financial advice/ home buying/ 401K

[viannqueen3]

Question for you (long)...

My husband and I are in our early 30's. Nine years ago we bought our first home in a starter neighborhood. We purchased a home far under what we were approved for at the time and worked hard over the years throwing our savings towards it and have paid it off outright. We were DINKS for awhile which obviously helped. Our only "debt" we have is a small loan we took against our 401K to pay for finishing the basement/ SUV which will be done in four years.

We are trying to decide to build a new home or not. We'd be moving closer to my husbands work and cutting his commute in half, but the area of town is much more expensive land wise. For a new home which is slightly larger on a 1/3rd acre would be cost about double of what our current home is worth. We know real estate can be risky but the markets have held pretty steady where we live. We both have excellent credit. I just have to brag- We opened an account at a different bank a year or two ago and the banker told my husband that his credit score was the highest he had seen at his bank so far (true story). My husband refuses to move unless it's to this specific area of town and on a 1/3 acre. I know that's a huge jump in house price but we always feel like we are playing catch up with house values. It just seems like we could stay where we are at and save... but the cost of building and land just grows faster than one can save.

Our safest option is to sell our current home. But we've always liked the idea of owning a rental and having another means of generating income. We have toyed the idea of moving and keeping this home as a rental. But there are obvious rinks that go along with that option. My concern is that in order to get a down payment on a new place we would need to either sell our home or raid our 401K. Now before you all tell me I'm crazy for touching our 401K hear me out. My husband is very distrustful of 401Ks as saving vehicles. He's watched as the markets crashed with our parents 401K savings and he's convinced that the rules will change by time we'd be in our 70's. He's always wanted to drain the 401K and put it towards a rental property as he just feels that real estate can be a safer long term investment. We also have a whole life insurance policy that has a cash value aspect towards it and my husband is more trustful as that as a retirement savings vehicle. Both of my grandparents have had rentals in their retirement to supplement income and it's worked out fairly well for them, though of course you have to deal with the occasional terrible tenant/ evictions etc.

What do you think?

Option1: Sell the house, leave the 401K alone and move (very comfortable monthly payment for us, but no rental)

Option 2: Keep our current house as a rental income, access the 401K for our down payment (monthly payment would be roughly half of our take home pay... tight but we could do it for a short term... we'd really need that rental income to make it a comfortable payment though) . If things don't work out we could just sell one of the homes.

Option 3: Stay put. Which is fine for the moment but we aren't content here indefinitely. We bought this house thinking we'd be here five years and we are double that.

Thoughts are appreciated.

[Roseslipper]

no one can tell you what to do. You have family members and financial advisor to talk too. I kinda agree with your husband about not trusting the 401k, but I'm not sure my thinking is right. Rental property is always a good thing if you can afford it, and u already know the problems u can have with it. The economy is still not in great shape, I do think things will still change and that we will have another big fall. To put $ in a bank today, you really dont make any $ with the interst rates so low. It's still a good to to buy because of the interst rates are low and homes are not sky high. I think homes are a good investment probably the best ones,if I could have more then one I beleive I would I think its a great investment, but like everything alse theres pros and cons, and if you have great credit thats a great thing, but things change, as you have seen property values go down as well. so theres lots of thngs to think about. But you are also young, and sometimes you have to take chances to make $. What ever u do think over all the pro's and con's put it on paper, pray about it. If you desided to buy becareful and dont go over your budget, you dont have to keep up with the jones. If I had to choice Id have a ruff time I have a hard time with choice, Do you home work!! i'd probably pick option 2, or 3.

[bytor2112]

When you say raid the 401k...you are obviously referring to a loan, which you will need to pay back. Most 401k providers don't allow you to access 401k assets any other way, As for not trusting the 401k, you don't mean the savings vehicle, but rather the investments and why? Bear markets come and go and as for asset classes nothing has ever outperformed equities over long periods of time and I see that you are very young, so, it would be 30 years or more before you retire anyway.

I would note also that the stock market has roared back and smart investors cleaned up. While real estate hasn't recovered and isn't liquid either. In 2008 when the economic crisis occurred, my clients earned anywhere from 6% on the low side and nearly 100% on the high side. I shorted the market for many of my clients and we did very well....

Real estate is a pain in the back side . while values are low, just remember that taxes, maintenance, insurance, etc detract from over all return on investments.

Sounds like Option 1 or 3 is best.

