Free Money Finance

The Two Best Ways to Insure Income for Life During Retirement

Here are some thoughts from the wonderful book The Bogleheads' Guide to Investing (I LOVED the book -- see my rating for details) on two ways to insure income for life during retirement:

There are two simple ways to remain financially flexible and reduce the odds of running out of money [in retirement]. First, keep your fixed living expenses as low as possible. Retirement is not the time to have an enormous mortgage, expensive car payments, credit card debts, and the like. Low overhead comes in very handy when the stock market goes into the tank and bears are growling on Wall Street. You need to have the flexibility of spending less during bear markets and more during bull markets.

The second way to increase spending flexibility is to have a viable way to earn income if needed. We aren't suggesting going back to work full-time or becoming a Wal-mart greeter. Technology makes it possible to do many paid tasks from the comfort of your home.

A few thoughts here:

1. It's no surprise that the same steps that help you become wealthy and save for retirement in the first place will keep you on track during retirement. Spending less than you earn, in particular, is the key to becoming wealthy.

2. If you need/want additional thoughts on spending less than you earn, earning more money, and ways to accumulate savings for retirement, see these posts:

• My Best Financial Advice: Spend Less than You Earn

• Free Money Finance Guide to Making More Money

• Free Money Finance Guide to Getting Rich

3. I'm hoping to be able to earn extra money in retirement using technology. Anyone think I'll still be writing Free Money Finance at that time? ;-)

The Four-Legged Retirement Stool

Here's an interesting article that says what used to be the three-legged stool of retirement (Social Security, pensions and personal savings) is now a four-legged stool of retirement (Social Security, employer retirement plans, home equity and work.) We'll start with their thoughts on Social Security:

With all of the hand-wringing over Social Security, one simple fact appears to go unrecognized. Even with absolutely no reform of the system--an outcome most believe to be implausible--Social Security is likely to pay 70% to 80% of promised benefits in perpetuity (depending on whose estimate you believe).

The notion that Social Security is disappearing as part of the American retirement landscape is simple nonsense. It makes good headlines--as when journalists reportedly cited studies of 25-year-olds who "don't believe Social Security will be there for them." But when did the opinions of 25-year-olds on retirement policy become a meaningful barometer of the future?

I'm not 25, but I am certainly one of those who's counting on nothing from Social Security. If I get something, great, that will be icing on the cake. However, I'm not putting my retirement at risk by relying on a program that may or may not exist, which may or may not change its requirements, and which pays out a pittance anyway.

And speaking of pittance, here's their next thought on what will happen to Social Security:

Although the debate on Social Security's destiny has been fractious, it seems clear where the political solution lies. On the benefits side, some type of progressive price-indexing will be introduced--which means that high-income households will see a meaningful reduction in their scheduled benefits, middle-income households may see a smaller reduction and low-income households will be unaffected. Private accounts may also be part of the solution; my guess is they'll be on an optional basis-in exchange for some tax increase needed to finance the system.

Great. Just great. All I read in this is that my benefits will be cut and I'll be paying more in taxes to the system. Just absolutely, wonderfully marvelous.

Have I mentioned lately how much I hate this program? It's a real head-banger -- paying tons of money year after year into a system that will eventually give me less and less of a return.

But I'm trying not to turn this into a rant -- let's move on. ;-)

Next they talk about "leg two," employer retirement plans (defined contribution plans -- 401k, etc.) The piece says that people are behind in saving in their 401ks and the like, but that they expect this trend to reverse as more people are covered by defined contribution plans. Their thoughts:

Most forecasts show that current workers will spend much more of their careers in account-based retirement programs, accumulating more sizable asset pools by the time they reach retirement. That's even after adjusting for all of the inevitable frictions, such as job changes and spending sprees.

Personally, this is the leg of the stool I'm banking on the most (in addition to saving in taxable accounts.) I'm counting on two things -- my own savings and investing -- to help me reach my retirement number.

Next they come to the two new legs of the stool -- home equity and work. I'm skeptical of both of these, but we'll address that as they come up. Here's what the piece has to say about home equity and how reverse mortgages can/should be used to help fund retirement:

Home equity is the largest untapped resource at the boomers' disposal. Most individuals don't access their home equity during retirement today. Some appear to free up equity by downsizing early in retirement. Others use home equity later in life--especially when they or their spouses enter nursing homes. Yet 80% of older Americans own their homes, and for the median U.S. household, 20% of its total wealth is in home equity.

Currently, the reverse mortgage market is stymied by concerns about misselling, high costs and complexity. But with additional standardization at the federal level and some private sector ingenuity, using home equity as a source of income will be a useful supplement for many boomers short of income during their retirement years.

I am not a big fan of reverse mortgages and I view them as a last resort. That said, I do like the downsizing option and I think we'll probably consider that as a way to free up equity when our kids are grown and out of the house.

Next is the last leg of the stool -- work. First, they note that many people are working longer:

More than 40% of 65- to 69-year-olds are still generating earnings from work, and it's the same for about a quarter of individuals in their early 70s, according to the Social Security Administration's 2002 Income of the Aged Chartbook. The transition from the world of work to that of retirement is increasingly gradual. For many, retirement isn't a period of permanent leisure, but a period of leisure accented by work.

In addition, they show that working longer is a big help in paying for retirement -- a concept I agree with:

Working for several more years is one way to close a retirement savings gap. Delaying retirement for such a time dramatically reduces financial risks in retirement. A longer period of work means better Social Security payouts, more savings, additional investment returns and--for the few covered by pensions--potentially greater benefits. It also means fewer years of retirement spending. (And if your employer picks up health insurance costs, that's even better!) Indeed, one of the most basic financial dangers people face at retirement is the risk of retiring too early.

Yet they recognize that not everyone who wants to work will be able to do so:

Of course, not everyone will be able to continue to work--especially those with debilitating health problems. But broadly speaking, older Americans are much healthier than they've been in the past. They're also better educated. As a result, many are more capable than their parents of remaining in the workforce for long periods of time.

I think they're right and they're wrong. They're right in saying that more people will be able to work longer (and will choose to do so.) They're wrong in that for many (maybe even most), working longer isn't practical or realistic.

