I’ve returned from vacation to an overflowing Ask Farnoosh mailbag. Thank you!
It goes without saying that your questions are really, really smart. I couldn’t pick just one to answer so this week, so we’re featuring three very interesting queries. From retirement to financing a home renovation to college savings, we’re about to cover a lot of ground.
Leland asks, “What if my employer-sponsored 401k does not have a match? Should I still invest in the 401k or would an IRA be a better route?”
That’s a bummer that your employer doesn’t offer a match. But that doesn’t mean your 401(k) is totally useless. The 401(k) comes with a number of advantages. First, contributions can lower your taxable income today. The same is true, of course, with a traditional IRA, but the contribution limit with a 401(k) is more than three times greater. You can invest up to $18,000 in a 401(k) this year, versus $5,500 in an IRA. The 401(k), therefor, can offer you a bigger tax savings if you contribute up to the limit.
That said, be sure to compare costs for both saving vehicles. Fees associated with a 401(k) vary and are typically higher than the fees you may find associated with an individual retirement account. The investment options may also be narrower in a 401(k) plan. I recently came across a website called BrightScope that helps you quickly evaluate your particular 401(k) plan components including costs and the overall plan rating compared to its peers.
Sara says, “My boyfriend and I have a baby now under a year old and are looking to do a house addition. We have $55,000 in cash for the addition and estimate it will cost $200,000. We are struggling with how to finance it. The mortgage is currently our only debt, which we anticipate will be at around $90,000 by the time we begin renovations. Our liquid day-to-day savings is low, about $4,000 combined. Any advice?”
Congratulations! You have two very exciting additions in your future!
Now, how to come up with about $150,000 to add to your existing $55,000 to cover the cost of this home renovation?
I have a couple of thoughts for you. First, do you really need to renovate? What if you just moved to a new place?
As someone who recently completed a massive home renovation, I can tell you firsthand that your project can end easily up costing more time and money than you initially calculate.
What if you sold your home, took the proceeds and tacked an additional $200,000 for a new home purchase? Is there anything in that range that would be to your liking?
Experiencing a home renovation while caring after a newborn sounds a tad stressful in my opinion.
If you’re set on renovating, I might suggest looking into a home equity line of credit (HELOC), which offers a credit limit equal to a portion of the difference between the market value of your home minus the value of your mortgage.
So, if you owe $90,000 on your mortgage and the home is appraised at, say, $200,000, you have about $110,000 in equity. A HELOC will usually provide a line of credit up to 90 percent of your home’s equity. How much you receive will depend on the outstanding mortgage, your credit history and other factors.
Even with a HELOC, you may experience a shortage of funds. If that is the case, I recommend either reducing your renovation budget or breaking up the project into at least a couple of phases to give yourself more time to save and finish the project with cash.
Kwan writes, “I have 2 kids, older one is 3 and the younger is 1-year-old. I have a 529 account for each of them. My older daughter has a balance of $56,000 and younger daughter has a balance of $42,000. I am expecting an $80,000 bonus by March 2018. I plan to contribute the whole lump sum to my older daughter’s 529 account next year and same for the younger one in 2019. I wonder if this is a good decision. (P.S. I max out my 401(k) and traditional IRA every year.)”
Wow, Kwan. I’m impressed. Your children have more money saved for college than probably anyone else at the playground.
You’re doing a really fine job of saving for their future and your own. I’m glad to hear you’re not sacrificing your retirement savings to fuel your daughters’ 529 plans.
Your plan to contribute aggressively to their college funds at a young age sounds pretty savvy to me.
I estimate that after placing that $80,000 lump sum into your eldest daughter’s account this year you could stop investing and just let compounding take over over the next 15 years.
After inflation, let’s assume the average rate of return on her account is around 5%. By her 18th birthday you’d be able to afford practically any school, with close to $300,000 sitting in her 529 account. (Of course, this assumes college is still around in 2032, but that’s a different blog post.)
Finally, if you’re not sure if placing a lump sum into the fund is better or worse than dollar-cost averaging (i.e. investing fixed amounts over a period of time) you can feel confident knowing that new research shows that lump sum investing performs better in the long run.
Farnoosh Torabi is America’s leading personal finance authority hooked on helping Americans live their richest, happiest lives. From her early days reporting for Money Magazine to now hosting a primetime series on CNBC and writing monthly for O, The Oprah Magazine, she’s become our favorite go-to money expert and friend.