[skippy740]

The problem in the 401k isn't necessarily the investments or other securities within it.

It's the fact that it's has a lien against it by the IRS for an undetermined future tax.

401k plans do 2 things:

1) Defer taxes

2) Defer the tax calculation at the time of withdrawal.

If you believe that taxes will go higher based on your current income and professional projections, then you will want to stop contributing to it (and increasing your future tax liability) and determine if you want to keep it there.

Think about it:

- Today, you defer $1,000 and save 25%.

- In retirement, you withdraw the same $1,000 and pay 35%. Was there any NET tax savings? No.

Granted, any specific tax advice should be done with a qualified tax professional in your state.

Keep in mind that if you decide to take out a LOAN against the 401k, your typical maximum loan allowed for a residential purchase, is $50,000.

If you take out the loan, and your husband changes jobs... that loan needs to be paid back in full within 60 days... or you will have taxes and penalties (10% of outstanding balance) due.

Borrowing against your life insurance CAN be a great way to go. Depending on your policy structure, your cash surrender values can continue to grow as though you never touched it. It is simply used as collateral for your life insurance loan.

Life insurance loans are NOT reported to credit bureaus. Also, the required payment each YEAR is just the interest due. So, if you have a significant cash surrender value in your whole life insurance, you may want to discuss that idea with your agent/advisor. Generally, you'll want a variable rate loan against your cash surrender values as this won't impact the dividend treatment of the collateralized balance.

I would talk to a qualified professional licensed advisor in your state and get some ideas and feedback as there is more than just 'dollars and sense' when doing financial planning and reviews.

Also, keep in mind that managing a portfolio of securities is a rather passive activity compared to actively managing real estate.

Are you ready to become landlords and managing tenants?

If it were me, I'd consider a property management service to help with all that... because they're professionals and will help keep emotions out of the property management details. I've heard quotes that most will charge about 10% of the rent balance each month. I think that's cheap insurance to ensure that you don't have to personally deal with a lot of the headaches of being a landlord.

Edited May 11, 2013 by skippy740

[pam]

I haven't heard someone use the term DINKS in ages.

[mnn727]

(monthly payment would be roughly half of our take home pay... .

I've always had a rule, the total of all bills could not exceed 1/2 of our take home income.

What happens if one of you loses their job for any reason?

Rentals don't stay rented and often cost you a lot of money in upkeep and repairs after a tenet moves out (not to mention insurance costs go up when you're personally not living in the house, if you homestead your taxes will jump also).

I had a rental once - thank God I don't any more, too much of a headache. Some people do very well with rentals, some people don't.

Regarding the 401K I lost 30% of my 401K value 10 years ago, I am now back up over what I lost by a significant amount. Investments are for the long term. If you can't out wait a downturn in the market then you should not be in it. The market has always gone up in the long term, although it does frequently down turn for period of time.

Edited May 12, 2013 by mnn727

[Just_A_Guy]

On a slightly different tangent: I've never seen an informed financial planner endorse whole life unless he was selling the stuff. I'd consider switching to term.

[skippy740]

On that same tangent, I've never met an informed financial planner be able to offer promises, protection and guarantees in a person's financial plan without it including an insurance contract. :)

[bytor2112]

On a slightly different tangent: I've never seen an informed financial planner endorse whole life unless he was selling the stuff. I'd consider switching to term.

I agree and having been in the financial planning business for 20+ years, I typically only use life insurance for estate planning...Irrevocable Life Insurance Trusts, 2nd to die or perhaps for key man insurance/business continuation issues and then it is not traditional whole life...usually some universal life hybrid or variable universal. Term makes more sense when insurance is used for income replacement.....(of course everyone should carry adequate amounts of life insurance and term is typically the most affordable).

Edited May 12, 2013 by bytor2112

[Just_A_Guy]

On that same tangent, I've never met an informed financial planner be able to offer promises, protection and guarantees in a person's financial plan without it including an insurance contract. :)

I'm not knocking life insurance, Skippy, just whole life insurance.

I acknowledge it can be helpful from a "forced savings" perspective if you aren't going to save any other way; but that doesn't sound like the op's problem in this cae.

[skippy740]

Then I would simply state that it depends on how the policy is structured.

Most 'plain vanilla' whole life insurance is good for the level premium and level death benefit. Too many whole life policies fall into this category.

But a policy in the hands of a skilled agent who can optimize the policy to maximize its benefits... can be a great wealth enhancement strategy.

