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Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
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Bankrate.com |
Time to get out of my retirement
plan?
Dear Dr. Don,
Would it be a good idea to take money from my retirement plan to
build a house in this sluggish economy? I have lost about 40 percent
over the past year or so. I know that there will be penalty and
taxes of about 32 percent, but is getting out now worth it to invest
in home equity?
Pat
Dear Pat,
Watching your account balance decline in your
401(k), 403(b) or IRA account is a gut wrenching experience. You
think, if only I had been smart enough to see that the stock market
was heading for a fall. If it helps, you weren't alone.
Let's say you had $100,000 in a 401(k) account and
you watched that account decline to $60,000. Paying income taxes
plus a penalty tax of 10 percent for an early withdrawal, assuming
that your 32 percent is correct, would result in you having $34,800
to invest in a home.
I've put together an example that compares your investment
in real estate to just holding on to your retirement account over
the next 20 years. In it I assume that your home appreciates in
value by 3 percent annually while a stock portfolio appreciates
9 percent annually.
The stock appreciation value is quite conservative
for a well-diversified portfolio of stocks. After all, the Standard
& Poor's 500 Index, an index of the largest capitalization stocks
in the U.S. market has averaged 12.7 percent annual returns in the
10 years ending Sept. 30, 2001.
We'll assume that you would pay the same in rent ($903
a month) as you would pay in mortgage payments. Another assumption
-- at the end of 20 years, you're in the 28 percent tax bracket
and you'll have to pay taxes on the profits in your retirement portfolio
(in this case, $94,154 in taxes).
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Now:
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Home
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Retirement
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Purchase price:
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$174,000
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$60,000
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Current value of retirement portfolio
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Down payment:
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$34,800
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20% of purchase price
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Loan amount:
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$139,200
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Loan rate:
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6.75%
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30-year fixed mortgage
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Monthly payment:
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($903)
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($903)
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Twenty years later:
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Home
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Retirement
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Appraised value based on 3% annual appreciation:
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$314,263
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$336,265
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Portfolio value in 20 years @ 9% avg. return
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Loan balance:
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$78,168
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$(94,154)
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Estimated taxes @ 28%
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Home equity:
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$236,095
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$242,111
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Portfolio value after taxes
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Note: The retirement scenario assumes that
you rent and that the rental expense is the same as your monthly
loan payments plus taxes and insurance for the home purchase
scenario.
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Now, I realize that these figures are all pie in the
sky calculations. You don't know how your real estate investment
will appreciate over time any more than you can know how the stock
market will do over time.
My point is that keeping that $25,200 working for
you in your retirement account vs. paying it out to the IRS in taxes
and penalties, can mean a lot for your future retirement. You have
to weigh how close you are to your planned retirement, and how comfortable
you are with the long-term prospects of real estate or the stock
market before you decide which decision is right for you.
Get professional help from a fee-only Certified Financial
Planner if you can't decide. The CFP
Board of Standards can help you with finding a financial planner
in your area and how to choose a planner.
-- Posted: Oct. 15, 2001
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