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Mailbag for Friday, January 12, 2007

Chris Farrell answers your financial questions.

KAI RYSSDAL: It's been one long week since you've heard the voice of our economics editor, Chris Farrell, answering your money questions so, what the heck, you reach us again. Chris, how are you?

CHRIS FARRELL: I'm doing well, Kai. And I'm glad to be with you again.

RYSSDAL: You know, I mean, we figured it was time, right?
CHRIS FARRELL (ECONOMICS EDITOR)
Yeah, it--absolutely.

RYSSDAL: 877-275-6669 is the phone number. That's 877-ASK-MONY, or you can go to our web site. Our home page is marketplace.org. Up in the top right-hand corner of the page there's a little link that says contact. You click on that, you send us an e-mail and we'll get you on the radio and everybody's happy. That is exactly what Richard, down at Fort Lauderdale, Florida did. He's on the line with us now. Hey, Richard, how are you?

RICHARD: I'm fine, thank you Kai.

RYSSDAL: Fort Lauderdale -- what do you do down there?

RICHARD: I'm retired. I lived in New York for 44 years and got tired of the winters and moved down here at the end of '04.

RYSSDAL: You know that's funny, my parents did the same thing. They said forget it, enough of this snow stuff. What's on your mind?

RICHARD: Well, when I moved down here I bought a house, which I own free and clear. And I bought a single term, fixed annuity, which pays me a monthly income for life. So in theory I'm all set up for the rest of my days.

RYSSDAL: And how many more days are there Richard? How old are you?

RICHARD: I'm 62.

RYSSDAL: All right.

RICHARD: My questions are about the -- getting a reverse mortgage. Now that I'm 62, I can get it, but I have some things that I don't understand about reverse mortgages.

RYSSDAL: Let's do this, why don't we? Why don't we take a break here and just do a very brief primer, Chris, on reverse mortgages, what they are and how they work.

FARRELL: Sure. A reverse mortgage is exactly what it sounds like. Instead of the homeowner paying the bank to pay off the mortgage, the bank pays the homeowner money from the equity and then the bank gets a lien on the home. So when you pass on, or you move, the home is sold and the loan that you have from the bank is paid off. Now is really a good time for people to start educating themselves about reverse mortgages.

RYSSDAL: Why is that?

FARRELL: Think of the past ten years, how much wealth has been built up in housing. It's basically a lousy product. Now, the product is getting much better. There's more competition. It's being streamlined. It's still a very complicated product, but the good news is it's getting simpler, fees are starting to come down. So over the next couple of years, I think one of the real revolutions in the mortgage market is going to be in reverse mortgages.

RYSSDAL: All right. Let's work through this with Richard though for a second. Richard, how much is the house worth?

RICHARD: About 220.

RYSSDAL: Okay, so Chris, Richard goes to the bank and says I'd like a reverse mortgage please. They say great and they give him a check for $220,000 and then he gives the deed to the house. Is that how that works? No? How does it work?
CHRIS FARRELL (ECONOMICS EDITOR)
Not how it works. Okay, it's okay--first of all Richard's right. You have to be age 62. And then how much money you get is a combination of your age, the location and value of the home and prevailing interest rates. But it's not just quite so simple as you make it though. For example, Kai, let me just toss in--fees are high. It can run about 8% of the value of a home. And you cannot do a reverse mortgage without counseling.

RYSSDAL: Oh, is that right?

FARRELL: It is a requirement. It's not voluntary. In talking to some people I still think -- you really can't do one of these without a financial advisor or a lawyer to help you work through the various choices.

RICHARD: Okay. My other main question is what will be left in its value after just, let's say 10 more years of life, will the total value of the house go to the mortgage company? Will there be value left at the end in case I want to leave some to, you know, a friend?

RYSSDAL: That's a good question.

FARRELL: Right. Or what if property values decline though?

RICHARD: Property values decline.

FARRELL: If property values increase and there's more and your equity continues to grow. All you've got to do is pay off what you owe. So therefore, if there's an increase in equity, hey, there's still equity left over. You can leave that to somebody else. You could also leave the home to somebody else, they could refinance it if there's a genuine increase in value, and pay off what you owe that way. If the value of the home declines, and it turns out you got more money in the reverse mortgage than the place is worth.

RICHARD: I've never heard of property declining in value in Florida.

RYSSDAL: Well there you go, an eternal optimist. Richard, thanks a lot for your time. We really appreciate your call.

RICHARD: Bye-bye.

