By Judy Loy, ChFC® and CEOat Nestlerode & Loy Investment Advisors
Having money gives one choices, but deciding how to utilize it artfully can create confusion and uncertainty. While investing, saving, and debt payments are guided by individual risk tolerance and circumstances, there are general guide-lines to allow for more objective thinking when making some common decisions.
Here are some frequent questions I receive:
If you get a raise or inherit money, should you invest it or pay down your mortgage? A mortgage is considered ‘good debt’ as it permits homeowners to finance a home and build equity in their house over time. Given the low interest rate en-vironment of recent years, most current mortgage holders have exceptionally low mortgage rates that are fixed. You typically also get a tax deduction for your mortgage interest if you item-ize.
Therefore, paying down your mortgage is similar to a guaranteed tax-free instrument earning the mortgage interest rate. First things to consider are: Do you have an emergency savings? How would you invest your money elsewhere?
If you don’t have savings set aside for emergencies, save enough money to cover three to six months of expenses in a liquid savings account or money market. This will prevent you from having to use high interest rate credit card debt in an emergency. After that, if you are not getting the full match from an employer contribution into a retirement plan, make that a priority before paying down the mortgage. You won’t get a better return than the 100% return you get from taking advantage of your employer’s matching contribution.
After exhausting these possibilities, compare the interest rate on the mortgage (tax adjusted) with the returns on the proposed investments. Remember, the investment returns that are beating the mortgage rate may not be guaranteed so factor in your risk tolerance. Putting money into a CD at 2% and not paying off a 4% mortgage doesn’t make sense but putting money into a mutual fund for 20 years where the average return has been 8% might make sense, if you can handle the volatility, and your mortgage rate is 4%.
I also urge clients to have their mortgage paid off before retirement so that there is one less expense to cover after you stop working.
If you plan on putting money into a personal individual retirement account (IRA), should you invest in a traditional or a Roth IRA?
The answer to this question includes understanding the differences between the two IRAs and reasons why you might choose one over the other. A traditional IRA allows for a tax deduction for money going into the IRA; therefore, if $2,000 went into an IRA in 2014,you would have $2,000 less income to pay taxes on when tax time rolls around in April 2015. Putting the same $2,000 into a Roth in 2014, would give you no tax advantage now.
Both accounts grow tax-deferred until money is pulled out, meaning any dividends or capital gains created inside the accounts are not taxed. However, in retirement, all withdrawals from an IRA are taxable as income. In contrast, qualified withdrawals from a Roth IRA in retirement are tax-free. Thus, the Roth benefits you tax-wise in re-tirement and a large amount of gains inside of a Roth will never be taxed.
If you have an employer retirement plan through work, a deductible IRA is only fully available to you if your Adjusted Gross Income (AGI) is under $59,000 if you are single or $96,000 if you are married filing jointly. A Roth is more forgiving as it does not take into account whether you have a retirement plan through work but merely goes by your AGI.
If you are single and your Adjusted Gross Income is under $114,000 in 2014, you are eligible to make the full Roth contribution. If you are married and filing jointly, you are eligible for a full Roth contribution when your AGI is under $181,000.If you are eligible for both, how do you choose? If you be-lieve tax rates will be higher for you in retirement, you should choose a Roth.
I believe a combination of Roth and Traditional IRAs (or traditional retirement plans) makes the most sense. In retirement, you may have a year you want to minimize income (possibly to not be taxed on social security), so having the option of pulling from either a Roth or a Traditional Retirement Plan helps diversify you tax-wise.
As you see, and talk you through your options.
Please call investment advisor Judy Loy, ChFC ® to help plan your financial future at: 814.238.6249