Overall, here are my thoughts on the four-legged stool of retirement savings for my family:

• Social Security -- We won't count on a penny from it. If we do get it, that will be a nice addition to our already-saved-for retirement.

• Employer plans -- I'm socking away the maximum in my 401k, contribute to a SEP IRA each year, and even make non-deductible IRA contributions. (Unfortunately, I'm excluded from investing in a Roth IRA.) I also save in taxable accounts.

• Home equity -- We won't likely use a reverse mortgage, but will seriously consider downsizing our home.

• Work -- I'd love to be able to work for a non-profit for free -- for no salary at all. That's the goal I'm shooting for.

For more thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

Five 401k Mistakes to Avoid

Here are five 401k mistakes to avoid as listed by Money magazine:

• Mistake 1: Not participating in your 401(k)
• Mistake 2: Not contributing enough
• Mistake 3: Not investing for growth
• Mistake 4: Borrowing from your 401(k)
• Mistake 5: Cashing out your 401(k)

Here are my thoughts on each of these:

1. Why would someone not participate in a 401k? At a minimum, you should contribute enough to get the full company match.

2. Again, contributing enough to get the full company match is retirement step #1. It's a no-brainer.

3. As long as you have a long-term time horizon of 10 years or so (which most 401k savers will have), you should be invested primarily in stocks to maximize the growth of your funds. Personally, I prefer index funds.

4. Borrowing from a 401k is the #1 mistake on the list of the 12 biggest money mistakes.

5. Cashing out your 401k is a very, very bad idea.

For more on making the most of your retirement, see Best of Free Money Finance: Retirement Posts.

How Much do You Need to Save the Month for Retirement?

Here's a piece courtesy of Marotta Asset Management that challenges us to know how much we need to be saving for retirement each month:

There are only a few critical financial planning questions you need to be able to answer. Probably the most important is, "How much money do I need to save this month to meet my goals?" Many people don't know the answer to this question and avoid it to the detriment of their long-term financial well-being.

Most Americans spend more time planning their vacation than their retirement. At least with a vacation, most of us pick a date and actually plan to go. Planning for retirement should be every bit as planned and anticipated as your vacation. Assuming you'll work in your seventies and eighties is not a retirement plan. Neither is dying young.

Without an adequate retirement plan, you will outlive your money. If your financial investments are not sufficient to keep pace with inflation, you will eventually lose your lifestyle and your independence.

Imagine you are driving 120 miles from Charlottesville to Williamsburg. For the first 60 miles of the trip you average 30 miles an hour. How fast do you have to drive the second half of the trip in order to average 60 miles an hour for the entire trip? If you quickly answered 90 miles an hour, you got the wrong answer.

You really can't know if you are on track to retire without some complex mathematical projections. It is a difficult projection to eyeball and get right.

If a couple is approaching retirement with only $250,000 saved and a lifestyle of $50,000 per year, it's not hard to tell they are headed for financial hardship. They only have enough savings to last for about five years. Their problem is worse if all of their savings are in tax-deferred retirement plans such as an IRA or a 401(k). That couple's entire savings will be taxed at ordinary income tax rates when it is taken out, and therefore, it will be used at a faster rate.

Similarly, if that same couple living off $50,000 per year has a $1 million portfolio they probably have enough funds to retire. If you think a $1 million dollar portfolio is overkill, you haven't really run the numbers and factored in the erosion of buying power that comes with 50 years of inflation (Thank you, Federal Reserve.).

When my grandmother was first starting a family, five dollars would feed her entire household for a week. She died a couple of years ago at age 99 1/2. If you had told her she would need hundreds of thousands of dollars to have a comfortable retirement, she would have thought you were crazy. Many Baby Boomers are approaching retirement in a similar state of denial.

Going back to our example, the couple with a $1million dollar portfolio probably has only twenty years of spending at $50,000. If their investments don't earn a significant amount over inflation they could retire at 65 years old and be broke at 85. This lack of retirement planning is more likely to hurt the wife's lifestyle and independence since she is more likely to outlive the family's assets.

While young clients need to be able to answer the question "How much money do I need to save this month?" retired families must be able to answer the question, "How much money can I spend this month and still be financially secure for the rest of my life?"

If a family spends too much of their portfolio too early in retirement, they will not be able to recover. On the other hand, living on a shoe-string budget during retirement in fear of running out of money isn't much better. In order to find the right spending balance you need to do regular retirement projections during retirement.

Just as excessive spending early in retirement can jeopardize your retirement, so also failure to save enough early in your career can jeopardize retiring on time.

In our driving example above, driving 30 miles per hour for the first half of the trip makes it impossible to average 60 miles per hour, no matter how fast you drive the last half of the trip. Driving 30 miles per hour means that the first half of the trip takes two hours - the amount of time that the entire trip would have to be completed in order to average 60 miles an hour. You would need to drive 90 miles an hour for 180 miles - three times as far - in order to average 60 miles per hour for the entire trip. Put another way, a family who fails to start their savings quickly enough will also need to save longer to reach their retirement goals as well.

Find out today how much you should be saving and investing this month!

The Best Foreign Country for Retirees

Here's the next item I wanted to cover from Kiplinger's "The Best List". Today, we're highlighting the best foreign country for retirees:

The Best Foreign Country for Retirees: Mexico

A warm climate and a lower cost of living plus access to quality medical care make Mexico a favorite retirement destination. The Lake Chapala area, about 25 miles south of Guadalajara, is home to a large community of U.S. and Canadian retirees. You can't count on Medicare south of the border, but there's no shortage of well-trained doctors and modern health-care facilities. And you can still receive Social Security benefits when you live outside the U.S.

