Use re­tire­ment sav­ings to pay debts? Not wise

While you’re work­ing, it’s best to make loan pay­ments us­ing your in­come rather than your nest egg.

Los Angeles Times - - PERSONAL FINANCE - By Liz We­ston

Dear Liz: I’m 60 and owe about $12,000 on a home eq­uity line of credit at a vari­able in­ter­est rate now at 7%. I won’t start pay­ing that down un­til my other, low­er­in­ter­est bal­ances are paid off in about two years. I have about $130,000, or about 20%, of my qual­i­fied sav­ings sit­ting in cash right now as a hedge against a fall­ing stock mar­ket. Should I use some of that money to pay off the HELOC? I know I would pay tax on what I pull out of sav­ings, but I’m not sure what the driv­ing de­ter­mi­nant is: the tax rate now while I’m work­ing ver­sus tax rate later after re­tire­ment? An­swer: There are enough mov­ing parts to this sit­u­a­tion, and you’re close enough to re­tire­ment, that you re­ally should hire a fee-only fi­nan­cial plan­ner.

Get­ting a sec­ond opin­ion is es­pe­cially im­por­tant when you’re five to 10 years from re­tire­ment be­cause the de­ci­sions you make from this point on may be ir­re­versible and af­fect your abil­ity to live com­fort­ably.

In gen­eral, it’s best to pay off debt out of your cur­rent in­come rather than tap­ping re­tire­ment sav­ings to do so. You’re old enough to avoid the 10% fed­eral penalty on pre­ma­ture with­drawal, but the de­ci­sion in­volves more than just tax rates. Many peo­ple who tap re­tire­ment sav­ings haven’t ad­dressed what caused them to in­cur debt in the first place and wind up with more debt, and less sav­ings, a few years down the road.

That might not de­scribe you, as you seem to be on track pay­ing off other debt. But it’s usu­ally best to tackle the high­est-rate debts first, which you don’t seem to be do­ing. It’s also not clear if you’re sav­ing enough for re­tire­ment. That will de­pend in large part on when you plan to re­tire, when you plan to claim So­cial Se­cu­rity, how much your ben­e­fit will be and how much you plan to spend.

A fee-only fi­nan­cial plan­ner could give you the ad­vice you need to feel con­fi­dent you’re mak­ing the right choices. You can get re­fer­rals from a num­ber of sources, in­clud­ing the Na­tional Assn. of Per­sonal Fi­nan­cial Ad­vi­sors, Garrett Plan­ning Net­work and XY Plan­ning Net­work.

So­cial Se­cu­rity math mis­take?

Dear Liz: In a re­cent col­umn you men­tioned So­cial Se­cu­rity’s de­layed re­tire­ment credit, writ­ing that some­one’s ben­e­fit could grow 32% by de­lay­ing ben­e­fits for four years be­tween ages 66 and 70. Four years’ worth of ac­crued 8% in­creases in So­cial Se­cu­rity re­sult in a cu­mu­la­tive in­crease of 36%, not 32%. I would think any fi­nan­cial plan­ner would un­der­stand com­pound growth.

An­swer:

So­cial Se­cu­rity’s de­layed re­tire­ment cred­its don’t com­pound.

You may feel silly for point­ing out an er­ror that wasn’t an er­ror, es­pe­cially be­cause you could have found the cor­rect an­swer through a quick in­ter­net search (“Is So­cial Se­cu­rity’s de­layed re­tire­ment credit com­pounded?”). But who hasn’t made a sim­i­lar mis­take? Some­times what we don’t know about money isn’t the prob­lem — it’s what we do know for sure that just isn’t true. (A sim­i­lar quote is of­ten at­trib­uted to Mark Twain, al­though there seems to be no ev­i­dence he ever said or wrote it.)

When I’ve made er­rors, it’s of­ten be­cause I thought I un­der­stood some­thing I didn’t or that my knowl­edge was up to date when it wasn’t. That’s why it’s so im­por­tant to dou­ble-check with au­thor­i­ta­tive sources.

In­de­pen­dent con­trac­tor test

Dear Liz: You an­swered a ques­tion from a mother who was con­cerned that her son didn’t un­der­stand the fi­nan­cial im­pli­ca­tions of be­ing an in­de­pen­dent con­trac­tor rather than an em­ployee. From what she wrote, the com­pany em­ploy­ing him may not be fol­low­ing the law. The IRS has cri­te­ria to de­ter­mine whether the worker qual­i­fies as a con­trac­tor. I have been in that sit­u­a­tion on at least two oc­ca­sions. In one of those, the IRS went after the em­ployer for all the taxes it should have paid even though I had paid all the So­cial Se­cu­rity and Medi­care taxes. This could put the worker in a dif­fi­cult po­si­tion if the em­ployer is found to be vi­o­lat­ing the law. An­swer: Thank you for bring­ing that up. Many states use the “ABC test” to de­ter­mine whether some­one can be clas­si­fied as an in­de­pen­dent con­trac­tor. Most of the states use just the first and third test (A and C), but a few states, in­clud­ing Cal­i­for­nia, re­quire all three:

The worker is free from the con­trol and di­rec­tion of the hirer in re­la­tion to the per­for­mance of the work, both un­der the con­tract and in fact;

The worker per­forms work that is out­side the usual course of the hirer’s busi­ness; and

The worker is cus­tom­ar­ily en­gaged in an in­de­pen­dently es­tab­lished trade, oc­cu­pa­tion, or busi­ness of the same na­ture as the work per­formed for the hirer.

The sec­ond prong is what will trip up a lot of busi­nesses hop­ing to re­duce their costs by clas­si­fy­ing work­ers as in­de­pen­dent con­trac­tors rather than W-2 em­ploy­ees. Liz We­ston, cer­ti­fied fi­nan­cial plan­ner, is a per­sonal fi­nance colum­nist for NerdWal­let. Ques­tions may be sent to her at 3940 Lau­rel Canyon, No. 238, Stu­dio City, CA 91604, or by us­ing the “Con­tact” form at askl­izwe­ston.com. Dis­trib­uted by No More Red Inc.

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