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 Post subject: Re: What to do with this money?
PostPosted: Tue Jan 08, 2013 6:23 pm 

Joined: Fri Sep 12, 2008 12:29 pm
Posts: 1557
Location: Seattle, WA
DoingHomework wrote:
josetann wrote:
If only there was some other deduction you could make, that would reduce your taxable income so you could contribute to a Roth IRA...aha!
Mortgage interest deduction. Take out a mortgage on your primary residence, make sure the interest paid will be just enough to reduce your income to a Roth IRA eligible amount, and pray your boss doesn't decide to give you an end of year bonus.

Um, it doesn't work that way actually.


Indeed... josetann's key misunderstanding there is that AGI is after "reductions" but before deductions. So more itemized deductions has no effect on your eligibility for a Roth IRA. Some things do, including 401(k) contributions and other pre-tax paycheck deductions like an HSA or FSA.

josetann's biggest mistake, of course, is:

josetann wrote:
So...paying $14,000 in interest saves you a total of $525...woohoo! Tell you what...give ME $14,000, I'll turn around and give you $1,050...that's DOUBLE what you'd "save" by having a mortgage and getting to deduct the interest paid.


Hey, I'll take that deal. But you also have to give me $250k up front, to do whatever I want with (though if I'm smart I'll invest it).

Which is to say, josetann is ignoring the opportunity cost of the $250k that the person has access to.

nelson wrote:
http://en.wikipedia.org/wiki/Marginal_utility

Basically, having a guaranteed place to live is more important than the *potential* upside of money invested if your goal is to retire on schedule. By "investing" in the mortgage you're reducing your downside potential. And when you retire, reducing the downside is more important than increasing the upside.


But you are giving this advice to people who are not, in fact, retired. So that doesn't really apply. Marginal utility applies only past a certain point, when you have enough money for a reasonably comfortable lifestyle. That is a point which most people have not reached. In the meantime, keeping a low-interest mortgage and investing instead, gives the person upsides, e.g. of potentially retiring earlier.

nelson wrote:
I paid off my mortgage last year (after 8 years) and it was one of the best decisions I've ever made. I have more disposable money than I know what to do with *and* I max out the retirement plans without a problem.


Ah, that explains why you keep beating that drum. You're a born again mortgage freeer. Come back in a decade when you've had time for that decision to sink in.

And you continue to ignore the fact that you can't more than max out retirement accounts. The max is, wow, a maximum. I have a mortgage and I max out the retirement plans without a problem. If I instead stopped doing that and paid my mortgage, there is no way I would be able to make up for that lost opportunity later.


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 Post subject: Re: What to do with this money?
PostPosted: Tue Jan 08, 2013 8:35 pm 

Joined: Fri Jun 25, 2010 3:06 pm
Posts: 81
Let's look at this analytically.

If the house is paid off, that's guaranteed income in the form of housing. The stock market however is not guaranteed. If you put it all into investing: Best case scenario, stock market booms and you can now buy two houses during retirement for cash with the money you have. Worse case scenario the stock market goes 1930s and you end up with neither a house nor investments worth anything. However if you pay off the house, you'll at least have a place to live. Stock market goes up, yes, it's true that you'll miss out on your 2nd house but if it goes down, you're not out in the streets.

Of course these are extremes. I advocate paying off the mortgage but still investing through retirement accounts. What I'm strongly against is putting everything you have into the stock market and being too smart for your own good by leveraging your house to invest in stocks.


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 Post subject: Re: What to do with this money?
PostPosted: Tue Jan 08, 2013 8:51 pm 

Joined: Sun May 17, 2009 5:45 pm
Posts: 4
LeRainDrop wrote:
ActYourWage wrote:
Can you please explain what you mean by "But after about 6 years of realizing we had dead money in the house and were giving up a free government handout in the form of tax deductible interest..."

In the United States, under certain circumstances, taxpayers may take a deduction for the interest paid on a mortage for a primary residence or second home. To take advantage of this benefit, when you prepare your taxes, you would need to itemize your deductions, and the itemized deductions must exceed the "standard deduction" amount. Taking a deduction like this reduces the amount of income on which the taxpayer must pay tax to the U.S. government. In other words, by paying mortgage interest, the taxpayer gets to reduce his income by a percentage and therefore pay less in taxes than he otherwise would without the mortgage interest deduction. http://en.wikipedia.org/wiki/Home_mortgage_interest_deduction#United_States


Thank you.


