Yet another investing question

I have a pension from a job I had many years ago. I'm nowhere near retirement age, and the value of the pension is ~$7500, so it's not going to support me when I get to that point anyway.

I recently received a letter stating that during a 2-month window I can cash out the pension, and either roll it tax-deferred into an IRA, or take a ~30% hit to keep the cash.

On the surface, the IRA seems like the obvious choice. But there are two issues that concern me:

1.) I understand that the tax advantage of an IRA comes from the presumption that your income will be lower after you retire, thus lowering your tax liability on the value of the IRA. Realistically though I'm another 20-30 years from retirement, and I hope to be earning a whole lot more than I do now by the time I get there. So I'm not sure how much benefit is there.

2.) If I don't contribute anything to the IRA how much will it grow over 20-30 years? Double? Quadruple? $30k 30-years from now sounds like barely enough to survive a year on...maybe? So I don't see a whole lot of value there.

3.) My near-term financial plan involves picking up more rental property. Houses are cheap here - $30/$40k for a 3 or 4 bedroom home. People want to live here for the schools & low crime, yet few have the 20% for a down-payment and/or the credit to buy. As an existing landlord, I'm well aware of the pitfalls also. I'll probably be ready to start shopping for another property come spring.

So am I crazy to take a ~30% hit and cash out my $5k, then use it with the other money I'm setting aside to get another house even sooner?

At $400/mo rent(about the low end of average around here), the full $7500 would be recouped in a year.

How much longer would it take to buy the house without that 5k? If it is less than a year, I'd say go with the IRA.

In reply to mtn:

Yes, most likely.

I'm curious, what is your reasoning?

To me, I see my money in an IRA(or 401k for that matter) basically stagnating, and while I realize there is greater risk with investment property, there's also greater ROI potential.

petegossett wrote: In reply to mtn: Yes, most likely. I'm curious, what is your reasoning? To me, I see my money in an IRA(or 401k for that matter) basically stagnating, and while I realize there is greater risk with investment property, there's also greater ROI potential.

As long as you factor in the tax issue on your rental property, you are probably right. Remember, if you depreciate the property you'll be reducing your basis in the house. When you sell you'll have to pay income taxes on your gain as well as the difference between your original basis and your depreciated basis. If you plan to have a higher tax rate in the future, then this might wipe out a lot of your previous income/gain. Versus the IRA earning tax-deferred income for its life.

Also, you wouldn't/shouldn't take IRA distributions in your highest income tax years. That should be the money you take last after investment earnings and/or pretaxed savings, so when your income is the lowest. Of course, there are required distributions at an advanced age, so you won't have a choice at some point.

Complex questions, but perhaps not worth dealing with for the amount of money involved.

Using round numbers for the purposes of keeping it simple, my reasoning is that, assuming

• a $200 mortgage (probably closer to $300?)
• $400 rent
• $2500 hit to withdraw it now,

it will take you 13 months to make up the money lost. If you can get the down payment without the funds before the 13 months, why not keep the $2500? The short term gain isn't that much of a gain in my eyes. Of course, by the same logic, it isn't much of a loss either.

Is there a house that you want to buy right now, and it has to be that one, and it won't be available in a year? Would you be purchasing another that much sooner with the $2500? Both of those situations would change my answer.

Also, even if it is a miniscule amount, anything is better than nothing in retirement. My uncle will have a pension from a company for $200 a month. He's planning on using it to buy a boat, since it doesn't fit into his retirement plan at all.

petegossett wrote: 2.) If I don't contribute anything to the IRA how much will it grow over 20-30 years? Double? Quadruple? $30k 30-years from now sounds like barely enough to survive a year on...maybe? So I don't see a whole lot of value there. 3.) My near-term financial plan involves picking up more rental property. Houses are cheap here - $30/$40k for a 3 or 4 bedroom home. People want to live here for the schools & low crime, yet few have the 20% for a down-payment and/or the credit to buy. As an existing landlord, I'm well aware of the pitfalls also. I'll probably be ready to start shopping for another property come spring. So am I crazy to take a ~30% hit and cash out my $5k, then use it with the other money I'm setting aside to get another house even sooner? At $400/mo rent(about the low end of average around here), the full $7500 would be recouped in a year.

20 years = $30k 30 years = $60k

At $400/mo rent, you're only clearing $200/mo profit, much of which is going to interest on your mortgage. Remember the 2% rule and the 50% rule when purchasing rental property. $400/mo is more like 1-1.3%.

go here, read: http://www.mrmoneymustache.com/forum/real-estate-and-landlording/ also this: http://www.mrmoneymustache.com/2011/10/10/lets-buy-a-foreclosure-episode-2-what-is-the-50-2-rule/

What zip code are you in? How much do houses appreciate? > 3% a year? In many places in the US (especially with home values that low), home values don't increase as much, effectively making your investment a depreciating asset after inflation.

