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Pay Retirement Before Loans

Question : What would you suggest that someone do with $20,000 if the someone is closer to 40 than 30, single, with $100,000 of student loan debt and a $250,000 mortgage? My salary is around $100,000 a year. I have an emergency fund equal to six months of expenses, and I make an annual IRA contribution since my employer doesn’t offer a 401(k) plan. Should I accelerate my student loan payments, since the interest isn’t tax deductible for me because my income is too high? Or should I invest instead? If I invest, should I put it all in a total market stock index fund or is that too risky?

Answer: Even if you’re making the maximum annual IRA contribution of $5,500 (people 50 and older can contribute an additional $1,000), you’re probably not saving enough for retirement. You can check the numbers using a retirement calculator (AARP offers a good one at its website, http://www.aarp.org). If indeed you’re coming up short, then consider opening a taxable brokerage account and earmarking it for retirement. You can use a chunk of your $20,000 windfall to get started, but also set up regular ongoing contributions.

The bulk of your retirement money should be invested in stocks, since that’s the only asset class that consistently outperforms inflation over time. If you try to play it too safe and avoid stocks, your purchasing power is likely to decline over the years instead of growing. A total market index fund with low expenses is a good bet for delivering diversification at low cost. But leaven your portfolio with bonds and cash as well, since these assets can cushion market downturns. All the returns that stocks give you in good markets won’t be much help if you panic and sell in a bad market. People who try to time the market that way often miss the subsequent rally, so they wind up selling low and buying high — not a winning way to invest.

If you don’t want to try to figure out an asset allocation, look for a low-cost target date fund. If you plan to retire in about 25 years, you’d want to look for a “Retirement 2040” fund.

Once you get your retirement savings on track, then you can start paying down that student loan debt. Target private loans first, if you have any, since they’re less flexible and have fewer consumer protections than federal student loan debt.

Question : We have four credit cards that generate airline miles, each of which has a yearly fee. We also have a Capital One card with no fee that we use for travel to avoid currency conversion fees. We pay all cards off every month. Since it is getting so hard to use miles, we are thinking of closing all but the Capital One account, which also accrues points toward air travel. I have read that closing credit cards is not a good thing to do. I am 73, my husband 79, so I doubt we will need to incur debt in the future.

Answer: You may want to preserve your good credit scores even if you don’t anticipate taking out any loans. Insurers in many states use credit information to set premiums (although not in California).

If you do still care about your scores, you could consider asking your credit card issuers if you could switch to one of their no-fee cards. The closures of your current accounts may still affect your scores, but having several open, active accounts probably will offset the damage over time.

Or you could just take your chances and close card accounts rather than pay unnecessary fees. But consider having at least one additional credit card, in case your Capital One card is compromised or lost and you need a temporary backup.

Question : In recent columns you’ve been discussing mandatory withdrawals from IRAs. Since these minimum required distributions are treated as income for tax purposes, can I use that money as the income necessary to make an IRA contribution this year? I am retired and lucky enough not to need the funds for current expenses.

Answer: Sorry. You need earned income, not just income, to make IRA contributions. For the purposes of an IRA, earned income includes wages, salaries, commissions, self-employment income, alimony and separate maintenance and nontaxable combat pay. It does not include earnings and profits from property or income from interest, dividends, pensions, annuities, deferred compensation plans or required minimum distributions from IRAs.

Liz Weston is the author of The 10 Commandments of Money: Survive and Thrive in the New Economy. Questions for possible inclusion in her column may be sent to 3940 Laurel Canyon, No. 238, Studio City, Calif. 91604, or by email at liz@lizweston.com. Distributed by No More Red Inc.