IRA contributions: Am I eligible?

What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.
1. When should we refinance?
2. What is rich?
3. Is debt snowballing still valid?
4. Precious metals investing
5. Retiring rapidly
6. Roth IRA ineligibility
7. Uneven estates
8. Where would I live?
9. Is kitchen renovation needed?
10. Next president?

My desktop computer seems to finally be going through its death throes, which means that I’m spending a lot of time (a) working on my laptop (which isn’t the most optimal place for me to work), (b) looking for a replacement desktop machine or at least some parts for this one, and (c) moving data completely off the failing computer.

I’m pretty sure it’s a faulty power supply that caused some damage elsewhere within the machine, if you’re curious.

Q1: When should we refinance?
We bought our first home in August of ’09. We currently owe $120K at 5.25% interest, 30 year fixed mortgage. I’ve been seeing interest rates as low as 4.5%, and I am wondering if we should look into refinancing while the rates are so low. I don’t know if it matters, but we did get the $8,000 first-time home buyers tax credit, and if we sell in the first few years, we have to pay part of that back — is refinancing considered selling, since you are basically paying off the one mortgage and getting a new one?
- Julie

The general rule of thumb for refinancing is that you need to have a 1% difference between rates to make it worthwhile. In your case, that rule might not be hard and fast, for two reasons.

First, refinancing is pretty cheap right now. The up-front costs of refinancing are incredibly low – you can likely find refinancing for $1,000 or less.

Second, you’ve just started on your mortgage, which means that the vast majority of your interest is yet to come. This swings the balances more in the direction of refinancing.

You really need to do two things. First, shop around and find the best deal you can. Next, use a refinancing calculator like this one to figure out whether or not it adds up for your specific situation.

Q2: What is rich?
I live in a country located in Eastern Europe. The minimum monthly wage is 120euro, the average wage perhaps 500euro.

I have been thinking a lot about money and personal finance – mostly because of the money trouble I was recently in. All my life I always thought we were poor, but perhaps we weren’t. Maybe we were middle-class. However, I have the impression we must have been poor probably because I constantly heard “We don’t have the money”, “Money’s tight” or “We can’t afford it”. I heard that A LOT.

I never had fancy clothes, telephones, computers or the like. We never had fancy cars or a fancy house with new furniture or equipment. I didn’t have a lot of pocket money. I lived with little money during my student years. Mom and Dad also lived with little money when they attended Unis in their late 40′s. I could never spend as much as I wanted. Mom and Dad always owned money to someone. I remember going on vacation a total of three times in my life.

However, thinking back, we never faced the possibility of starving or being homeless. We were never cut off of power or water, we were never sued for money. Me going to Uni was never a question. I had a computer and also a piano. I didn’t have to work summers after school or Uni. I could take on the risk with starting my own business (which I did) and its cost of 2500euro. We are now having gas installed, the total cost for which was 1600euro so far.

So maybe we never were really poor. But then what happened to the money earned? Was it well-managed or not? I can’t figure it out. I don’t remember my parents buying anything expensive, I remember them always oweing money to someome, I remember living tight. Did they not make enough? Hm, from what I remember they did make quite enough. But I’d never seen them talk about money with me present, nore make a budget or save. They didn’t even talk about saving or making a budget, let alone writing it down. They never talked about long-term financial goals. They did, however, use the word “loan” and “owe” quite often.

Too bad I was too young to remember what they used to make and spend. I got really curious about it – did my parents manage money well or bad? I think “bad” is a safer bet.

Did I mention the house we live in is huge? Over 110 sq.m.! 5 rooms on the second floor, 2 rooms on the ground floor, 1 really big room there as well, basement with three rooms and an attick, a garage with a small semi-opened barn to it, one big open terrace with a tiny (2x2m) sheltered “summer kitchen” and one closed terrace facing the street, plus a front yard (5x5m) and a back yard (4x4m), and a long paved way from the street to the house door, probably 2x20m. The two-story family house was built by my grandfather and my dad got it as heritage, he was raised there. Point being, my parents didn’t pay for it.

So what do you think? Were we rich or poor? Did my parents manage their money well?
- Raya

My perspective on “rich” and “poor” is a little different. Were your parents happy? Did they fight a lot? Were they stressed out by money or work or other stresses? Did you have a happy childhood?

If those things are all true, then they were rich. What else, really, does life have to offer than joy and low stress? You can have all the material stuff in the world – a big home, a shiny car – but if you spend all of your time stressed out and working, is it really worth anything?

I think that the usual way of looking at “rich” and “poor” – in terms of one’s possessions – is just a way of keeping score against others at the expense of your own internal happiness.