Also, I may have missed something, but the 30% hit is taxes, right? There is an additional 10% early withdraw penalty for taking an IRA distribution before age 55 (not using SEEP/72(t) )

Also, being optimistic (but not wholly unrealistic) and assuming an 8% return on the $7500 for 30 years, you're at about 75k. Now you take that money and put it into less aggresive accounts, for a 3% return during retirement, and you have 20 years of $5000 in income. Not much, but that is a Miata every year. Or a downpayment on a new place, every single year.

6% return for thirty years and you have 10 years of $5k.

Of course, inflation would throw that logic out the window. But still fun just to play around with it.

mtn wrote: Of course, inflation would throw that logic out the window. But still fun just to play around with it.

Not really. The average return of a US total market fund (long term) is 7% after inflation

ProDarwin wrote:

mtn wrote: Of course, inflation would throw that logic out the window. But still fun just to play around with it.

Not really. The average return of a US total market fund (long term) is 7% **after inflation**

Ok, then definitely keep the money in the account.

There's another thing to keep in mind and that is, what is the expected monthly payout of said pension. In most cases, employers like to rid themselves of pension liabilities and save some money that way, so the return and (guaranteed) payout you can get might well be higher than what you can achieve investing the money yourself.

Re the investing, there's a third option if you want to withdraw the money. Take the tax hit, but put the money into a Roth IRA. Those grow tax free, withdrawals are not going to be taxed when you hit retirement and you've got a nice long time for the investment to grow. Five grand fits nicely into the contribution limit, plus my gut feeling is that with a bit of careful, well diversified investment in a few low-cost index funds, you'll outperform the expected growth in house prices.

BoxheadTim wrote: Take the tax hit, but put the money into a Roth IRA.

^^^ This is what I was typing when he posted.

If you are considering buying houses and acting as a landlord, $5k shouldn't come into the equation relative to the cash on hand it takes to support getting the mortgage, floating the house when un-rented, and fixing issues as they come along.

petegossett wrote: In reply to mtn: Yes, most likely. I'm curious, what is your reasoning? To me, I see my money in an IRA(or 401k for that matter) basically stagnating, and while I realize there is greater risk with investment property, there's also greater ROI potential.

not sure what you mean about stagnating ... when I retired in Nov. I had a bit over $250K in various IRA's & 401K ... after drawing out $1500/mo since then I now have $300K+ ... in my IRA's ... so your tax deferred savings don't have to stagnate ....

and the tax break you get is the $2000 (or more depending on your age and the changing rules) you can take off your income each yr, plus the fact that, while the tax rate is the same as we age, your exemptions do go up as you pass certain ages ... so your tax bill could go down

and if your not going to use the tax deferred opportunities a traditional IRA offers, you might consider a Roth ... you won't get the $2000 off the top of you annual income, but the interest/capital gains are not taxed when you start withdrawing ....

mtn wrote: Also, being optimistic (but not wholly unrealistic) and assuming an 8% return on the $7500 for 30 years, you're at about 75k. Now you take that money and put it into less aggresive accounts, for a 3% return during retirement, and you have 20 years of $5000 in income. Not much, but that is a Miata every year. Or a downpayment on a new place, every single year. 6% return for thirty years and you have 10 years of $5k. Of course, inflation would throw that logic out the window. But still fun just to play around with it.

maybe I'm doing the math wrong ... 1.08x$7500x30= $243000 (which doesn't take into account the idea of compounding interest, which would make that amt. higher

mtn wrote:

ProDarwin wrote:

mtn wrote: Of course, inflation would throw that logic out the window. But still fun just to play around with it.

Not really. The average return of a US total market fund (long term) is 7% **after inflation**

Ok, then definitely keep the money in the account.

Ok this is good to know.

Regarding the $5k vs. buying a house, no not a huge impact in the situation either way.

Sounds like I need to research Roth IRAs.

Thanks everyone!

I'd cash it out and buy more rental property. The gains you can make in the next few years will be better than 1.4% in an IRA. The wildcard is "Why should you be allowed to have that retirement account when so many others have nothing?" I'm thinking the government is going to do a one time tax on all retirements savings to level the playing field, exempting unions. The future gains on your IRA might not be worth as much as real property in 20 years.

clownkiller wrote: I'd cash it out and buy more rental property. The gains you can make in the next few years will be better than 1.4% in an IRA.

Where do you get the 1.4% from? Just curious...

Quick CD average, ball parking it.

http://www.interest.com/sem/cd-rates/best-cd-rates/?prods=16&local=false&ec_id=m9081573&popup=0&ef_id=UlXl6QAAAVtpqDMF%3A20131010002725%3As&MSA=0520

Yebbut, if you put it in an IRA and have 20-30 years, you would probably put the money into low-cost index funds rather than CDs? I don't think that's what the OP is planning, but I might have misread something.

wbjones wrote:

mtn wrote: Also, being optimistic (but not wholly unrealistic) and assuming an 8% return on the $7500 for 30 years, you're at about 75k. Now you take that money and put it into less aggresive accounts, for a 3% return during retirement, and you have 20 years of $5000 in income. Not much, but that is a Miata every year. Or a downpayment on a new place, every single year. 6% return for thirty years and you have 10 years of $5k. Of course, inflation would throw that logic out the window. But still fun just to play around with it.

maybe I'm doing the math wrong ... 1.08x$7500x30= $243000 (which doesn't take into account the idea of compounding interest, which would make that amt. higher

You are doing it wrong.