RYSSDAL: Bye-bye now. All right, from Florida we go down to San Diego, California. Here's what Eric says in the first e-mail of the day. He's 28-years-old. He wants to go sailing around the world and he's trying to put money away to fund it. He's got about $6,000 so far. He thinks he needs about $50,000 before he leaves in five years. But, and this will warm the cockles of your heart, one hopes Chris, he doesn't want to lose sight of his retirement savings. He wants to know, basically, how to figure out this savings problem. He's got this big goal that he wants to keep in mind, but he wants to keep putting money away for retirement. Is there a way to really do this so that he can get both?

FARRELL: First of all, what a lot of people do in his situation, assuming that he has a 401k or a 403b, is they continue to participate in that plan while they're working and he's putting his money aside to save, but up to the match. And then you take that difference and you put that into his money market mutual fund or whatever kind of account that he's trying to build. That's sort of a classic, just continue to participate in your retirement savings plan at work, if it's offered, especially to the match. And then save elsewhere. But let's say he doesn't have the retirement savings plan at work. You know, what does he do? You know, you do the Roth IRA. That's what I would do. Save in the Roth IRA to the maximum and then in an emergency you could remove the principal or some of the principal without any tax consequences or penalty. You can't touch the earnings, but you can touch the principal amount that you put in there, your principal contribution. So, if you needed $2,000 or $3,000 and he's putting in a couple thousand dollars a year over the next five years, so it solves both problems--emergency fund and retirement savings, one product.

RYSSDAL: All right. There you go, Eric, a one-stop shop man, how about that. 877-275-6669 is our telephone number. That's 877-ASK-MONY, M-O-N-Y is the way we spell that. Our web page is marketplace.org. Click on that contact link if you want to write things down and send us an e-mail, that works for us too. Back to the phones we go. Elizabeth's on the line from Indianapolis, Indiana. Hey, Elizabeth, how are you?

ELIZABETH: Hey, good, how about you guys?

RYSSDAL: I'm good. You sound all peppy.

ELIZABETH: Well of course.

RYSSDAL: Why, of course?

ELIZABETH: Well I just got done getting a massage, so you know what, I'm good to go.

RYSSDAL: There you go. Now I understand, my producer tells me you're actually a massage therapist.

ELIZABETH: Yes I am.

RYSSDAL: So, it's you give and you get right?

ELIZABETH: Yes, that's right. I'm better at giving if I get.

RYSSDAL: How's business by the way?

ELIZABETH: Actually business is really good. Something's happened in the last six months, I don't know what it is, but it's…

RYSSDAL: Yeah, people are really tense, that's what happened.

ELIZABETH: Yeah, I don't know.

RYSSDAL: Well, what can we do for you?

ELIZABETH: Well, I have a question and it's kind of a--I don't know if it'd be considered a nosy friend question or what, but -

RYSSDAL: Are you the nosy friend or is somebody else being nosy to you?

ELIZABETH: I am the nosy friend.

RYSSDAL: All right.

ELIZABETH: I have a friend and she and her husband just kind of started an investment plan and it's kind of their, what I would consider the sprint to the finish line.

RYSSDAL: How old are they?

ELIZABETH: They are in their late 40s.

RYSSDAL: Okay.

ELIZABETH: And I don't think they've done a ton of planning for their retirement. And so they got involved with an investment planner. And she's just kind of mentioned it in passing a few times. And the more she talked about it, the more I kind of got curious. And then, concerned because she said they are buying these life insurance policies. They each have one and that's I guess that's what they'll buy is each of them buys--and they'll pay on it $350 a month each for eight to nine years and then they will turn around sell them and they are expecting to bring in over $600 and some thousand each -- off each of their policies.

RYSSDAL: Wow. I guess, Elizabeth, the root of your question is is this a smart idea?

ELIZABETH: The root of my question is if this is really possible and if it is why can't I do that?

RYSSDAL: Yeah, well you probably can. It's just a question of what you are going to get out of it in the end. Chris?

FARRELL: All right. This goes back to Chris Farrell's law of saving for retirement keep it really simple. Once you get into these games whether it is the type of policy that they are pursuing and trying to buy life insurance products and then sell them for 80% of the value later on or you're getting the variable life insurance policies or the variable annuities they don't work for the majority of the people and I just would steer clear. Somebody is making money it's there are just so many fees, hidden costs forget it, just forget it. I can hear you--I can hear the breath coming. I can hear that breath and you are right.

