6 Money Dilemmas (Part 2 of 3)

Won't your tax bracket drop once you're no longer working?  Don't count on it.  If you're just starting your career, you'll almost certainly be earning more in 40 years.  Even if you're mid-career, you can't assume your tax bracket will plummet.  With federal tax rates currently at their lowest levels in decades and the federal deficit growing, it's not hard to imagine Congress raising taxes between now and your retirement.  Assume a lower bracket only if you're near retirement and know your tax rate will fall.

A regular 401(k) has one thing going for it: the up-front tax break, so you'll see your disposable income shrink if you switch to a Roth.  But for the regular 401(k) even to come close to the Roth as a savings vehicle, you'd have to invest the extra cash that it put in your pocket.  Would you?  So, unless you are on the verge of retiring and know your income will drop, the Roth wins.

Lease a car or buy a car?  With leasing, you always drive a shiny new car, and your monthly payments are lower.  So why would you buy?

A new Toyota Camry will run you just under $27,000.  Buy one and finance with a no-money-down, five-year loan at 6.9 percent (today's average), and your monthly payments will be $526.  That's $31,560 over five years.  Say you instead pay $1,000 up front for a five-year lease.  Your monthly payment will be $415.  At the end of five years, you'll have spent $25,900.  So leasing wins?  That's not the full story.  If you buy a car, it'll be worth something once you've paid off the loan.  Your Camry would fetch about $10,000 after five years, according to estimates by Edmunds.com.  That cuts the out-of-pocket cost to $21,560.

What if you really want a new car?  In that case, the gap narrows.  Take out a three-year loan on the Camry and your monthly payments would spike to $821, for a total of $29,556.  If your three-year-old Camry sells for $14,000, your net cost drops to $15,556.  If you leased, though, your payment would be $485 a month, putting an extra $336 in your pocket compared with the loan.  Invest that $336 in a money-market fund paying 4.5 percent, and you'd earn $589 after taxes in three years, assuming a 28 percent tax bracket.  Factoring that in, your total lease cost would be $17,871.

Also, the Camry holds its value well.  With models that don't, the manufacturer often sweetens the deal by inflating the car's assumed value at the end of the lease term.  If you buy the same car, you won't make that much when you sell it, which could tilt the scales in favor of leasing.

Remember: Leases come with mileage restrictions, typically 12,000 miles a year.  Plus, if you ding a leased car, you'll get dinged with fees.  Over the long term, buying costs you less.

Prepay your mortgage or invest?  When some extra cash comes your way, it's tempting to put it toward your mortgage.  You'll save on interest and pay off your house earlier.  Buying stocks, on the other hand, feels like a risky leap into the unknown, especially now.

Paying off your mortgage or any loan is an investment, and your return is essentially the interest rate on the loan.  If you have 25 years left on a 30-year mortgage with a fixed rate of 6.2 percent and you deduct your interest payments on your taxes, you'll earn 4.5 percent by prepaying the loan (assuming you're in the 28 percent tax bracket).  Now let's say you invest your spare cash in stocks instead.  You'll pay a 15 percent tax rate on your long-term capital gains and dividends.  So to beat the 4.5 percent return you'd get from prepaying your mortgage, you'd have to earn just 5.3 percent a year on your stocks before taxes.

The odds of your doing that over the 25-year remaining term of your mortgage are excellent: Historically, a portfolio of 80 percent stocks and 20 percent bonds has returned 7.5 percent a year after taxes.  Paying down the mortgage earns you a risk-free 4.5 percent, as good as you'll do with Treasury bonds.  True, and if you are investing for a near-term goal and don't want to take any risk, you can make a stronger case for prepaying your mortgage.  But if you are investing for a goal that's more than a decade away, you can and should take more risk for a chance at a higher return.