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Don't tap retirement fund just to get a lower mortgage

August 14, 2011|Liz Weston | Money Talk

Dear Liz: My husband is 30 and I'm 28. We were told the importance of contributing to our retirements and so now have $58,000 saved. We have an additional $65,000 saved for a down payment. Due to my son's recent liver transplant, I won't be able to work for an indefinite amount of time, so we are reduced to one income of about $60,000. We have to move to get into a better school district and can't decide what to do. We're currently looking at homes in the $200,000-to-$250,000 range. My husband wants to use my $38,000 retirement savings (which would be $30,000 once taxed) to get into a home with a lower payment that will not require me to work. I'm scared to do this since everyone preaches retirement, but at this rate we won't have a mortgage when we retire. Plus, who wants to be a millionaire at 60! I want to enjoy life while we're young and our kids are young. We are very disciplined but just don't know what to do. Thanks!

Answer: You can enjoy life and still refrain from doing stupid things that will jeopardize your retirement.

And tapping retirement funds early is typically pretty stupid. You're giving up all the future tax-deferred returns that money could have earned. By the time you're 60, that $38,000 could have grown to nearly $450,000.

You also may be underestimating the tax bite. You can withdraw up to $10,000 from an individual retirement account for a first-time home purchase, but the remainder of the withdrawal will be penalized at a 10% federal rate, plus whatever penalty your state assesses. The entire withdrawal will be taxed at your current income tax rates.

The taxes and penalties are substantial for a reason: You're supposed to leave this money alone. Since you probably won't be able to contribute to a retirement account for a while, it's even more important not to squander these funds.

Besides, the extra $30,000 would lower your monthly payment by about $160 on a 30-year fixed-rate mortgage at 5%. That doesn't seem like much of a payoff considering what you'd be giving up.

Dear Liz: I really enjoy the columns you've written about living frugally and especially appreciate when you discuss healthcare expenses. I find it extraordinarily frustrating when people who promote a frugal lifestyle answer that they keep healthcare expenses down by "eating healthy." I recently experienced a serious medical situation even though I maintain a healthy weight and otherwise take care of myself. It is in this area, I believe, the frugal community lacks understanding. Some believe that you get sick only because you don't take care of yourself, or assume that their emergency fund will get them through a rough patch of health issues. Those that believe this are setting themselves up for disappointment should they have the unfortunate experience of a healthcare problem. Thank you for drawing attention to the importance of healthcare and making sure your family is covered.

Answer: Eating healthful food, exercising, maintaining an appropriate body weight and investing in preventive healthcare can lower healthcare costs on average. But no individual, no matter how vigilant, is immune from an accident or illness that can result in catastrophic medical bills.

So you're right that people who voluntarily go without health insurance are deluding themselves. They're pretending they have the sole power to determine their future health, when that's clearly not the case.

Dear Liz: I invested in an annuity, and now I'm sorry. How do I cancel an annuity? And what are the ramifications of doing so?

Answer: Annuities are a lot easier to enter than they are to exit. Many annuities have substantial surrender charges if you try to cash out in the first few years. You also may owe taxes and penalties on any earnings.

You may be able to get the insurer to "unwind" the annuity (essentially, refund your money without surrender charges) if the salesperson used deceptive tactics. If that's the case, consider enlisting the aid of your state insurance commissioner.

Otherwise, you may want to consider waiting until the surrender charges no longer apply, and then cashing out or exchanging it for a lower-cost annuity. A visit with a fee-only financial planner could help you decide on the right move.

Liz Weston is the author of "The 10 Commandments of Money: Survive and Thrive in the New Economy." Questions for possible inclusion in her column may be sent to 3940 Laurel Canyon, No. 238, Studio City, CA 91604 or via Distributed by No More Red Inc.

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