Many do a combination of base policy + term rider + paid up additions riders, etc., etc., etc.

The majority of insurance agents don't know how to do this, but there are a few that do. (I'm one of them, I'd like to think. I wish I could make more money doing it... but I've got other issues in my life. I'm planning to re-launch my financial planning practice after about a year from now.)

The problem is, is that there is a statement now that says to just get term insurance... without analyzing exactly what the OP already has. Regardless of one's profession, I think that's not such a good idea to make blanket statements.

I don't know the OP's agent, nor have I seen the policy. Therefore, it's generally recommended that you leave insurance alone... until you can look exactly at what the insured already has.

My brother had a whole life insurance from a well-known company with a 'duck' as its mascot. That kind of policy can't be utilized in the way that I am talking about. When he asked me if he should continue it or dump it - while the decision was his - I said that there are better uses for the same premium dollars.

If one is REALLY curious (or just extremely bored), give this video a look:

Edited May 12, 2013 by skippy740

[Just_A_Guy]

The problem is, is that there is a statement now that says to just get term insurance... without analyzing exactly what the OP already has. Regardless of one's profession, I think that's not such a good idea to make blanket statements.

Weaselly lawyer alert!

I'd consider switching to term.

IMHO, it boils down to: Can your broker/asset manager take the difference between term and whole life, invest it, and get a better return than the whole life insurer is offering? If you can't, then how is it that your insurance company's brokers (who are doing exactly that with the difference) are able to get such a drastically superior result?

That's why I remain suspicious of whole life. What information do its brokers purport to have, that an independent broker would lack? And why is it that if I die--which is the reason I bought insurance in the first place--most of these plans keep the savings/investment component for themselves?

Edited May 12, 2013 by Just_A_Guy

[skippy740]

IMHO, it boils down to: Can your broker/asset manager take the difference between term and whole life, invest it, and get a better return than the whole life insurer is offering? If you can't, then how is it that your insurance company's brokers (who are doing exactly that with the difference) are able to get such a drastically superior result?

That's why I remain suspicious of whole life. If people habitually got more out of them than they put into them, logic dictates that the insurers wouldn't offer them.

Sometimes, avoiding the losses is a smarter strategy than trying to pick the winners. It all depends on the financial soundness, and risk tolerance of the person we're talking about.

Many whole life policies are (generally) easily generating about 5% interest per year after the first couple of years. That's much better than what banks are paying today and it's generally safe. (I say generally because each company and product strategy is different and I cannot speak for them all.)

Most people don't have 'a difference' to save either. In that case, buy term is the best strategy. Maximize your face amount for protecting your income in the event of your passing during the time the term policy is in force.

A small whole life policy (maybe around $50k or less) is a good idea to obtain while you're young in order to have a permanent burial fund. I see so many of those Colonial Penn commercials offering exactly this kind of policy, but for younger people - if you start earlier, it could be a better financial asset - even if it doesn't have any extra 'bells and whistles'.

[getting off my 'life insurance is great but doesn't do everything' soapbox now] :)

Of course, now we've taken the thread completely off track from the OP's question. Based on the OP, I'd hate to see the first 3 years of premium (the average time it takes before cash surrender values begin to accumulate in a traditional whole life policy) wasted by cancelling the whole life policy.

However, as life changes, you may need to make new decisions based on new circumstances and information.

It MAY make sense to cancel the whole life policy and get a larger term policy. Just keep in mind that you are guaranteed to lose just about everything you've put into it if you decide to cancel it. Is it worth it? Only you and your husband can make that decision with the help of a professional.

However, as with all professional services, talk to a licensed professional in your state for such advice.

If you want to find a life insurance professional, I'd refer you to this service. It's not infallible, but working with a CLU professional regarding life insurance is typically a great way to go.

CLU® - Highest Standard of Knowledge and Trust

Edited May 12, 2013 by skippy740

[Just_A_Guy]

Sometimes, avoiding the losses is a smarter strategy than trying to pick the winners.

Is that the strategy the insurance company uses when it invests the difference? Surely not.

Many whole life policies are (generally) easily generating about 5% interest per year after the first couple of years. That's much better than what banks are paying today and it's generally safe. (I say generally because each company and product strategy is different and I cannot speak for them all.)

Why is the company paying 5% if it's not possible to get more than that through a good, independent broker? Either the insurer is spending itself into oblivion, or we're back to Grandma's advice about something that sounds too good to be true, probably is.