Q3: Is debt snowballing still valid?
Do you still recommend doing the interest rate snow ball if it will take several years to pay of your highest interest debt? We’ve been making equal extra payments on our 3 debts that we want to pay off, one is a small student loan of $7,000 at 4.125%, a large student loan of $30,000 at 4.75%, and a pesky second mortgage of $50,000 at 9.125%. If we focus all of our extra repayment power on the mortgage, it will still take at least 3-4 years if not more for us to finish it, but if i put it towards that small student loan, we could pay it off pretty quick, though i guess it doesn’t really help us much interest wise. I do think it would be fabulous to not have that second, esp considering the market right now and our underwater status, but 3-4 years seems so far away… I’m not sure what to do. I fear putting all of my eggs in the mortgage basket, but we do have every intention of keeping our house and maybe i would feel better if we weren’t carrying so much debt on it.
- Michelle

Absolutely. Regardless of how long it takes, you’ve still got to pay off that debt.

If I were you, though, I wouldn’t do a straigt-up debt snowball. I would focus all of my extra payments on that second mortgage because of the very high interest rate.

Don’t worry about it being far off. Instead, focus on looking at the forward progress you’re making on each statement on that mortgage. Notice how the interest you’re paying is steadily going down and the principal you’re paying is steadily going up. That’s progress you can see. Compare the statements to the previous ones to see the progress. That will help keep you motivated.

Q4: Precious metals investing
Do you invest in precious metals?

My brother monitors the ups and downs of gold and silver value on a daily basis. It is his private passion. Through this obsession he has been urging me to get involved and notifies me when it’s a good time to buy. Is this worth my time and money? Would it really count as diversifying my portfolio?
- Linda

I don’t invest in precious metals. They’re too volatile and speculative to have much interest for me, and they’re currently riding a bubble fueled by people who are quite willing to advertise on behalf of gold investments on talk radio stations.

Gold and silver are riding high at the moment, but at some point, those buyers will become sellers. Remember, gold isn’t like a stock or a bond – it doesn’t return dividends or payments to you for merely holding it. At some point, buyers will want a return on investment and they will sell.

If you want to include precious metals as part of your portfolio, make sure it’s a small part and make sure your whole portfolio is well-diversified.

Q5: Retiring rapidly
I am obsessed with retiring early. However, I havent really taken advantage of all I needed to do. I’ve done the matching of a 401K but that’s it. I must say for 38 I dont feel I am where I need to be for retirement.

I read your article on how to retire early by 40. Wish I had that information at 20. My question is….I am 39 if I did the 20% of my gross payday how long would I have to work to achieve earlier retirement? It would seem being older and starting the program I wouldnt have to work 20 years doing it like a 20 year old.
- Chris

If you’re 39 years old and you start saving 20% of your gross income for retirement, you’ll likely be ready to retire at your actual retirement age – somewhere around 60 – with a very healthy retirement plan for you.

If you choose to save less, you’ll have to keep working much later in life and likely retire with less in the bank.

The truth of the matter is that the earlier you start saving for retirement, the easier it will be. Once you reach the age of forty, it becomes much, much harder to make it to a “typical” retirement age with adequate retirement savings.

Q6: Roth IRA ineligibility
I am a biologist and unfortunately don’t have a ‘real’ job. I am a government contractor (specifically, an ORISE fellow). This means that I work at a US Army base and do everything that the Federal employees do, except I don’t have benefits. I don’t have a W-2; I have a 1099. I pay taxes quarterly; they are not taken out of my paycheck.

I would really like to set up a Roth IRA since I don’t have any company retirement benefits, but I have heard that I may not be eligible for one due to my science fellowship. The CPA firm that does my taxes told me this. It’s not considered ‘income’ but a fellowship, which means no one knows the tax rules regarding my status.

So I was wondering if I set up a Roth IRA, am I allowed to have it? I really don’t want to sic the IRS on myself, but I would like to start saving for retirement while I am still in my 20s. Do you have any advice? Also, is the Vanguard Targeted Retirement Funds the best option for those of us who have no idea what we are doing?
- Cammie

I can’t see any reason why you would be ineligible for a Roth IRA unless your income is very, very high. It may be that you’re ineligible for the typical government retirement plan (TSP) and people are confusing that for a normal Roth IRA.

A Vanguard Target Retirement fund is a very good option for retirement. It’s quite literally the investment I’m using for my own retirement and I wouldn’t have my money in there if I didn’t believe in it.

If I were you, I’d sign up for that Roth IRA today and try to get some 2010 contributions in place before the year ends.