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 Post subject: Re: What to do with this money?
PostPosted: Wed Jan 09, 2013 5:34 am 

Joined: Fri Apr 27, 2012 1:08 am
Posts: 35
DoingHomework wrote:
Um, it doesn't work that way actually.


I should probably create a signature, something along the lines of: I ain't no stinkin' professional, any and all so-called "advice" I give should be construed as "questions to ask a real professional who knows what they're talking about." Yeah, I possibly made a big boo-boo. Probably because I've never been in that situation, read quite a bit of stuff regarding how to lower your income to qualify for a Roth IRA, and (wrongly) assumed that this would do the same. Ah well.

DoingHomework wrote:
It's not that crazy. And you are actually missing quite a bit of the reasoning. I'll list just a few little things that can come into consideration:

....

- everyone needs a place to live. You say interest on that $250000 home is $10000 a year. It's probably less because you have overstated the going mortgage rate by about half a percent. But rent on that house would be probably at least $1500 a month or $18000 a year. So property taxes plus interest = $12000 saves you $6000 a year.
....
- Having a fixed rate mortgage gives you inflation protection on housing costs for the most part. Renters are subject to inflation risks. I don't anticipate high inflation any time soon but it should clearly be recognized as a risk.


Good reasons. And they don't have (much of) anything to do with getting a deduction for the mortgage interest. THESE are the reasons I can get behind for getting a mortgage. Costs less than rent NOW...costs less than rent IN THE FUTURE (make sure you figure in things like upkeep and property taxes, of course). You can even say that getting the deduction for the mortgage interest (after taking into account needing to itemize) is what just barely tipped the scales in favor of buying vs renting...but saying that you're buying a house solely for the interest deduction, that's what gets me.

DoingHomework wrote:
It's not much different than stocking up on tuna when it is on sale. (High five to the first person to identify that reference!)


I don't get the reference, but we do stock up heavily on tuna when it's on sale. Does that count? :)


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 Post subject: Re: What to do with this money?
PostPosted: Wed Jan 09, 2013 5:38 am 

Joined: Fri Apr 27, 2012 1:08 am
Posts: 35
stannius wrote:

Indeed... josetann's key misunderstanding there is that AGI is after "reductions" but before deductions. So more itemized deductions has no effect on your eligibility for a Roth IRA. Some things do, including 401(k) contributions and other pre-tax paycheck deductions like an HSA or FSA.


Yup, we all make mistakes, and that's one of mine.

stannius wrote:
josetann's biggest mistake, of course, is:

josetann wrote:
So...paying $14,000 in interest saves you a total of $525...woohoo! Tell you what...give ME $14,000, I'll turn around and give you $1,050...that's DOUBLE what you'd "save" by having a mortgage and getting to deduct the interest paid.


Hey, I'll take that deal. But you also have to give me $250k up front, to do whatever I want with (though if I'm smart I'll invest it).

Which is to say, josetann is ignoring the opportunity cost of the $250k that the person has access to.


Hey, we all make mistakes...that's ok. Here's the part of my post you missed:

josetann wrote:
And no, I'm not gonna say "if you're just throwing away money, might as well give it to a charity, same effect!" because that'd be forgetting all about the cash you got (or freed up) by taking out a mortgage. I'll assume you put that in some kind of savings account or investment vehicle (one that hopefully doesn't make so much money, as to bump your income back over the allowable limits).


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 Post subject: Re: What to do with this money?
PostPosted: Wed Jan 09, 2013 5:51 am 

Joined: Fri Apr 27, 2012 1:08 am
Posts: 35
nelson wrote:
If the house is paid off, that's guaranteed income in the form of housing. The stock market however is not guaranteed. If you put it all into investing: Best case scenario, stock market booms and you can now buy two houses during retirement for cash with the money you have. Worse case scenario the stock market goes 1930s and you end up with neither a house nor investments worth anything. However if you pay off the house, you'll at least have a place to live. Stock market goes up, yes, it's true that you'll miss out on your 2nd house but if it goes down, you're not out in the streets.


