not a realistic plan. Please do not make the mistake of not saving for retirement (or not saving as much as you can) on the assumption you will be able to work forever—even if that’s what you want.

  YOUR WORK-LONGER GAME PLAN

  • Plan on making less in your 60s than you did in your 50s. Maybe this won’t come to pass, but now is the time to do as much saving as you can so in the event you can’t work as long as you expect, or you take a lower-paying job, your retirement plans won’t be thrown off course. That’s another reason why I recommend paying off your mortgage sooner rather than later; if you are still saddled with a hefty mortgage payment in your early 70s or 80s you are walking quite a financial high wire.

  • Aim to delay your retirement until age 66 or 67. When it comes to Social Security, your goal should be to wait until you reach at least your full retirement age (FRA) so you can claim your full retirement benefit. While your grandparents’ FRA was 65, the system was tweaked in the early 1980s to gradually raise the FRA. Anyone born between 1954 and 1959 has an FRA between age 66 and 67; it depends on the exact year you were born. For example, someone born in 1957 has an FRA of 66 years and 6 months, while someone born in 1959 has an FRA of 66 years and 10 months. Everyone born in 1960 and later has an FRA of 67.

  A Note About Potential Social Security Reform

  In 2010, as our government began to debate possible fiscal reforms to address the national debt and deficit, raising the FRA for Social Security was one of the options thrown into the conversation. Please understand that none of the current proposals—and they are just that, proposals that have yet to garner any momentum—would change the age requirements for people already in their 50s. One proposal to raise the FRA to 69 would impact today’s toddlers, not you.

  I’d love for you to keep working until you reach your FRA, if possible, so you don’t feel tempted to draw your Social Security benefit beginning at age 62. As I will explain in the next lesson, delaying your Social Security start date is a great strategy to give you more income in retirement. And trust me, most of you will need it.

  Delaying your retirement just 3 to 4 years—or more if you’re willing and able—can have a tremendous impact on your retirement security. It reduces the number of years you will be living off your retirement income and allows your investments to continue to grow. So often the “How Am I Doing?” segment on my CNBC show involves a couple who want to retire in their early 60s and seek my opinion. In the vast majority of these calls my advice is to keep working. Here’s what they and you need to understand: According to research by T. Rowe Price, if you retire at age 67 rather than 62 you could have nearly 40% more retirement income, and that assumes that from age 62 to age 67 you don’t save a penny more for retirement. Delay retirement all the way to age 70—again assuming you stop saving at age 62—and your retirement income can be more than 60% higher than what you would have if you retired at age 62. The big increase is a function of your savings continuing to grow a bit longer, the fact that you will be living off your retirement savings for fewer years, as well as the benefit of waiting to take your Social Security payout at a later age. (We will cover this important step in the next lesson.)

  • Spend your 50s planning for your 60s. Waking up at age 62 laid off or sick of your job is not the ideal time to think about what you might do to bridge the gap to age 66 or 67. You want to be planning for that day at least a decade before. If your dream is to transform a hobby into a part-time job that will bring in some income during those transition years, you need to start testing the waters and picking up any necessary new skills you may need. Or if you want to do something entirely different that requires formal training, get that schooling now, before you need it. In fact, if your employer offers education benefits, have your company help you pay for your next-stage career. If you anticipate you will want to segue into a consulting role in your area of expertise, well, now is the time to start doing a little bit of that on the side (assuming your employer has no objections), or focusing on building industry relationships that will make it easier to bring on clients when you do start your consulting work.

  I also recommend you make an effort to develop relationships with the 20- and 30-somethings in your office and at industry networking events. Those are the folks who 10 to 15 years from now will be running the show when you are looking for a late-career job in your 60s.

  LESSON 3. DELAY YOUR SOCIAL SECURITY BENEFIT

  Nearly two-thirds of Americans rely on Social Security retirement benefits as their primary source of retirement income. Yet most Americans settle for a Social Security benefit that can be 30% to nearly 80% less than what they are entitled to because they choose to start receiving their benefit at an early age.

  For our parents and grandparents, Social Security was a no-brainer—the benefit started to kick in and subsidized their retirement. But for baby boomers who are suddenly staring down retirement, it is a whole new ball game and it is so very important to learn the ins and outs of how Social Security works. And learning about this in your 50s is very important. If you decide that waiting until age 66 or 67 to begin your Social Security payments makes the most financial sense, that may impact other decisions, such as whether you will want to keep working—even if just part-time—until the time is right for you to start drawing your Social Security benefits.

  I want to call attention to the fact that this is a whole new strategy I am presenting here, different from what I’ve written about in my previous books.

  Changes in the economy and our retirement system necessitate this shift. For example, most of you will not have a steady pension to rely on in retirement; that ratchets up the need to be as strategic as possible in how you take your Social Security benefits. Moreover, taking early benefits used to mean a maximum 3 years of early benefits, as past generations had an FRA of age 65. Today the FRA for people currently in their 40s and 50s is somewhere between the ages of 66 and 67. That stretches the period—and the penalty—for early benefits from 3 years to as much as 5, and thus it changes the calculus of this important decision. Social Security to our parents and grandparents was a cornerstone of the American Dream. For my generation and the generations that follow, Social Security is still a part of the American Dream of retiremen
t, but because you may not have that steady pension, or because you may not have been able to save up enough on your own through your 401(k) and IRA, squeezing the absolute maximum amount from Social Security becomes one of your most important retirement planning strategies.

  The time to learn how best to take your Social Security benefits is right now, when you are still young enough to be able to adapt.

  SOCIAL SECURITY BASICS

  We are all eligible to begin receiving our Social Security retirement benefit at age 62. But what you may not fully appreciate is that the Social Security program will give you a higher benefit for every month you wait to start, between the age of 62 and age 70.

  The payment scale pivots around your full retirement age. As I explained above, the FRA for today’s worker is somewhere between age 66 and 67; everyone born after 1959 has an FRA of 67.

  If your FRA is 67, that is the age at which starting to draw your benefit will entitle you to 100% of what you have earned. If, however, you decide to start drawing an early benefit at age 62, it would be just 70% of your full benefit. In other words, when you start your benefit at age 62 you are locking in a 30% reduction compared to what you could earn if you waited a few years. Another way to look at this is that between the age of 62 and 67 Social Security will pay you 6% a year if you delay starting your benefit payments.

  Even if you were to take the money early with the intention of saving it for your later retirement years, I think you’d be making a mistake. That 6% bonus each year is guaranteed. There is no way you could be absolutely assured your investments would generate that return. Maybe yes, maybe no. But either way you would have to invest in far riskier investments than what you can get guaranteed by delaying when you start to draw your Social Security benefit.