Of course, now we've taken the thread completely off track from the OP's question. Based on the OP, I'd hate to see the first 3 years of premium (the average time it takes before cash surrender values begin to accumulate in a traditional whole life policy) wasted by cancelling the whole life policy.

Another issue I have with whole life. It's your money--except when it isn't.

[skippy740]

I will simply provide a link to John Cummuta's website. John Cummuta first published a course called "Debt Free & Prosperous Living" back in the 90's. He's the first person I heard "Buy term and invest the difference".

However, there has been a fundamental shift in financial planning since 2002 and again in 2008. The markets are not the strong backbone of financial planning as they once were.

He's made a 180 on his position and has outlined it in this video.

The Banker's Secret to Permanent Family Wealth

The strategies are not about comparing rates of return, but in maximizing one's total financial picture - to restructure your spending and wealth building through your whole life policy (or universal or index universal) and re-capturing the interest that were being transferred unknowingly and unnecessarily to other financial institutions.

BTW, you'll notice I always said "cash surrender value" - never cash value. Because you're right - it's NOT "your money". But thanks to non-forfeiture laws, the interpolated terminal reserve is available as YOUR asset to borrow or surrender, if you want to.

I can always tell when an agent is an amateur when they talk about "cash values" because it shows that they aren't detailed enough to figure out how to properly explain the structure of a cash value policy.

[viannqueen3]

Thanks for your thoughts (though I'm not sure I understand the past few posts!) Skippy pretty much nailed it- my husband is afraid the current tax structure will change by time we are in our 70's. I asked my husband about the 401K and he really just wants to drain it and eat the penalty fee. I'm not sure how I feel about that. But if we did it would allow us to put a nearly 20% down payment on the new home and that's significant, while allowing us to rent out the current place.

For what it's worth for years we were very much on team "term insurance" and then we finally got around to purchasing life insurance my husband found a whole life policy that was structured in a way that was very appealing to him (cousin is a financial planner). I really don't understand it well, but there is enough of a cash surrender value (I think it's called that) that we could cover the mortgage for 10 months or so if he lost his job. His job has been very steady over the past ten years and has been in high demand so I'm not terribly concerned about that. Though if he were to switch jobs we'd likely be moving out of state. I think he wants to leave that cash surrender value alone as a backup in case we ever need it.

Our tentative plan is that landlording duties would largely fall upon me. I figure that it would be a good job for me until my kids are old enough that I can start working full time professionally again. I'm not really afraid of maintenance and upkeep. Just in the past two weeks I've installed an undermount sink, installed light fixtures, wired outlets, switches, and I'm no stranger to a chop saw/ skill saw etc. I'm very much the handyman in this house. I'm just a very non confrontational person so laying down the law with missed payments, starting the eviction process or other various renter issues isn't my strong suite. Then there is all the extra insurance, tenant turnover, upkeep on the home. I just think the first few years will be tight but it could be really good long term for us? So much to think about.

Edited May 13, 2013 by viannqueen3

[skippy740]

As far as accessing cash surrender values - there are two reasons to access them:

1) Opportunity

2) Emergency

The problem you have, is that it's still building up. Which, to me, means to not touch unless it's an emergency.

(BTW, if your policy has disability waiver of premium... then if something happened to your husband's ability to work, the CASH would continue to be contributed by the insurance company! It's a way to ensure your savings goals. But I digress...)

The 401k plan is generally illiquid... unless the IRS says you can access the money. (Here's another instance where others think it's their money, but the IRS controls it. I think I'd rather deal with an insurance company than the IRS. I digress again...)

One of the hardship provisions allows you to withdraw money from a qualified plan (like 401k or Traditional IRA) for the purchase of a primary residence. You'll still pay taxes & penalties... but at least you can access the funds while still working for your employer.

Retirement Plans FAQs regarding Hardship Distributions

Whether a need is immediate and heavy depends on the facts and circumstances. Certain expenses are deemed to be immediate and heavy, including: (1) certain medical expenses; (2) costs relating to the purchase of a principal residence; (3) tuition and related educational fees and expenses; (4) payments necessary to prevent eviction from, or foreclosure on, a principal residence; (5) burial or funeral expenses; and (6) certain expenses for the repair of damage to the employee's principal residence. Expenses for the purchase of a boat or television would generally not qualify for a hardship distribution. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee.