That's how I look at it, except I call it "planning for the worst case (realistic) scenario." Zombie apocalypse counts as a worst case scenario, but not realistic. Stock market crashing, that's realistic. If my house and car are paid for and the economy takes a nose-dive (causing my retirement accounts to fall 90%, or lose our jobs, or whatever), I'm screwed, but can still have a halfway decent life (living off foodstamps, welfare, and unemployment if young, or social security if older). If my house and car are NOT paid for and the economy takes a nose-dive (again causing retirement accounts to fall 90%, losing our jobs, etc.) then I'm screwed, soon to be car-less and homeless.

I've done the numbers. We can live a decent lifestyle with one person earning minimum wage in the US (some things would need to be further cut back...going out to eat would be a few times per month instead of per week, our big yearly vacation would be cut by half, stuff like that). So a lot of our financial security is coming from the fact that we don't need a lot of money coming in, and not because we have six+ figures sitting in a savings account.


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 Post subject: Re: What to do with this money?
PostPosted: Wed Jan 09, 2013 9:03 am 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
Also, what has been muddled here is the accumulation phase vs drawdown. The OP is in the accumulation phase where they are not dependent on "stock market" returns. I find having the cash in hand (or at least with some reasonable liquidity) is much more powerful than a "paid off" house.

When considering a "paid off" house vs not in retirement, one should also explore the cost of ownership vs rent for their market. Owning a home is not free.

_________________
Bichon Frise

"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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 Post subject: Re: What to do with this money?
PostPosted: Wed Jan 09, 2013 2:06 pm 

Joined: Fri May 04, 2007 8:14 pm
Posts: 1560
josetann wrote:
I should probably create a signature, something along the lines of: I ain't no stinkin' professional, any and all so-called "advice" I give should be construed as "questions to ask a real professional who knows what they're talking about."

Wouldn't "Following my advice could result in fines and other penalties if you're audited" be more accurate as a signature?


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 Post subject: Re: What to do with this money?
PostPosted: Wed Jan 09, 2013 5:04 pm 

Joined: Fri Apr 27, 2012 1:08 am
Posts: 35
VinTek wrote:
josetann wrote:
I should probably create a signature, something along the lines of: I ain't no stinkin' professional, any and all so-called "advice" I give should be construed as "questions to ask a real professional who knows what they're talking about."

Wouldn't "Following my advice could result in fines and other penalties if you're audited" be more accurate as a signature?


Wow, guess you've never made a mistake (and admitted it). I thought that's what forums were for, to discuss things, and to learn. So we discussed, and we (or at least I) learned something.

Hopefully no one takes what any one person on the internet says as gospel truth, and instead can do further research, and talk to professionals when needed. Whether it deals with finance, how to raise a child, or even medical issues (if one's having chest pains, and reads one post where someone described having chest pains that went away on their own...hopefully they don't say "ah, I'll just sleep it off then" without further research/consulting a professional). Then again, I can think of some people who would do just that....


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 Post subject: Re: What to do with this money?
PostPosted: Wed Jan 09, 2013 5:15 pm 

Joined: Fri Apr 27, 2012 1:08 am
Posts: 35
Bichon Frise wrote:
Also, what has been muddled here is the accumulation phase vs drawdown. The OP is in the accumulation phase where they are not dependent on "stock market" returns. I find having the cash in hand (or at least with some reasonable liquidity) is much more powerful than a "paid off" house.


And I find that having a paid off house is much more powerful than having a mortgage. Less stress in my day to day life. No worrying about what'll happen if we suddenly can't afford the mortgage. Of course...this is assuming that you've chosen to "own" and not rent; whether one should own or rent is a completely separate discussion. Anyways, that's exactly why it's called PERSONAL finance...neither way is necessarily better than the other. My way's better for ME, your way's better for YOU.

Bichon Frise wrote:
When considering a "paid off" house vs not in retirement, one should also explore the cost of ownership vs rent for their market. Owning a home is not free.


