Q. I want to contribute to my daughter’s wedding and I don’t have the cash. I need $20,000. Should I take a home equity loan or take from my IRA? I’m 60 so there are no penalties.
— Cash poor
A. Congratulations to you and your family on the upcoming wedding.
While this is an exciting time for everyone, it’s also very easy to get caught up in the emotional aspect of the event and set aside prudent, rational reasoning.
“As a proud parent it is easy to overlook the fact that you are thinking about mortgaging your retirement and future financial security in order to help pay for a wedding, which in the big picture scheme of things is really just a one-day party,” said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield. “As time goes by, the memories of that day will fade but the bills will linger.”
He said he really can’t get behind you taking out money from your future to pay for the wedding. If you can’t afford to spend $20,000 right now, you shouldn’t be thinking about raiding your IRA or your home to do it, he said.
Instead, you should be honest with your daughter about what you can truly afford to spend and ask her to reconsider the budget for the wedding, DeFelice said.
“If you can only afford to give her $5,000 or $10,000, then that is exactly what you should contribute,” he said. “Otherwise, you are just hurting yourself in the long run.”
That being said, let’s go over the two options you listed:
The idea of a home equity loan would depend on how much equity you currently have in your home.
If there is enough equity to allow you to pull out $20,000, you could either refinance your primary mortgage and take some extra cash out, or take out a second mortgage, DeFelice said.
“Either one will come with bank fees and closing costs on top of the amount you are borrowing, not to mention adding more years to when the home will finally be paid off,” he said. “The other thing you have to be cognizant of is your overall debt-to-equity ratio including the $20,000.”
If you borrow more than 80 percent of the home’s value, you’ll pay private mortgage insurance (PMI), which could raise your mortgage payment by more than $100 per month, DeFelice said.
Then, he said, there are other questions to consider: What is your plan for paying back the loan? Are you still working? If so, how much longer until you retire? Can your monthly cash flow support the home equity loan payments you will need to make until it is paid off?
If you must borrow from your home, a better option would be a home equity line of credit instead of a home equity loan or second mortgage, DeFelice said.
The closing costs are usually nominal, and you only pay interest on what you use.
For example, you could open a $50,000 line of credit if your home equity supports it, but only pay interest on the $20,000 you borrow. Additionally, most standard HELOCs allow you to make interest-only payments for the first 10 years, and then after that any remaining amount outstanding is amortized into a fixed principal/interest payment loan over the next 20 years, DeFelice said.
The first 10 years carry a floating interest rate and then it locks in at prevailing rates after the tenth year. That’s fine for now when interest rates are still just off historic lows, but they have already started creeping higher, and this could become a real problem down the road if you don’t get this loan paid off quickly – as you could potentially be stuck with a much higher fixed payment than you originally budgeted for, DeFelice said.
“The one good thing is that interest on both home equity loans and lines of credit is tax deductible,” DeFelice said. “But the fact remains that if this loan is held for any significant amount of time it could add thousands of dollars in interest payments above the $20,000 you thought this wedding would cost you.”
Now let’s look at your IRA.
This would avoid the complications of borrowing money and dealing with the extra monthly interest payments that could put a crimp in your cash flow, DeFelice said. The other good thing here is that because you are over 59 1/2, you will not be subject to a 10 percent early withdrawal penalty.
But, he said, you will still have to pay ordinary income tax on your distribution.
Assuming you are in a 25 percent tax bracket, that means in order to net $20,000, you would have to withdraw more than $26,500 to account for your tax liability, DeFelice said. And then you have to be careful that the extra $26,500 you withdraw and declare as income doesn’t bump you into a higher tax bracket altogether, which would wind up costing you even more money.
Then there’s the fact that these savings were designed to help fund your retirement, which could be a 20 or 30 year period of time – not to pay for a one-day event.
“In order to answer whether or not this is the right move for you, it would also depend largely on how much you have in your IRA,” DeFelice said.
If you had $1million, the $26,000 withdrawal probably won’t make a huge difference in your retirement lifestyle. But, he said, if you only have $200,000 saved, it could make things very difficult for you over the long term.
“Not only would you be taking a large distribution, but you also reduce potential earnings power and income-producing ability of that money in the future,” DeFelice said.
He recommends you sit down with your daughter and be honest about your financial circumstances.
“The best gift you can give is to not put your financial future at risk so that one day you have to rely on your daughter and her new husband to support you,” he said.
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