I've actually written on this topic quite a bit. For the masses out there who aren't saving enough for retirement but still want a great (or at least decent) standard-of-living when they retire, moving to a foreign country is a great option. For more details, see these posts:

• Best Financial Tips from FMF Readers, Part 7: Retire Overseas

• Comments: Best Financial Tips from FMF Readers, Part 7: Retire Overseas

• Comments: Best Financial Tips from FMF Readers, Part 7: Retire Overseas, Part 2

• Save Money: Retire in Panama

• Retire in Style South of the Border

• The World’s Best-Kept Retirement and Investment Secret

For more thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

New Survey: Many Americans Still Plan to Rely on Social Security for Retirement Income, Gap between Retirement Targets and Source of Income Continues

Here's a press release I was sent the other day regarding a new survey on Social Security:

CINCINNATI, OH, November 7, 2006 – Despite the common knowledge that social security and company provided pensions may not be available for Americans when they approach retirement, many still plan to rely on them as significant sources of income when they retire.  According to a new survey by the Retirement Corporation of America, nearly one in four Americans indicate they will look to social security (23 percent) for their primary source of income during their retirement years. 

The survey also highlights a distinct gap between what Americans think they need to have saved by the time they retire and where they expect to derive their income during their retirement years.  While nearly six in ten (59 percent) believe that they are likely to reach their savings goal, only three in ten (31%) believe that their savings, mutual funds or IRAs will be the primary source of their income. Sixty-one percent of non-retired Americans believe that they will need to have saved $500,000 or more when they retire.

"It is not surprising that many Americans believe they will have enough money to retire," said Daniel Kiley, chairman and chief compliance officer of the Retirement Corporation of America.  "Increased life expectancy has driven many to work for a longer period of time, offering a greater chance of achieving financial retirement targets.  However, as traditional sources of retirement income such as company pensions and Social Security dwindle by each passing day, more Americans will have to take charge of their finances and begin planning and investing to generate alternate streams of income.”

Survey respondents were split in their views about retirement age. While one in four Americans does not plan to retire at all, another quarter plan to retire between the age of 51-60 and 36 percent plan to retire between 61 and 69. 

Further, most Americans indicate that they are actively planning for retirement, as 70 percent indicate that they are regularly saving or investing some of their income and 38 percent say the amount they are saving or investing will be enough for their retirement. 

About the Survey -- The survey is based on a national phone poll of 1,000 non-retired Americans conducted September 29-October 1, 2006 and was compiled by Rasmussen Reports, LLC, an independent research firm. The margin of sampling error for a survey based on this number of interviews is approximately +/-3 percent with a 95 percent level of confidence.
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Is it just me or do people seem to be in denial about retirement savings?

How Much You Need to Save for Your Kids' College Expenses

Here's another item on Money magazine's list of 25 rules to grow rich by. Today's tip gives some thoughts on how much you need to save for your kids' college expenses:

Aim to accumulate enough money to pay for a third of your kids' college costs. You can borrow the rest or use some of your income to help out when your child is in college.

The advice acknowledges that parents are also trying to save for retirement at the same time and that retirement savings should be a priority over saving for college.

We've set both our retirement number and our college saving number and we're planning on doing a bit better than this. We hope to fund our retirement fully and also save half of the costs for our kids' college educations. Of course, it helps that we started saving for both of these many years ago and we're now seeing the power of compounding kick in to help us reach our goals.

For more thoughts on making the most of your retirement, see these posts:

• The Best Retirement Plan is Simple

• Key to Retirement: Planning Ahead

• How to Have a Successful Retirement Savings Plan

• Retirement Wisdom: Review Your Savings and Plans Annually

• Key to Retirement Saving: Start Early

• How to Double Your Retirement

The Best Place to Manage Your Retirement Income

Here's the next item I wanted to cover from Kiplinger's "The Best List". Today, we're highlighting the best place to manage your retirement income:

The Best Place to Manage Your Retirement Income: Fidelity

Whatever your age, start with Fidelity's Retirement Income Planner to estimate your retirement income and expenses and to plan your investment strategy. It's free to anyone by phone (800-343-3548) or in person, and it's available to Fidelity customers online. Once you are retired, open a Fidelity Income Management Account to handle your cash flow. You can consolidate your sources of income, get investment advice and create a regular "paycheck."

"Hello? Is this Kiplinger's? Yes, I'm from Fidelity and I'd like to place an ad for my retirement services, but I'd like to disguise it as a recommendation from you. Can you make this happen? Oh, yeah, and can you call us 'the best'?"

I'm not buying this one. I've had two retirement plans with Fidelity in my work career (I have one now -- my 401k) and I've also had several accounts with Vanguard. Without any reservations I can say that I prefer Vanguard because of their low costs and great customer service.

And no, Vanguard didn't pay me to do a commercial for them, though I wouldn't mind having them as an advertiser here. It would be one company I could recommend whole-heartedly.

For more thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

The Most Tax-Friendly State for Retirees

Here's the next item I wanted to cover from Kiplinger's "The Best List". Today, we're highlighting the most tax-friendly state for retirees:

The Most Tax-Friendly State for Retirees: Delaware

People tend to focus on states with no income tax, such as Florida, Texas and Nevada. But for many retirees the biggest burden is property taxes and sales tax. That's why Delaware is a first-class bargain. There's no state sales tax, property taxes are relatively low, and homeowners 65 and older qualify for a tax credit on half of their school taxes, up to $500. Delaware does have a maximum state income tax of 5.95%, but Social Security benefits are exempt, and so is up to $12,500 of investment and pension income for residents 60 and older.

Yeah, but you have to live in Delaware. ;-)

Ok, all of you readers who live in Delaware -- don't write me. I was only kidding.

If you want to see where your state compares, check out this map that lists tax burdens across the U.S. Some (warmer) places with low tax burdens: Tennessee, Alabama, and South Carolina.

For more thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

Some People Think a 100% Return on Your Investment Isn't Enough

Here's a comment left on my post titled The Best 401k Plan that I really, really like and thus wanted to share it with all of you:

The best 401k plan is simply one that you participate in!

It is a shame more people do not see the value in the wealth building tool that most employers provide them with. I help manage a 403(b) plan for a company and it is my job to get people enrolled, help them with their investment options, and hopefully secure a better retirement. Unfortunately, it is still difficult to have enrollment top 75%. We even offer a match like yours, dollar for dollar with a 3% max, and people will still turn down a 100% return, I don't know why.

