Thursday, 13 June 2019 00:00

A Few Good Ideas... Which Probably Aren’t

By Stephen Kyne, Partner, Sterling Manor Financial | Families Today
A Few Good Ideas... Which Probably Aren’t

As a Certified Financial Planner, one of the biggest challenges I face is in helping people take a step back and look at their financial life in the aggregate. Because people are busy, and are usually a professional at doing something other than managing their finances, I find that many times people may take a whack-a-mole approach to their finances. When looking at the entirety of their finances, however, strategies that may have seemed to make sense on the surface often lose their appeal. Let’s take a look at some common ideas, and I’ll show you why you may want to reconsider.

1. Should I use my 401k (403b, Deferred Comp, etc) to pay off my mortgage? 

The answer to this question is almost always a booming “NO.” Many people view all debt as bad and find a level of comfort in the idea of zeroing it out, but it’s often a terrible idea, where your mortgage is concerned. 

First, if you’ve refinanced in the last ten years, your interest rate is probably somewhere between three and four percent (even lower when you adjust for the tax deduction you may receive). If your 401k is invested in a relatively moderate portfolio, you’re probably earning about six percent.  That means your spread on this borrowed money is two to three percent. Consider that banks make money by borrowing from depositors at one rate and lending that money out to borrowers at a higher rate. While not perfectly analogous, if it makes sense for them, doesn’t it make sense for you?

Second, remember that your 401k has never been taxed before. That means, in order to pay off your mortgage, you’d need to withdraw funds, pay taxes (and possibly penalties, if you’re younger than 59 ½), and then pay off the loan. Depending on the amount, you may push yourself into a higher tax bracket, as well.

Let’s assume your mortgage balance is $100,000, and that the withdrawal will push you into the 24% tax bracket, not to mention about 6% to New York State. That means you’ll need to withdraw $142,857, in order to net the $100,000 needed to pay off the loan. As if that isn’t bad enough, remember that you’re also now foregoing the 3% net compounded rate of return on the withdrawal for every year going forward! Assuming ten years left on the mortgage, the amount you withdrew would have grown to $192,988 in that time, while you would have only paid $115,873 if you just kept the mortgage. All told, the strategy cost you an additional $77,115. While there are exceptions, this payoff strategy is a great way to make cheap debt very expensive, and should generally be avoided.

2. Should I shift all of my investments to bonds and CDs when I retire?

How hard your money needs to work in retirement is a function of how much you need your assets to supplement your guaranteed income sources for the duration of your retirement. If you’re lucky enough to have large pensions and a low cost of living, then you may be able to invest much more conservatively. If, however, you only have Social Security as a guaranteed income source, your assets may need to work harder in order to provide the additional income you’ll need to maintain your standard of living.

Your last years of retirement are going to be much more expensive than your first, and we know that most people don’t begin their retirement on a fixed income; they end their retirement on one.  As a retiree, let’s assume that your personal rate of inflation is 4%, which is higher than average due to the proportion of your spending allocated to energy, food, and health care. If you put the brakes on your investments at retirement and rely on CDs earning 2%, you’ve essentially committed yourself to safely losing 2% each year. 

The only asset class which consistently outpaces inflation is stocks. This isn’t to say that you should be aggressive, but most retirees will need at least a portion of their investments allocated to stocks in order to be able to outpace inflation. In order to determine how big this portion should be, you’ll need to work with your independent financial advisor to determine the rate of return you’ll need to average over your lifetime, based on your personal needs, and then back into an allocation which is likely to provide those returns. 

3. We only need enough life insurance to cover the mortgage.

Having enough life insurance to cover basic debts is certainly better than having none at all but, from a practical standpoint, it probably isn’t enough coverage. 

When working with clients, we consider life insurance need on a spectrum. At the low end is the amount that would be needed to cover basic debt, and to provide enough for a survivor to get back up and running. At the high end is the amount that would be needed to replace all the income that the decedent would have earned had they lived. Where you should be on the spectrum depends on a number of factors.

If you are a young couple, without children, and you both make roughly the same amount, you may be able to get by with a relatively low amount of life insurance. However, if you are a young couple with children, and one spouse is primarily a homemaker, the need will be very different.

In this instance, let’s say the working spouse earns $100,000, and the desire is to provide enough death benefit to get the surviving spouse through the childrearing years (20 years). The rough math, then, is that the working spouse should consider a $2,000,000 20-year term policy. This coverage would be relatively inexpensive and probably provide enough to allow the family to maintain its standard of living. 

Don’t forget about the stay-at-home parent! Even though the work is unpaid it represents a huge economic contribution to the home which would have to come from paid help in the event of the homemaker’s death. 

Every time I see a Go Fund Me page for a young family where one parent died prematurely, I’m all the more saddened because I know how truly accessible and affordable term life insurance is. Work with your independent financial advisor, determine the coverage level to meet your needs, and get insured. No surviving spouse ever complained that their spouse was over-insured. 

I’ve said this before, and I’ll say it again: in these circumstances, term insurance is probably going to be all you need since it provides more death benefit per dollar of premium than other forms of life insurance.

Of course there are exceptions to each of the scenarios I’ve outlined above, and that is why it’s so important for you to work closely with your independent financial advisor, assess your need, and devise a personal strategy that encompasses the entirely of your financial life. Review that strategy on a regular basis to ensure that it stays relevant and forward-looking.

Stephen Kyne, CFP® is a Partner at Sterling Manor Financial, LLC in Saratoga Springs, and Rhinebeck, NY. Securities offered through Cadaret, Grant & Co., Inc. Member FINRA/SIPC. Advisory services offered through Sterling Manor Financial, LLC, or Cadaret Grant & Co., Inc., SEC registered investment advisors. Sterling Manor Financial and Cadaret Grant are separate entities.

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