Free Money Finance

2010 Roth Conversion: Factors to Consider Before Making a Decision

The following is a guest post by Bryan Olson, CFA, Vice President, Head of Portfolio Consulting for Charles Schwab & Co., Inc.

For more than a decade, Roth IRAs have been offering investors a number of benefits generally including tax free growth in earnings, tax free withdrawals assuming you begin your withdrawals after the age of 59 1/2 and have held the Roth account for the minimum five-year holding period, and no required minimum distributions as is the case with traditional IRAs.

Through the end of 2009, conversion to a Roth IRA from other retirement accounts including a traditional IRA or 401(k) plan is limited to people with a modified adjusted gross income of $100,000 or less. But as of January 1, 2010, all investors will be eligible to convert funds from a traditional IRA or 401(k) to a Roth IRA, regardless of income level. While this change will present some attractive options for certain investors, people should weigh the costs and the benefits unique to their own specific financial plans and tax situation before deciding if a Roth IRA conversion is right for them.

What is Roth IRA? How is it different from a traditional IRA?

Roth IRAs offer several unique characteristics that differ from a traditional IRA. First, growth in a Roth IRA is generally income-tax-free, meaning that while you pay taxes on your initial contributions, you do not pay income tax or capital gains on any earnings in your Roth account, assuming you begin your withdrawals after the age of 59 1/2 and have held the Roth account for the minimum five-year holding period.

Second, qualified withdrawals after the age of 59 1/2 are tax-free, which can be very useful for people seeking to manage their income tax bracket in retirement. In addition, unlike a traditional IRA, in which required minimum distributions (RMDs) are mandatory beginning age 70 1/2, a Roth IRA does not require withdrawals at any time during a person’s lifetime, so investments can remain in the account and continue to grow until they are needed.

Third, contributions can be withdrawn from a Roth IRA at any time tax-free, but they are not tax-deductable up front. Conversely, contributions made to a traditional IRA may be eligible for a tax deduction when contributed and are taxed upon withdrawal, but cannot be withdrawn without penalties until the age of 59 1/2.

The case for converting: What are the potential benefits?

While the two main reasons that investors typically consider converting to a Roth IRA are to achieve a greater ending portfolio value or to capture estate planning benefits, there are a few additional potential benefits as well. Here a few reasons converting to a Roth IRA might make sense:

• Potentially greater ending portfolio value: If you think your future tax rate will be the same or higher than the rate you're currently paying, you may enjoy a greater ending portfolio value if you convert your funds to a Roth IRA now, because the taxes you pay on the conversion amount today will likely be less than the taxes you'd pay on withdrawals from a traditional IRA in the future.
• Estate planning: If you don’t think you will need to utilize your IRA to live off of in retirement (including emergency expenses such as health care) and your goals include maximizing the assets you leave to heirs and beneficiaries, a Roth IRA can offer some unique estate planning benefits. While the value of a Roth IRA will still be included in a person’s gross estate, because there are no required minimum distributions, the account could grow larger than it otherwise might under traditional IRA distribution rules. This can leave more for heirs to withdraw income tax-free over their lifetimes. In addition, the income tax paid at conversion (preferably from assets other than the IRA) will reduce the owner’s gross estate. In effect, the account owner is prepaying income tax on behalf of future beneficiaries without such payment being recognized as a taxable gift.
• Tax-risk diversification: Risk diversification is a key tenant of investing and diversifying tax risk can be an important factor to consider. Diversifying income tax risk means considering whether and how assets should be divided among three primary types of accounts:

• Taxable accounts in which taxes on investment income and capital gains are paid as they occur,
• A tax-deferred account such as a traditional IRA in which taxes are paid at the ordinary rate in the future when you make withdrawals,
• And a tax-free Roth IRA account in which contributions are after-tax and/or taxes are paid upon conversion for investments going into the account, and qualified withdrawals are income tax-free.

• Flexibility to influence income tax bracket in retirement: Individuals in a higher tax bracket at age 70 1/2 might be forced to take RMDs from a traditional IRA even though they do not need the money at that time. This can also result in taxation in a higher tax bracket. Converting some assets to a Roth IRA will lower RMDs from a traditional IRA, thereby lowering taxable income and potentially even an individual’s tax rate. Roth IRAs allow for additional flexibility in retirement since Roth IRA qualified withdrawals are tax-free and there are no required minimum distributions from a Roth IRA.

Roth IRA conversion considerations to keep in mind: Know the consequences!

The act of converting a traditional IRA or 401(k) to a Roth IRA might have consequences that make it less attractive or appropriate for certain people. The most significant of which is the tax that becomes due at the time assets are withdrawn from a traditional IRA, but there are some other things to keep in mind as well.

• Income taxes due: Converting traditional IRA assets to a Roth IRA triggers a taxable event. It does not make sense to convert to a Roth IRA if you cannot afford to pay these taxes from a readily available source other than the IRA. Investors who are younger than age 59 1/2 will incur a 10% early withdrawal penalty if they use funds from their traditional IRA to pay the conversion taxes. Investors over the age of 59 1/2 could pay taxes from their traditional IRA with no additional penalty, but this would significantly diminish the potential tax-free growth benefits of a Roth conversion versus paying the tax from sources other than the IRA.
• Five-year lock up on conversions: Funds converted into a Roth IRA are subject to a five-year rule, which will result in a penalty if broken before age 59 1/2. There is a five-year waiting period for withdrawals for each conversion amount, which starts on the first day of the year in which the conversion is made. This rule only applies to the specific assets that were converted, not to withdrawals of earnings, contributions or previous balances.