Luckily I have one of the best jobs I could think of having, and I am in a position to hopefully convince people the importance of enrolling in their plan. I get to speak at all of the new employee orientations to talk about the plan and outline why it is so important.

My biggest roadblock right now is getting through to the younger people, who of course are the least likely to enroll. It doesn't matter how you explain it, or paint a picture of what retirement will be like without social security or a pension, a lot of people under 30 just refuse to have any concern.

Some employees I talk to about the match, even though it is free money, they still don't want to enroll. Yet, I'll ask them if their bank offered a savings account of 100%, would you put your money in that bank? They always say yes, but then I immediately say ok, sign up for the retirement plan and that can happen. They still won't sign up.

Oh well, hopefully with help from all the finance bloggers out there we can help encourage people to take advantage of a wonderful tool at their disposal.

It always amazes me why/how people turn down the free money associated with a 401k. There's simply no other investment that will return anywhere near what a company match to a 401k will return.

How Much You'll Need to Save for Retirement

Here's another item on Money magazine's list of 25 rules to grow rich by. Today's tip gives some thoughts on how much you'll need to save for retirement:

Aim to build a retirement nest egg that is 25 times the annual investment income you need.

So if you want $40,000 a year to supplement Social Security and a pension, you must save $1 million. This rule is based on the amount that you can safely withdraw from your nest egg in retirement.

This is one of the methods I used when I set my retirement number (I called it the 4% method since you can withdraw 4% out per year.) It's a good rule of thumb to use, though I preferred developing my own spreadsheet to estimate how much I needed for retirement. (Or even the guidelines detailed in How Much to Withdraw in Retirement.)

Want to see how you're doing? One way to see if you're on the right path to saving enough for retirement is to determine your R-score.

For more thoughts on making the most of your retirement, see these posts:

• The Best Retirement Plan is Simple

• Key to Retirement: Planning Ahead

• How to Have a Successful Retirement Savings Plan

• Retirement Wisdom: Review Your Savings and Plans Annually

• Key to Retirement Saving: Start Early

• How to Double Your Retirement

The Best Place for IRA Rollovers

Here's the next item I wanted to cover from Kiplinger's "The Best List". Today, we're highlighting the best place for IRA rollovers:

The Best Place for IRA Rollovers: T. Rowe Price

Whether you have decades to go before retirement or just a few years, T. Rowe Price's Advisory Planning Services will provide personalized financial advice if you roll over money from a 401(k) or from another IRA. The new service charges a one-time fee of $250, which includes annual reviews. The fee is reimbursed if you roll over at least $100,000.

I'm going to have to disagree with them on this one. First of all, many readers of this blog won't need (and won't want to pay for) the Advisory Planning Services that seem to be the key to their recommendation here. It sounds as if T. Rowe Price paid Kiplinger's for this mini-commercial. Strange. Second, I prefer Vanguard because of their low costs and great customer service. I've rolled over a few IRAs with them and they are great to work with.

And no, Vanguard didn't pay me to do a commercial for them. ;-)

For more thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

The Best Low-Cost IRA

Here's the next item I wanted to cover from Kiplinger's "The Best List". Today, we're highlighting the best low-cost IRA:

The Best Low-Cost IRA: Scottrade

With one of the lowest minimum investments around -- $500 -- and no set-up fees or annual maintenance fee, Scottrade is a great place to open an IRA for yourself or a custodial IRA for your child. As long as children have earned income -- from flipping hamburgers, mowing lawns or babysitting -- they can contribute up to $4,000 a year or up to their total earnings, whichever is less.

A few thoughts on this:

1. I've never used Scottrade, but I've heard good things about them.

2. I prefer Vanguard, but I believe their minimums are a bit higher, so that's probably why Kiplinger's goes with Scottrade.

3. It's a great idea to set up an IRA for your child as early as possible -- doing so could make them wealthy when they retire.

For more thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

Where to Put Your Retirement Savings

Here's another item on Money magazine's list of 25 rules to grow rich by. This time we'll be sharing their thoughts on where to put your retirement savings:

All else being equal, the best place to invest is a 401(k). Once you've earned the full company match, max out a Roth IRA. Still have money to invest? Put more in your 401(k) or a traditional IRA.

Good, basic advice, and I agree with it 100%. And I use it myself.

I end up maxing out my 401k and still contribute to a non-deductible IRA as well. I'm trying to get as much money away from taxes as possible. I figure that 25 or so years of not paying taxes on the gains is something that's worth an awful lot. ;-)

For more thoughts on saving for retirement, see Best of Free Money Finance: Retirement Posts.

The Best All-Around Retirement Account

Here's the next item I wanted to cover from Kiplinger's "The Best List". Today, we're highlighting the best all-around retirement account:

The Best All-Around Retirement Account: Roth IRA

A Roth IRA lets you stockpile tax-free savings for retirement with plenty of escape hatches for other financial goals, such as paying for college or buying a first home. You can contribute up to $4,000 in 2006 ($5,000 if you're 50 or older) as long as your income doesn't exceed $110,000 if you're single or $160,000 if you're married. And you can withdraw your contributions (but not your earnings) tax- and penalty-free at any time.

Ok, I'm going to get a lot of flack for this, but I wouldn't rate the Roth as #1 for people who have access to a 401k, especially for those who have a 401k where the employer matches part of the employee's contribution. The 401k gives you a tax deduction this year (in that it lowers your taxable earnings), gives you an instant, strong return on your investment (when the employer matches), allows you to save much more than the Roth IRA, and isn't subject to the income limits that the Roth IRA is. Yes, the Roth allows for tax-free withdrawals, but I don't think that outweighs the 401k's benefits. As such, I'd rate the 401k the best all-around retirement account.

That said, my recommended strategy for people who have a 401k and can contribute to a Roth IRA is as follows:

1. Contribute to the 401k to get the full employer match.

2. Contribute to the Roth IRA as much as you have left over -- to the limit, if possible.

3. Contribute any remaining retirement savings funds to the 401k (without the employer match at this point.)

For more thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

Should You Contribute to a Non-Deductible IRA?