RYSSDAL: Well I -- it's not actually a question of substance. It's a question of clarification. This is, I guess, you could call it an insurance policy that's kind of really an annuity.

ELIZABETH: No, she said, she thought it was an annuity.

RYSSDAL: I don't know, Elizabeth, if you've ever heard Chris Farrell talk about annuities but he doesn't care for them.

ELIZABETH: Yeah, I think I've picked up on that a few times.

FARRELL: It's not a good idea.

RYSSDAL: Okay. So lets help Elizabeth not just a nosey friend but a helpful friend. If she goes back to this couple and says, hay, I was talking to Chris Farrell and he said you guys were idiots that's not really going to help very much. She needs to go back to them with a plan. How can they get out of this and what should they do?

FARRELL: Okay. So look I talked to Chris Farrell and he was skeptical about this and he's a little bit concerned about your retirement. Okay. So what he said to do is there's this guy James Hunt, long time--been involved with the insurance business for a long time. If you go to consumerfed.org he offers a service where he evaluates life insurance plans. So lets not take Chris Farrell's word for it lets go with James Hunt. There's also, in Indiana, a wonderful professor, done a lot work, Joseph Belth who has a service that will also do an evaluation. And you know what you're putting $700 a month into this kind of thing, I tell you what.

FARRELL: We are gonna go to a pretty expensive fee only financial planner, we're gonna spend, you know, $1400 but this is your retirement, you're putting $700 a month. Let's find ourselves a really good fee only financial planner he's going to look at this policy, he's going to look at where you are. And you know what I think he is going to give you the same advice Chris Farrell gave you, but he'll also give you some very concrete steps that you can take with your goals and what you are trying to do to sort of have a really good plan and portfolio for your later years.

ELIZABETH: Alrighty.

RYSSDAL: There you go Elizabeth and listen if they've got questions tell them to call us.

ELIZABETH: I sure will.

RYSSDAL: Bye-bye now.

ELIZABETH: Bye.

RYSSDAL: 877-275-6669 that's our phone number ASK-MONY, that's 877-ASK-MONY is the way we spell that. Our web page is marketplace.org if you want to send us an email. This Marketplace Money from American Public Media. Chris back to the emails we go. It's Gary from Cincinnati, Ohio. This time around and here's what he says. He's got a regular monthly deposit automatically sent to his IRA, but at the end of the year he realized he sort of made a goof. His adjusted gross income was more than he counted on that means he then made more than the allowable contribution to his IRA. So now what happens? Does he just deduct that without the penalty does he call the tax man and say, help? What does he have to do?

FARRELL: Okay. The IRS is aware that this happens. It's fairly simple you have to make the correction by April 15, but if you don't make it by April 15 there's an automatic six month extension if you file your tax return by April 15. So he's not going to have any trouble.

RYSSDAL: Okay.

FARRELL: And you have to remove the excess amount plus you must also remove and applicable earnings off that amount. And the IRS has a form it's going to be a taxable event and there's going to be a tiny penalty associated with the earnings that you withdrawal.

RYSSDAL: But he made and honest mistake?

FARRELL: Yeah, but you know what your not--I mean, look Kai, you're not talking much money.

RYSSDAL: Yeah, I guess it's the principle of the thing.

FARRELL: Okay. It's the principle I understand you should just be able to take it out and say hay, you know, I made an honest mistake and of course people like me and you, we advice people to do these things automatic. That's what we advice. I mean it's a good thing. But it is really simple, he does realize that it's really not going to cost him anything. Now if he ignores it.

RYSSDAL: Yeah, yeah.

FARRELL: Then you start getting into some penalties over time. So anyway let's just deal with it let's get it over with.

RYSSDAL: Now that extra money that he is now taking out of his traditional IRA. It's tempting to go blow it. What might be the prudent thing to do with it.

FARRELL: Well I think, you know, the prudent thing to do is to start funding next year's IRA. You know you can start doing that. You know, I'm going to give you the most boring investment in the world. I think I'm the only person that really likes this investment. But I like I-bonds. You got a little extra money. You know buy yourself and I-bond, no commissions and it can compound for you. So try an I-bond.

RYSSDAL: All Right. I-bonds it is. 877-275-6669 or 877-ASK-MONY. If you want to write down your financial and send it to us we'll get it, we'll read it, we'll call you back, we'll put you on the radio. Our website is marketplace.org, click on that link that says contact. Chris we'll talk to you.

FARRELL: I'll talk to you later, Kai.

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