Yup. All those extra "hidden" costs that you're supposed to add to the cost of the mortgage when deciding whether it's more cost-effective to rent vs own...those costs don't go away.

To throw another monkey-wrench into the discussion...when considering worst case scenarios, look at what assistance may be possible with owning your home vs renting (i.e., I believe there's more programs offering rent assistance...but not so many offering mortgage assistance). So even those of us saying "pay off the house, you'll be more secure if things go south" may not be 100% correct.


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 Post subject: Re: What to do with this money?
PostPosted: Wed Jan 09, 2013 5:47 pm 

Joined: Fri May 04, 2007 8:14 pm
Posts: 1560
josetann wrote:
VinTek wrote:
josetann wrote:
I should probably create a signature, something along the lines of: I ain't no stinkin' professional, any and all so-called "advice" I give should be construed as "questions to ask a real professional who knows what they're talking about."

Wouldn't "Following my advice could result in fines and other penalties if you're audited" be more accurate as a signature?


Wow, guess you've never made a mistake (and admitted it). I thought that's what forums were for, to discuss things, and to learn. So we discussed, and we (or at least I) learned something.

It's not that mistakes aren't allowed. It's the cavalier attitude you take that bothers me. You aren't the one who pays for your mistakes; it's the ones who listen to you that pay the penalties.

josetann wrote:
Anyway, I'd think that after you were called out last June for claiming that Roth IRAs were tax deductible that you'd at least exercise a little more caution.

Hopefully no one takes what any one person on the internet says as gospel truth, and instead can do further research, and talk to professionals when needed. Whether it deals with finance, how to raise a child, or even medical issues (if one's having chest pains, and reads one post where someone described having chest pains that went away on their own...hopefully they don't say "ah, I'll just sleep it off then" without further research/consulting a professional). Then again, I can think of some people who would do just that....

You said yourself that you'd never actually done the things you advise. Why don't you actually write about the stuff you've done, instead of writing about stuff you've read and then misinterpreted? People ask questions here because they don't know the answers. When you give answers and pretend to know (remember, you didn't actually say that you hadn't done them until after you were corrected), people who believe you can potentially get hurt. Why do you even bother put forth answers when you actually don't know what the answers are? Remember, you didn't couch your answer as an area to investigate. You pretty much said it was something that could be done. That's pretty unambiguous -- and wrong.


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 Post subject: Re: What to do with this money?
PostPosted: Wed Jan 09, 2013 6:26 pm 

Joined: Fri Apr 27, 2012 1:08 am
Posts: 35
VinTek wrote:
It's not that mistakes aren't allowed. It's the cavalier attitude you take that bothers me. You aren't the one who pays for your mistakes; it's the ones who listen to you that pay the penalties.


I admitted my mistake right away. What would you prefer...that I didn't admit it, or perhaps do what many do, and shout that I'm right and call you names (while sticking my fingers in my ears so I can't hear you)?

josetann wrote:
Anyway, I'd think that after you were called out last June for claiming that Roth IRAs were tax deductible that you'd at least exercise a little more caution.

Hopefully no one takes what any one person on the internet says as gospel truth, and instead can do further research, and talk to professionals when needed. Whether it deals with finance, how to raise a child, or even medical issues (if one's having chest pains, and reads one post where someone described having chest pains that went away on their own...hopefully they don't say "ah, I'll just sleep it off then" without further research/consulting a professional). Then again, I can think of some people who would do just that....


I think you somehow misquoted me there, I believe the top part was meant to be an idea you wrote, and not mine. Regardless, that particular "error" was to do with terminology...deduction vs credit. I did explain, in detail (including forms used) how it came to be that my tax refund was higher due to me contributing to a Roth IRA. Anyways....

VinTek wrote:
You said yourself that you'd never actually done the things you advise. Why don't you actually write about the stuff you've done, instead of writing about stuff you've read and then misinterpreted? People ask questions here because they don't know the answers. When you give answers and pretend to know (remember, you didn't actually say that you hadn't done them until after you were corrected), people who believe you can potentially get hurt. Why do you even bother put forth answers when you actually don't know what the answers are? Remember, you didn't couch your answer as an area to investigate. You pretty much said it was something that could be done. That's pretty unambiguous -- and wrong.