Usually, I don't answer reader questions. First of all, I'm not a qualified financial advisor and many of the questions are complicated and beyond my knowledge. Second, I simply don't have the time to answer them all. Otherwise, that's all I'd do. Third, these people could get the answer themselves if they'd just care enough to do 30 seconds of work -- ever hear of a site called Google? It can help you find the answer to almost anything.

That said, here's a question I recently received from a reader that I felt was worthy of a post (since it impacts me personally and will be of interest to many of you):

I've heard some financial "gurus" say it is not smart to invest in an IRA if you can't deduct it from you taxes. Example, you have no earned income, or you are enrolled in a plan at work.

My question is why not? Even if I can't deduct the contribution, it still grows tax deferred.

First of all, you have to have earned income to contribute to even a non-deductible IRA. Second, I have my own thoughts on the issue (of course), but before I get to those, here are a few from various sources around the web. First, we'll start with Money magazine, who says that a non-deductible IRA is a good option for people who have exhausted all other (preferred) retirement savings options:

If you're right and you can't contribute to a Roth, you and your wife might want to consider investing in a nondeductible IRA. Why? Well, in May Congress passed a law that starting in 2010 eliminates the restriction barring anyone who makes more than $100,000 from converting a traditional IRA to a Roth. The law provides a back-door way to start putting away money today that can eventually go into a Roth. What you and your wife can do is starting this year invest annually in a nondeductible IRA, which anyone with earned income can do. Come 2010, you can then convert whatever money you've accumulated in your nondeductible IRA to a Roth. And you can continue to contribute to a nondeductible IRA and convert it year after year, in effect skirting the income limitations for doing a Roth.

Good thought. Here's another, related thought on the non-deductible IRA:

If you don’t qualify to make a deductible IRA contribution or a Roth contribution, your only other option is to make a non deductible contribution to a Traditional IRA.  The reason this can make sense is that your investment will grow tax deferred which should help you grow your savings.  In addition, funds in an IRA receive some protection from creditors.  The problem with a non deductible IRA contribution is the complexity of tracking the post tax portion of your IRA.  The problem gets more difficult when you withdraw from your IRA and will likely continue until after you die.

When you make a non deductible contribution to a Traditional IRA, you need to keep track of your non deductible contributions year after year so you don’t end up paying taxes again when you withdraw.  When you make a withdrawal from your Traditional IRA, you need to determine the percentage of your IRA that makes up your original, non deducted contributions.  That percentage of your withdrawal is not taxed because you already paid taxes on that money before you made the contribution.  Now you need to reduce your original non deductible contribution by the amount of un-taxed funds you just withdrew.  The total reduced amount of non deducted contributions is used to make the same calculation when you make your next withdrawal in a future year.  The calculation must include Traditional IRA funds from all of your IRA accounts- including 401(k) rollovers.

So it gets a bit complicated, but you can work through that issue if you're prepared for it in advance and you keep good records. Here's a bit more clarity on the non-deductible IRA issue:

If you cannot deduct your contribution yet make one anyway, you must file IRS Form 8606, Nondeductible IRAs (Contributions, Distributions, and Basis), every year you add to or make a withdrawal from an IRA. This form tells the IRS that you already paid taxes on a portion of the money that you had contributed to the IRA.

What happens if you don’t file the form, or if you file but fail to keep a record of it for the rest of your life? There is a $50 penalty for failing to file, and if you don’t keep your records in order, you’ll have to pay taxes when you withdraw the money — even though you already paid taxes when you contributed to the IRA years earlier. Indeed, you’ll pay taxes twice on the same money!

Personally, I contribute the maximum to a non-deductible IRA. I'm looking to get as much income as possible earning as much as possible and out of the tax man's hands -- and it offers this option to me. However, I'm not sure my record keeping is up to snuff. I just emailed my accountant to make sure we're ok -- she'll get it all sorted out for me (just another reason I use a CPA to do my taxes.)

The Best 401k Plan

Here's the next item I wanted to cover from Kiplinger's "The Best List". Today, we're highlighting the best 401k plan:

The Best 401k Plan: It could be yours.

There's a good chance your plan will get better as a result of a new law that allows plan providers to give one-on-one investment advice. Or you may be able to participate in a managed 401(k) account, in which financial professionals make investment decisions for you for a flat fee. More 401(k) plans are expected to adopt target-date retirement funds -- which invest in a mix of mutual funds that grow more conservative as you near retirement -- as their default investment.

I am a huge fan of 401k's -- especially when the employer matches a portion of your contribution. There's nothing better than FREE MONEY, huh?

My employer matches the first 3% of my contribution dollar-for-dollar. That's a 100% return on 3% of my salary even before the money gets invested into a mutual fund (where it will earn even more.) I don't know about you, but anything that gives me a 100% return is a good thing!

I think 401k's should be used in conjunction with Roth IRAs to maximize your retirement savings. To see my thoughts on this issue as well as a whole host of information on retirement, review Best of Free Money Finance: Retirement Posts.

Roth IRAs Make Great Estate Planning Tools

Here's a piece courtesy of Marotta Asset Management on how Roth IRAs make great estate planning tools:

If the tax-free growth of a Roth IRA wasn’t enough to wet your appetite, the estate planning benefits it offers should seal the deal. Bequeathing a Roth is much the same as setting up a life-time tax-free stream of income for your heirs. Because Uncle Sam has already taken his cut of the principal when you put the money in, withdrawals from a Roth can be made tax-free, either by you or by your beneficiaries. All this happens simply by naming the appropriate beneficiaries for your Roth.

A Roth will protect your investments from its worst enemies: taxes and required distributions. Unlike their traditional counterparts, Roth’s don’t require you to begin withdrawals from the account once you reach the magic age of 70½. With time on your side and your investments sheltered from taxes, your Roth will begin to experience what Einstein called the "greatest discovery of all time" - compounding interest.

The traditional IRA is an unwieldy estate planning tool in more ways than one. Account owners must begin distributions from their account at age 70½, whether they need the cash or not. What’s more, investments in a traditional IRA grow tax-deferred, not tax-free. Uncle Sam won’t let you defer those taxes indefinitely.