(Reg. §1.401(k)-1(d)(3)(iii))

So, at least you CAN get access to the 401k plan balance, if you choose to do so.

There are some downsides or restrictions you'd need to know about:

1) You can't put the money back into the qualified plan. (Your husband won't care about that).

2) You can't begin to make NEW contributions back to the plan for 6 months. (Again, your husband won't care that much.)

So, with the funds being available, you just have to decide if it's really what you want to do.

I admit, the thought of rental property - where you have more control over the value, look, appearance, condition and the tax advantages... are a lot better to me, than "buy & hold (and pray)" for your retirement.

Just my opinion.

Edited May 13, 2013 by skippy740

[mnn727]

I'm just a very non confrontational person so laying down the law with missed payments, starting the eviction process or other various renter issues isn't my strong suite.

From my limited experience as a landlord, these are the number one qualities needed - and the reason we sold our rental.

[Guest]

From my limited experience as a landlord, these are the number one qualities needed - and the reason we sold our rental.

You can always hire a property manager.

In a rental, your "income" does not have to come from the monthly payments. Your % ownership is your income. Having somebody else pay for all, or part, of your mortgage and upkeep as you work towards home ownership is of value as it is. You choose when to cash out that ownership - usually by waiting for good market indicators and usually by adding it to your retirement plan.

[ElectofGod]

With this current economy? 2007 was just a warning, its going to crash again soon. How soon I don't know. But soon. It will be gone when it does. I cashed out my measly 5k in my 401k and took the penalty to pay off college debt. Best decision. I would take it all out if I could but still work at my current job. I don't trust this market. But if you are already out of debt than I stay out of debt and don't do anything to put yourself in debt including borrowing from a 401k. Whatever you decide to do.

Go pray about if you should move than go from there is my say. If you should move don't get in debt if at all possible. Make sure you have your emergency supplies, etc...

[mrmarklin]

The three prime rules of real estate are:

Location

Location

Location

If your new house is in a better area with more appreciation potential, you should buy it, and relocate. Don't drain your 401k if it has any significant $$ in it. That's a waste to send your hard earned $$ to some government. 401ks are a very efficient way to save, and are tax sheltered until you retire, so don't mess it up now.

Based on your own statements, you are not landlady material. I would advise you to sell you current residence, and move. If there is cash left over from your downpayment, you can also invest that, or alternatively just have a lower mortgage. Interest rates for homeowners are at historical lows. Be sure to get a fixed rate.

[viannqueen3]

Location is the number one factor in our move. While the home we are in now has appreciated in value, it hasn't gone up in value at the rate of other nicer homes in the area that we could have bought at the time and didn't. That's been frustrating. It's also a busier street than I want for young children. I feel like if we bought the new home and decided in a couple of years it just wasn't working out the market in that area has been in demand enough that we could sell it and be okay (assuming there isn't another housing bubble at that time). The new location is minutes from the interstate, yet behind an older neighborhood in a secluded area next to open space (a wetland/ park reserve of some sort) so it can't be built out past where it is. We would also be at the bottom of the price range of homes. I think its priced a bit high, but the location is amazing. We are currently twenty minutes from the interstate and way out west... so the commute is a bit long.

I've talked to some neighbors that have had pretty good luck renting out their homes. My biggest worry is it being destroyed. We are going to give it a try and just really make sure we screen the potential renters really well.

[derblitzenator]

Have you looked at the possibility of converting your 401K into a self-directed 401K and then using the proceeds to finance the rental property? I personally wouldn't withdraw 401K funds unless it was the December of a year that I had no income, because otherwise you get slammed with fees and taxes. However, if you keep it in place and convert the funds to buy a property, it may be within the parameters of the 401K uses without accruing penalties.

[skippy740]

The self-directed 401(k) is only available to self-employed individuals - typically called a Solo-401(k) or something similar.

You probably meant a self-directed IRA (IRC code section 408).

[derblitzenator]

The self-directed 401(k) is only available to self-employed individuals - typically called a Solo-401(k) or something similar.

You probably meant a self-directed IRA (IRC code section 408).

That's only partially true. As a full-time employee, you can get your HR department to allow you to set up a self-directed 401K. If they don't allow it, then you can convert it to a self-directed IRA tax-free. In the alternative, you could open up a side business for a couple years and get the 401K account open. You can lose money and write off expenses for 3 years before the IRS scrutinizes your business model. There are plenty of ways to get this done.