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Jan 7 2013 12:00AM

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Question

We have $80,000 in student loans for our daughter coming due next month. We bought real estate in Colorado many years ago to pay for our kids’ colleges but with the economy, we have not been able to sell. Do we take money out of our retirement or do we take a second mortgage on our home? 

Answer

As we do not have complete data gathered for your situation, below are a few questions for you to consider: 

  1. How much will you need for retirement and how much of that income will be from pensions, annuities, social security as your 'base' income?
  2. Do you currently have enough in retirement assets that will be a resource to provide 'lifetime income?  
  3. Are you currently retired or if not what is your timeline for retirement?
  4. What is your current debt including credit cards, auto loans?
  5. What is the value of your home and what is your current mortgage as well as interest rate?  When did the current loan start? 
  6. What is the value of your Colorado home and what is the current mortgage and interest rate? When did the current loan start?

Do we take money out of our retirement?  

Taking $80,000 out of your retirement now could 'cost' you far more in the future than the student loan today. Depending on how many years before retirement, the future value of $80,000 could be substantial and the difference between retiring comfortably or not -- or having to delay retirement -- or continue to work to supplement your income. Careful consideration should be taken when accessing retirement assets.

If you are currently employed and you have a 401(k) plan which allows for loans, this could be a partial or full solution. Depending on the value of the 401(k) plan and what amount or percentage the plan allows for loans would determine the amount of money accessible. While you're still employed, it is usually required that the loan be paid back in five years at a prescribed interest rate. This rate may be well below rates for accessing money elsewhere.

With either of the above strategies, your timeline and retirement income needs must be taken into consideration. If you are working for another five years, then borrowing from the 401(k) plan could work. However if you plan to retire earlier than five years whatever the outstanding loan amount at the time will be considered a distribution and taxable in that year. If you are now over 59 1/2 today taking $80,000 will be fully taxable in the year taken. Depending on your tax bracket you may want to pay at a 2012 tax rate on the $80,000 (with tax rates possibly increasing in 2013). If you are under 59 1/2 then you will have, in addition to taxes, a 10% penalty. The $80,000 will 'cost' you literally more than $80,000 today between taxes and penalties.

Finally, have you considered asking your daughter to participate in paying off some of this loan or taking on part of the debt herself? If interest rates are fixed and lower today, (if it’s financial feasible for you) it may be beneficial to help her make payments. Depending on your assets and/or income, you might consider gifting up to $13,000 each or $26,000 in 2012 to help pay down her loan. This can be repeated until paid. Again, review strategies with your trusted adviser with whom you can review all the details of your current financial situation.

Do we take a second mortgage on our home?

After answering the above questions you might consider borrowing from the Colorado home if there is enough equity. Issues for refinancing or second mortgage may arise since the home is not in your state of residence. Is it currently being rented, creating some cash flow? I recommend talking with the current lender with whom you have the current mortgage as well as shop with others to investigate what options/opportunities may be available.  

In regards to question number six above - if you have enough equity and if the current interest rate can be lowered by at least 1.5% it might make sense to re-finance and include a line of credit to pay down the student loan. Here again a conversation with your lender (and others) could help determine if this is a viable solution - transferring student loan debt to your home.

With any strategy discussed here or considered, it is essential that you have this conversation with your financial and/or tax professional. She/he will be able to advise you on tax considerations that will be important in deciding your best course. 

Please note that the information presented is by no means based on all considerations appropriate to the details of your situation. These are general considerations based on the information you provided.

 

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