By taking the required minimum distributions out of your traditional IRA each year, you put the brakes on the snowball effect of compounding interest. Plus, your required withdrawals deplete the account, making it difficult to control what you actually leave to your beneficiaries.

However, it won’t make much difference whether you leave your heirs a traditional or a Roth if they plan on draining the funds right up front. A Roth can offer a goldmine, but only if the owner keeps the funds in their tax-free environment over the long haul.

A Roth can help you keep more of your money by sheltering your investments from capital gains and from minimum distribution requirements — at least for a while. Spouses who inherit a Roth can also forgo taking distributions, preserving the account’s ability to grow unchecked year after year.

All of that changes once the Roth is passed on to the next generation. All other beneficiaries of a Roth must begin taking distributions after inheriting the funds. It is best to drawn down an inherited Roth as slowly as possible over the beneficiary’s expected lifetime. The required distribution amounts are based on the beneficiary’s age: the younger the heir, the smaller the required distribution. Taking the smallest distribution each year will ensure the beneficiary achieves the maximum tax-free growth of tax-free income.

Let’s look at an example. Dad opens a Roth at age 60. He takes no withdrawals in his lifetime, and the funds grow tax-free. His wife inherits the Roth after her husband’s death at age 75. She wisely passes up on the opportunity to take withdrawals from the account. Ten years later she passes away and the Roth is inherited by her son, Dwayne. Thus far, the Roth has enjoyed 25 years of growth, without being depleted by withdrawals or taxes. Dwayne, age 55, must begin minimum distributions and does so for 30 years. Thirty years later, the funds are fully depleted; however, over its lifetime the Roth has provided 55 years of tax-free earnings and withdrawals. The benefits are even greater if the account is left to grandchildren!

No traditional IRA can offer that kind of benefit to your heirs. If they were to inherit a traditional IRA of equal value to a Roth, the IRA of the traditional variety would run dry long before the Roth. Because taxes are due on withdrawals from a traditional IRA, larger amounts must be taken out to match the tax-free sums taken from the Roth. Those hefty withdrawals from the traditional IRA eventually drive it to zero. Meanwhile the Roth account would still be growing and withdrawals could still be made.

So, what can you do if your funds are sitting in a traditional IRA? If you already own a regular IRA, you may have the option to convert it to a Roth. With a Roth conversion, you pay taxes now so that your beneficiaries won’t pay later. Even if you inherited a traditional IRA from your spouse, it is still not too late to convert to a Roth.

Converting to a Roth and paying Uncle Sam now may be a good thing, especially if you plan on leaving more than $2 million to your heirs. Paying taxes for the conversion will mean you reduce the size of your estate, and therefore your estate’s tax liability. Your heirs will pay less estate tax, and they will inherit a tax-free income stream.

Currently, the option to convert to a Roth is only open to those with a modified AGI less than $100,000. But not to worry if your AGI exceeds that number. Thanks to the recent changes in our tax code, Roth conversions will be open to all Americans beginning in 2010.

Even if you are currently taking distributions from a traditional IRA, you can still do a conversion. However, the amount you withdraw for the conversion, also known as your conversion contribution, won’t count toward this year’s required minimum distribution from your IRA. The rules and options are complex, so seeking professional tax advice before doing a Roth conversion is important.

A Roth IRA can provide your heirs with a life-time stream of tax-free income. But, a Roth in itself cannot provide a complete answer to your estate planning needs. Please seek the advice of a financial planning professional who can provide you with a comprehensive financial plan.

Reverse Mortgages Are A Last Resort

Here's a piece courtesy of Marotta Asset Management that says reverse mortgages are a last financial resort:

Before reverse mortgages, pensioners wishing to tap into home equity were presented with two options: either sell the house or get a home equity loan. But since their humble beginnings in the late ‘80s, reverse mortgages provided seniors with an additional tool for accessing home equity. The going offer: get cash now, make no monthly payments, and keep your home sweet home. For retirees struggling to make ends meet, a reverse mortgage can provide a much-needed way forward.

A reverse mortgage should be considered only as a last resort. With early retirement planning, such 'last resort' options can be easily avoided. Still, reverse mortgages are a far cry from the blinking neon signs offering fast cash in exchange for a car title. At least with a reverse mortgage the borrower gets to keep the title and avoid the ugly monthly payments.

To understand the way a reverse mortgage works, let’s look at its opposite: the traditional home mortgage. Both are mortgages. But with a standard home loan—also known as a forward mortgage—over time the homeowner’s equity rises and the debt falls. A reverse mortgage does just the opposite. With a reverse mortgage, the debt rises and the homeowner’s equity falls.

Unlike a home equity loan or a home equity line of credit which immediately begin monthly collections on the loan, no payment is due on a reverse mortgage until the borrower sells or moves. Borrowers are given a guarantee of lifetime occupancy of the home. But, once the borrower no longer resides at home, the loan must be repaid. Typically, repayment is made from the proceeds from the sale of the home. The good news here is a reverse mortgage will not hold the borrower personally liable nor can they owe more than the market value of the home.

Minimum qualifications require borrowers to be age 62 or over and must either own their home free and clear or have little remaining debt against the house. But, meeting the initial requirements won’t mean the loan is a done deal. Borrowers should be prepared for an extensive interview and educational component before they can sign on the doted line.

Reverse mortgages are becoming ever more popular, in part, due to the customizable distribution options. Seniors may choose to receive one lump sum or monthly advances—either for a limited time or spread out over the course of their lifetime—for as long as they reside in the home. Others may choose to open a line of credit or pick a combination of payment options to suit their cash flow needs.

But, the convenience offered by a reverse mortgage comes with a price tag. Although loan fees can be financed as part of the loan, origination fees can easily cost borrowers in the neighborhood of $12,000- $18,000. Add to that the principal loan amount, interest, and maintenance fees, and the total cost will likely account for a sizeable portion of the home’s total value, if not all of it.

In addition to the costs of maintaining the home, borrowers are also expected to continue home owner’s insurance and property tax payment in addition to paying for routine maintenance on the home.