7500 invested at 1.08 for 30 years is 7500 x (1.08^30) = $75K. That's compounded annually. Compounded monthly would be slightly higher.

For the OP: https://personal.vanguard.com/us/funds/vanguard/TargetRetirementList

Roll your money into a tax-deferred IRA (not roth). The money will continue to grow tax free, and you can still contribute up to $5500/year to it. Even the idiot-proof target retirement funds started just before the market crash in '08 are still @ 6%+ since inception. Of course if you get an IRA through Vanguard, Fidelity, etc.... you have the option of organizing the investments how you want to try and earn more, or go for stability.

wbjones wrote: maybe I'm doing the math wrong ... 1.08x$7500x30= $243000 (which doesn't take into account the idea of compounding interest, which would make that amt. higher

You are giving him 7500 each year for 30 years. 7500x30=225,000. I would take that deal if he could get it.

Oops see above. Beat me to it

ProDarwin wrote:

wbjones wrote:

mtn wrote: Also, being optimistic (but not wholly unrealistic) and assuming an 8% return on the $7500 for 30 years, you're at about 75k. Now you take that money and put it into less aggresive accounts, for a 3% return during retirement, and you have 20 years of $5000 in income. Not much, but that is a Miata every year. Or a downpayment on a new place, every single year. 6% return for thirty years and you have 10 years of $5k. Of course, inflation would throw that logic out the window. But still fun just to play around with it.

maybe I'm doing the math wrong ... 1.08x$7500x30= $243000 (which doesn't take into account the idea of compounding interest, which would make that amt. higher

You are doing it wrong. 7500 invested at 1.08 for 30 years is 7500 x (1.08^30) = $75K. That's compounded annually. Compounded monthly would be slightly higher.

face palm .... you're right ...duh...

ProDarwin wrote: For the OP: https://personal.vanguard.com/us/funds/vanguard/TargetRetirementList Roll your money into a tax-deferred IRA (not roth). The money will continue to grow tax free, and you can still contribute up to $5500/year to it. Even the idiot-proof target retirement funds started just before the market crash in '08 are still @ 6%+ since inception. Of course if you get an IRA through Vanguard, Fidelity, etc.... you have the option of organizing the investments how you want to try and earn more, or go for stability.

why are you recommending traditional IRA vs Roth ? as long as he doesn't have a huge amt. to roll over, the initial tax bite won't be that much ... then it's tax free coming out 30 yrs from now ....

(yeah, I understand if the amt. to roll over is so large that the tax that yr. would be staggering)

in his OP he seemed to be worried about the income/tax on investment at retirement time ... if he can afford it ... it seems like a Roth fits his needs better (half of my retirement money is Roth, and I'm fairly happy with that... everyones situation is unique)

wbjones wrote:

ProDarwin wrote: For the OP: https://personal.vanguard.com/us/funds/vanguard/TargetRetirementList Roll your money into a tax-deferred IRA (not roth). The money will continue to grow tax free, and you can still contribute up to $5500/year to it. Even the idiot-proof target retirement funds started just before the market crash in '08 are still @ 6%+ since inception. Of course if you get an IRA through Vanguard, Fidelity, etc.... you have the option of organizing the investments how you want to try and earn more, or go for stability.

why are you recommending traditional IRA vs Roth ? as long as he doesn't have a huge amt. to roll over, the initial tax bite won't be that much ... then it's tax free coming out 30 yrs from now .... (yeah, I understand if the amt. to roll over is so large that the tax that yr. would be staggering) in his OP he seemed to be worried about the income/tax on investment at retirement time ... if he can afford it ... it seems like a Roth fits his needs better (half of my retirement money is Roth, and I'm fairly happy with that... everyones situation is unique)

I guess if he expects to be earning (withdrawing) a lot more then than now, the Roth may be a better option. I would take a look at taxable income now vs. what he expects to actually use when retired (likely no mortgage at that point, no kid expenses, etc.) and what tax bracket he would be in for each situation.

yeah .. ok ... research is your friend ...

my decision was that the $$ reduction in taxable income each yr didn't come anywhere near what I expected (as a return) after 20+ yrs of interest coming out tax free

wbjones wrote: why are you recommending traditional IRA vs Roth ? as long as he doesn't have a huge amt. to roll over, the initial tax bite won't be that much ... then it's tax free coming out 30 yrs from now ....

Not to mention that in case E36 M3 really hits the air movement device, the OP would be able to at least withdraw his contributions from a Roth IRA without taxes and penalties.