Perhaps part of the issue, which I will indeed work on (trying to think of the perfect signature that should take care of all angles), is that the particular posting was not actually meant to be advice. But rather..."hey, this is the only situation I can think of that you may possibly want to do such a crazy thing." Had it been meant to answer someone's actual question (other than my own rambling), I'm pretty sure I would have done some further research. Heck, even if I was about to answer that one could reduce your taxable income by upping your 401-k contribution, I'd double-check (as these darned tax laws seem to be constantly changing). I don't put as much fact-checking into my rambling hypothetical scenarios, I probably should.

Of course...the fact that I was wrong, just helped to strengthen my original point (that it's [usually] pretty silly to have a mortgage solely because there's a tax deduction...rather you should look at it a bit deeper than that). If I was in politics, I'm sure I could claim this as an overwhelming victory. But I'm not, so I'll just keep trying to come up with a signature to cover myself.

Edit: I addressed the part about putting forth answers I wasn't 100% sure of (didn't believe it applicable at the time, yes I need to rethink that, etc. etc.). But as for being part of the discussion; I like keeping myself informed (yes yes, I know you're already coming up with a scathing reply to that). Just because certain laws, rules, ideas, etc. don't apply to me now, doesn't mean they never will. And even if they don't...I still think that having a better understanding of a subject (in this case, IRS tax rules) can only be beneficial when dealing with the subject. So yeah...now knowing that 401-k contributions can indeed reduce your AGI, but not deductions such as mortgage interest, will presumably help me in my dealings with the IRS (even if they don't include 401-k and mortgage interest deductions).


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 Post subject: Re: What to do with this money?
PostPosted: Thu Jan 10, 2013 6:44 am 

Joined: Tue Oct 23, 2007 7:07 am
Posts: 201
josetann wrote:
And I find that having a paid off house is much more powerful than having a mortgage. Less stress in my day to day life.


That is not the entire alternative though. It is having a mortgage AND having the cash in hand/in an investment that could pay off the mortgage.


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 Post subject: Re: What to do with this money?
PostPosted: Thu Jan 10, 2013 8:37 am 
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nelson wrote:
Let's look at this analytically.

If the house is paid off, that's guaranteed income in the form of housing. The stock market however is not guaranteed.


That's true. But I have never suggested the comparison should be with investing in stocks. Prepaying a mortgage earns a risk-free return at the interest rate of the mortgage. It should be compared with the expected return of an alternative risk-free investment. US Treasuries are risk-free so they make the ideal comparison in the US. Rates are very low right now but over the term of a mortgage they will almost certainly go higher.


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 Post subject: Re: What to do with this money?
PostPosted: Fri Jan 11, 2013 3:07 am 

Joined: Wed Nov 07, 2012 6:21 am
Posts: 132
nelson wrote:
Let's look at this analytically.

If the house is paid off, that's guaranteed income in the form of housing. The stock market however is not guaranteed. If you put it all into investing: Best case scenario, stock market booms and you can now buy two houses during retirement for cash with the money you have. Worse case scenario the stock market goes 1930s and you end up with neither a house nor investments worth anything. However if you pay off the house, you'll at least have a place to live. Stock market goes up, yes, it's true that you'll miss out on your 2nd house but if it goes down, you're not out in the streets.


Actually, things would have to be much worse than the 1930's before you couldn't make a buck in the stock market over the long-run. Talking about the 1930's as a worst case scenario, consider the "Dogs of the Dow" stock trading strategy, which has been popular for years now. This strategy takes the 30 stocks on the Dow Jones Industrial Average and simply selects the top 10 dividend yielding stocks. This strategy beats the vast majority of traditionally managed mutual funds in the long run, has beaten the S&P 500 in performance for each decade, and actually made money starting from the end of 1929 by the start of 1938 (without adding in extra money). Actually investing more during the 1930's made a respectable profit show up. In fact, this strategy was covered in an article in Barron's that I believe was written in 1992 and covered 63 years of its performance of the stock market.

So yes, even the 1930's is no match for this strategy. Sure, you can have times like the 1930's happen. But a good strategy for stocks will prevail in the long-run.


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