Currently, reverse mortgages come in three flavors: single-purpose, proprietary, and federally-insured loans. Single-purpose reverse mortgages are very low-cost. But, unlike the other two, they can only be used for one purpose, such as paying property taxes or making house repairs. Proprietary loans are offered through private banks. Although they are more expensive, they lend larger sums. Of the three loans types, the most common is the federally insured Home Equity Conversion Mortgage (HECM).

The actual amount a homeowner can hope to borrow using a reverse mortgage will be significantly less than the market value of the home itself. Although a HECM offers lower interest rates than private lenders, borrowers are subject to regional 203b loan caps ranging from $200,160 to $362,790. Ultimately, the total loan amount will be determined by the value of the home or the regional loan cap (whichever is less), the borrower’s age and the going interest rate.

So how do you know if a reverse mortgage is right for you? AARP advises prospective borrowers to consider three questions: 'How much would I get?' 'How much would I pay?' and 'How much would be left at the end of the loan?'

Although the lender almost always wins, a reverse mortgage does offer a Band-Aid solution to pending cash flow problems. Some seniors take the loan to eliminate remaining forward mortgage payments still owed on their home. The majority, though, choose a reverse mortgage to pay medical bills. In either case, a reverse mortgage allows the homeowner to live at home while shoring up immediate, and even long-term, cash flow shortfalls.

There are some cases in which you should never take a reverse mortgage. Avoid a reverse mortgage if you are close to the minimum age requirement. Assuming a reverse mortgage early on will provide you little income and will ensure you will have no equity left in your home at the end of the road. If you currently have little equity in your home, a reverse mortgage is also not worth the cost of the loan origination fees. The fees alone will likely eat up what little equity you have. Finally, avoid a reverse mortgage if you expect to move in the near future. The hefty costs of getting the reverse loan will be wasted and the loan will come due as soon as you move out of the home.

Before going forward with your reverse mortgage, consider your options carefully. There are many creative ways of managing cash flow needs without taking a loan against the value of your home.

As always, begin by looking at your budget and cutting unnecessary expenses. Generating additional income may be as simple as renting out a portion of your home. Or, you may consider moving to an area with a lower cost of living. Sell high and buy low. Then, invest the profit from the sale of your home. By doing so, you may be able to create a permanent cash stream without taking on any debt at all!

Finally, investigate community assistance programs. You may find that you qualify for additional social security benefits or for property tax relief.

More information about reverse mortgages can be found by visiting the AARP website at www.aarp.org. Of course, the best way to avoid a reverse mortgage is by planning early for retirement.
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Two points worthy of mentioning again:

1. "A reverse mortgage should be considered only as a last resort."

2. "The best way to avoid a reverse mortgage is by planning early for retirement." For assistance in this area, see Best of Free Money Finance: Retirement Posts.

Good Tips to Make the Most of Your Retirement Savings

Looking for some tips for making the most of your retirement? Here are several good, basic, money tips that will help you be as prepared as possible for retirement. They are provided courtesy of Nationwide's RetirAbility Check tool. Their thoughts:

Tips for building a strong 401(k):

• REVIEW – Don’t forget about your account. Mark your calendar to review your fund choices at least once a year.
• GET IT - Don’t let FREE money get away. If your employer offers a match, ask how to get the maximum.
• DO MORE –Increase your contribution. It’s tax deferred so it may be cheaper than you think.
• BUILD – Increase your contributions over time. If you do it when you get a raise, you might not even miss the money.
• CATCH UP – Consider making catch-up contributions if you’re eligible.

Tips if your company doesn’t have a 401(k) plan:

• START – Don’t delay. Build your own retirement plan by looking into other options, such as traditional or Roth IRAs.
• BUILD – Are you self employed? Check into tax-advantaged investment options, such as KEOGHs and individual 401(k)s.
• BADGER – Your future is on the line. Ask your company to offer a plan and keep after them until they do.

Tips for every consumer:

• SHRINK – Cut the plastic habit. If you carry credit card balances, you may be shocked at the REAL cost of that lunch you charged last week.
• PAY #1 – That’s right! Pay yourself first. Don’t wait until you have extra money to put into savings. There’s no such thing as extra money.
• DO IT – Don’t leave your financial future to Uncle Sam – or chance. Take charge and prepare for your own needs through a 401(k) or IRA.

As I said, these are pretty basic tips, but let's face it, that's where most people are when it comes to saving for retirement -- just trying to get the basics right.

For more thoughts on making the most of your retirement, see Best of Free Money Finance: Retirement Posts.

Are You Ready to Retire? Find Your Retirement Score to See (And Have a Chance to Win $50,000); Or Win a Book from Me

In case you haven't noticed, there's a new advertiser here at Free Money Finance. It's Nationwide, the insurance company that's "on your side." (I still remember that jingle from when I was a kid.) You'll see their ad in the upper right side of this blog for awhile.

In addition to placing the ad, they asked me to review their new retirement score (or R-Score as they call it) tool. It's a Flash-based program where you input items like how much you have saved for retirement, how much you earn, etc. -- all the standard retirement calculator measures -- then it spits out your R-Score, tells you how you're doing, and makes suggestions for improvement. Since I just set my retirement number and the issue of retirement is on my mind, I was glad to take it for a spin.

Overall, I liked the tool, though there are definitely some improvements that could be made. Here are my thoughts:

1. It's not a tool that will give you a retirement number (like "you need to save $2.3 million") but rather a score that tells you how you're doing versus what you'll need to live on at retirement at your current income level. (If you score 100 or higher, you're on track. If you score below 100, you need to catch up.) I liked the fact that it wasn't just a "regular" retirement calculator -- I've already seen enough of those. But this tool was unique in that it gave me an additional point-of-view on how I was doing at saving for retirement.

2. In addition to this, the tool gives handy tips and facts along the way -- as you fill out the information. There's not a lot new here for seasoned personal finance students, but since I'm a tip/fact sort of guy, I liked it.

3. Much of the Flash-based narration by the "host" is more for show than anything else, and I turned it off (BTW, it can be loud, so be careful if you're listening to it at work.) Besides, being a 40-something guy, I got the 40-something host instead of the cute 20-something co-ed (which I'm sure Jim got.) Maybe I would have kept the volume on if she was talking to me. ;-)

4. The process took ten minutes to complete (which was fine) and despite the fact that it said you didn't need your financial information available, you really do to complete it exactly. That said, you can always estimate and get a really good approximation of your score. I took it one day from memory and the next with my actual data and I was within 5% of the same answer each time.