Q7: Uneven estates
Five years ago, as a single mom of a young son, I married a man with 6 children of his own. We decided to have one child together, and a few months ago we had a son. Recently my parents, who are millionaires and who are currently doing their own estate planning, expressed a desire to place the money they intend to leave to me in a trust, and structure it in such a way that when I die the money in the trust will then go to my two biological sons. (Fearing, I believe, that if I died and my husband later remarried, their assets would never pass to their grandchildren.) When my husband learned of this plan, he told me that he disapproves of the idea of some of our children inheriting a great deal more than others. He wants to modify our own estate plan in response, so that my son and our son together will inherit less from us as a result of them anticipating a substantial windfall from their grandparents. I feel, however, that trying to do this is unfair to my sons. What my parents choose to do with their money is their own affair; I want my sons to have a share of the fruits of MY labor if I am in a position to leave them an inheritance someday (God willing). What’s your take on all this? If you were in our shoes would you try to even things out?
- Katie

I am intimately familiar with a situation not too much unlike this one and I can certanly say that it’s uncomfortable.

First of all, you have to respect that your parents are going to do with their money what they want to do with their money. It’s their decision. I think you have to let that sleeping dog lie.

Now, as for your own estate, my suggestion is simple. If you disagree on the principle, divide the estate in half. With one half of it (your half), split it evenly among all eight children. With the other half, divide it evenly among the children not receiving the large trust (the other six).

This would essentially mean that your estate has fourteen “shares.” His six children would each get two “shares” and the other two would each get one “share.”

That’s how I would handle this unless you want a great deal of conflict.

Q8: Where would I live?
If you could live anywhere in the world, where would you want to live and why? Please don’t include family relationships in your answer.
- Ellen

I would live in a coastal area with a warmer climate. It wouldn’t have to be on the coast, just near it. The area would have to have a good school system in place or access to good reasonably-priced private schools. Southern Oregon or northern California would be possibilities.

Honestly, I haven’t researched such a question in depth. Much of our criteria for where to live involves being near family and friends. Home is where the heart is and for us, our heart is with the people around us.

If we were to leave Iowa, we would probably live in Washington state, near the coast, somewhere south of Tacoma. This would allow us to be near a significant number of people we care a lot about, perhaps the greatest density outside of the upper Midwest.

Q9: Is kitchen renovation needed?
I need some perspective: should I renovate my kitchen?
My family has lived off of the 10-10-80 rule years (give 10, save 10, live on 80).
We are a one income family, and my wife home schools our kids, so they spend the better part of most days in the home.
All my kids love cooking. And we entertain a lot. We really like our house. We love our neighborhood. We don’t think it’s wise for us to move.

But our kitchen is tiny! We make it work, but it’s not fun. We’ll need to replace our appliances in the coming year. The question is, should we renovate? The only way to grow our kitchen is to move a load bearing wall, which means I can’t do it without professional help. In sum, the renovation to get the kitchen of my wife’s dreams will cost roughly $30,000.

I could totally exhaust our savings, and almost cover it.
Or I could take out a home equity loan, and make a couple changes to our budget, and cover the additional cost of about $350 per month.

A kitchen renovation will probably not increase the value of our home to offset the cost. So this it really about living in the house. This would make my wife’s life much easier, and it would help with entertaining.

But here’s the final piece of the puzzle: I am a pastor, actually a church planter. We started a new church three years ago here. The work is going well and the church is growing. But I live with a sense that the whole thing could fall apart. I think it’s that fear that keeps me from making the investment in this renovation.

Can you offer me some insight or perspective? Can you tell me, renovate that kitchen! Or tell me I’m a fool, don’t renovate, and make it work!
- George

I would keep building my savings until I could cover the entire expense without depleting my emergency fund. You’re going to want an emergency fund on hand in case of the unexpected.

Once you have that savings in hand, go for it. If a kitchen remodel is something you deeply personally value, then it’s something you should do.

Remember that the kitchen remodel will add some value to your home, so if things do collapse at a later date, you will have an increased home equity.

Q10: Next president?
Who do you think will be the next president of the United States in 2012?
- Shaun

Like any midterm election, it depends entirely on the economy. If the economy is rebounding in the summer and fall of 2012, Obama will win re-election. If the economy is stagnant, he won’t.

Almost every single time a president has faced a midterm election since World War II, the economy has decided things. Bush won in 2004 on the back of a rebounding economy. Clinton won in 1996 during a rebounding economy. Bush lost in 1992 during economic troubles. Reagan won in 1984 on the back of a rebounding economy. Carter lost in 1980 due to economic troubles. Ford lost in 1976 due to economic troubles (and the shadow of Nixon).

I think you have to go back to 1972 to find a midterm election that wasn’t just about the economy, and then you have to go back to one of the most inept modern political campaigns ever, that of George McGovern. Who would have thought that naming a person who underwent electro-shock therapy as your running mate would undermine your credibility?

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag. However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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