After I completed the tool, here's what it gave me:

The ideal score is 100 or higher. You scored 200+. This means you are on track to have 200+% of what you need to maintain your current standard of living if you retire at age 65.

In addition, I was listed as a "high achiever." People "like me" scored 169 while the "national average" is 116.

I felt good about the score (as you can imagine), especially since I assumed no Social Security payments as part of my retirement. It basically told me I need to keep doing what I'm doing and, as such, was nice feedback to have.

I suggest you do the same and see what it tells you. Go get your R-Score, then come back here and leave your comments. What did you think of it? What was good? What was bad? What score did you get? How do you feel about the score? Those of you who fill out the form then come back here and leave a comment will be eligible to win my review copy (a few notes in it, but it's almost "like new") of The Money Coach's Guide to Your First Million (you can find my review of the book here) . I'll pick a winner out randomly and the same rules apply as my normal giveaways -- I'm the final judge, US addresses only, yada, yada, yada.

Also as part of Nationwide's R-Score section, they're having a sweepstakes to win $50,000. Don't bother signing up for it -- I already did and I KNOW I'm going to win! ;-)

Should You Start Collecting Social Security at 62 — or Wait?

Here's one of those "it depends" questions -- as many are when it comes to personal finances. The question is "which is better -- taking Social Security benefits at 62 or waiting until later in life?" At issue is the fact that if they're taken at 62, they're lower than they would be later on.

There are lots of factors to consider, here are the main thoughts from MSNBC:

In the end, since you don’t know how long you’ll live, your decision will likely have less to do with maximizing your total payout and more with your personal retirement plan. Collecting early means locking in a lower payment for the rest of your life – and for your spouse if they survive you.

So some people may prefer the security of collecting a bigger check. On the other hand, if you need the money at 62, you may be better off collecting early and letting your tax-deferred savings and investment continue to accumulate returns.

Personally, I think it will be a miracle if Social Security is around in any form close to today when I get to be 62. It's more likely that my choice will be whether or not to take it "early" at 72 -- not 62. That's why I set my retirement number assuming I'd get nothing from Social Security.

For more thoughts on this topic, see The Best Age to Start Social Security, Don't Take Early Social Security Retirement If You Don't Have To and The Five Costliest Mistakes Retirees Make about Social Security.

And if you'd like more information on retirement in general, visit Best of Free Money Finance: Retirement Posts.

How Much to Withdraw in Retirement

Here's a piece courtesy of Marotta Asset Management that gives some thoughts on how much of your retirement savings you can withdraw in retirement. It starts with a question from a reader:

Dear Marotta Asset Management,

My wife and I are hoping to retire soon. What percentage of our investments can we withdraw each year? And, do you recommend a high-yield investment portfolio to create the necessary cash flow during retirement?

--Ready to Retire

Dear Ready to Retire,

Studies suggest that for people retiring between the ages of 62-65, withdrawal rates of 4% of their assets are safe, but 5% significantly increase the likelihood of running out of money during your lifetime. Unfortunately, those studies are not very helpful for real financial planning questions.

Not everyone is between 62 and 65. Nor do everyone’s withdrawal choices move in neat intervals between four and five percent. Real clients want to know the specifics: "What percentage of my assets can I safely take out this year and still be able to provide for my spouse and me each year for the rest of our lives?"

As a result, we’ve developed safe withdrawal rates for ages 0 to 100. Our rates are based on age-appropriate asset allocation mixes and assume that withdrawal rates will go up each year to meet the needs of inflation. Withdrawal rates should also be conservative enough to allow for constant increases even when the markets have a poor year.

Reproduced in this table are some of the results:

Age: Withdrawal Rate 

• 62: 4.11%
• 65: 4.36%
• 70: 4.77%
• 75: 5.35%
• 80: 6.22%
• 85: 7.66%
• 90: 10.42%
• 95: 17.86%

To illustrate this point, let’s take a real-world example of the Wahoos. Wally and Wilma Wahoo are 75 with a $1 million portfolio. If they withdraw $53,500 or 5.35% from their account at the beginning of the year, and their portfolio grows by or 9% over the next 12 months, then at the end of the year their account would be worth $1M -$53,500 = $946,500 + 9% growth = $1,031,685.

Next year, when they are 76 years old, their new withdrawal rate according to our table is 5.49%--slightly more. Since their account value and withdrawal rate are now larger they would get a raise. Following this plan, at the beginning of year two they would receive a 5.9% raise or $3,139 more for the year. (5.49% of $1,031,685 = $56,639 for the year.)

Since their monthly “allowance” increased $262, their standard of living can keep up with inflation and then some.

Many people make the mistake during retirement of thinking that they need to have mostly interest-paying and dividend-paying investments to generate cash for withdrawals. This is incorrect.

People often have an unwarranted fear that they can’t "touch the principle" and therefore, should not sell stock to generate cash. For retirement income, it doesn’t matter if you receive $50,000 in interest and dividends or if you receive $50,000 by selling assets that realized a capital gain. Either way, $50,000 is $50,000.

Let’s consider an example. If 100 shares of a stock double in value and then, the stock splits and you sell half your shares, have you "touched the principle?" The truth is, you are left with 100 shares of the exact same stock at the exact same value, plus a pile of cash. There is no difference between this case and getting paid that pile of cash in dividends.

Putting everything in one type of investment is usually more volatile than diversification. Therefore, we do not recommend an exclusively interest and dividend-paying portfolio. But, having said that, I must add that good dividend-paying stocks, sometimes called "value" stocks, get a higher return and at the same time are less volatile than "growth" stocks. We would recommend overweighting value stocks, even in a non-retirement portfolio.

Retirement plans should be reviewed annually. Doing a projection every year will help you determine how much you should be saving, or if you are retired, how much you can spend. A handy goal to aim for is to save 24 times your salary by the time you retire.