The bottom line is that converting to a Roth IRA can be a complicated, individual decision with tax implications, so you should be sure to consult a professional tax advisor before making any final decisions. Additional details about the 2010 Roth IRA conversion rule changes and Roth IRAs in general are available at www.Schwab.com/Roth.

This information is for general informational purposes only and is not intended as an individualized recommendation or to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

Americans Still Not Ready for Retirement

Here's some information that's a good follow-up to our discussion about Americans not being ready for retirement. We'll start with a summary of how most people fund their retirement.

Americans typically build retirement savings in three ways, says Laibson. For all of us, our required contributions to Social Security will provide a guaranteed monthly check. Owning a home and gradually paying off the mortgage during your working life generates housing wealth that supports retirees' standard of living (if you've paid off your mortgage, you don't have to pay out of pocket for housing). Finally, company plans, such as 401(k)s and defined pensions, provide the other key source of financial support in retirement.

So, the three-legged stool for retirement is Social Security, having a home paid off, and company plan (aka "personal savings" in my book), huh? Sounds right to me. I'm not counting on receiving anything from the first option and I already have my home paid off. So my entire focus right now is saving up as much as I can in both my 401k as well as in other personal accounts.

Of the three legs, there's one that is more important than the others in determining retirement savings success:

Laibson, who studies retirement issues as well as the psychological factors influencing savings behaviors, observes: "The most important driver (of whether an individual ends up retirement-rich) is the savings institutions at the workplace."

About half of all private sector employers don't offer any type of 401(k) or pension plan. That's a big reason why some 60 percent of Americans aren't building the savings they'll need.

"If their workplace isn't helping them save, they're not doing it on their own," Laibson says.

Of the rest, some 30 percent are saving just about adequately and 10 percent will wind up retirement-rich, according to Laibson. His estimates aren't based upon his own research, but rather upon sifting through dozens of research reports and integrating the findings.

Ok, a few thoughts here:

1. While not having a mortgage is key to a good retirement, four in ten people aged 60 to 69 have a mortgage. Oops.

2. Basically, I'm getting out of this that people don't have the motivation to save on their own. If their company doesn't force/encourage them to save, they don't do it.

3. 60% aren't saving enough. I'd say that's a big problem.

4. 10% are "saving too much." How actually is that done? Can't they run the numbers and simply retire earlier if they are indeed "saving too much"? For instance, if someone is 40, wants to retire at 65, and at his present rate of savings will have enough to retire at 60, why doesn't he simply do so (and is he really saving too much up to that point)?

Another way of looking at it is that he is not saving too much until he gets to 60 and keeps saving at his current rate. At that point, he's "saving too much", not when he's 40. Or looked at from a different perspective (one I prefer), he's building in a margin of safety with his retirement saving. It's much easier to give some away once you have too much than it is to save too little then try and earn more with limited opportunities and potential health problems at age 70.

Americans Not Ready for Retirement

Here's a piece from MarketWatch about how your home equity figures into your retirement plans. But what struck me were these figures on what Americans have saved for retirement:

The equity in your home represents a big part of your wealth. If you're married, your non-financial assets -- mostly the equity in your house -- represent about 70% of your total assets, according to a 2009 Society of Actuaries report "Segmenting the Middle Market: Retirement Risks and Solutions."

What's more, the report noted the median value of financial assets is less than 1.5 times median income -- $75,000 -- for the majority of middle-class households and that the median value of financial assets is just three times median income -- $132,000 -- for the vast majority of affluent households.

Ok, do these numbers say "yikes!" to anyone else? Granted, they don't include Social Security and traditional pension plans (the latter of which can't be much), but still! Think about this:

• If your home is 70% of your assets (or close to it), that means you only have 30% at most saved in investments for retirement. That's not very much at all when you think about how long most of us will be retired.
• If I'm reading this right, middle-class households have $112,500 saved for retirement and even affluent households only have $396,000 saved. Neither of these amounts will come near to supporting the savers at a level even close to what they were earning pre-retirement.

Maybe the data is off a bit -- maybe this is what people have NOW, not what they'll have at retirement. Then again, I'm not optimistic about that. After all, the author would have surely noted this if it was the case, wouldn't he?

Anyway, these numbers are way too low for my comfort -- even with Social Security factored in. I'm saving so that I can withdraw 4% of my funds per year, live at a level I'm living at today, and not count on Social Security for a penny (if I get anything, that will be gravy.) In addition, I plan to work as long as I can (I know, lots of people are thinking this way and physical ailments may not allow it), at least part-time, since I can't see myself retiring completely. I'd be too bored!

What's your take on these numbers? Too low or am I making a stink for nothing?

The World's Best Places to Retire

One of my ten most-hated money saving tips is move to a foreign country. Separately, I've suggested retirees can afford to retire by moving to a foreign country (when they aren't able to retire here in the US.) Both of these ideas are built upon cost savings -- that it's cheaper to live in a foreign country. But now there's a list of the world's best places to retire where cost is only one factor -- quality of life is the major part of the results. In fact, here's how various countries were scored and what percentage each factor was weighted in the decision process:

Here's how the countries were scored:

• Real estate. Weight: 15%
• Entertainment, recreation and culture. Weight: 10%.
• Cost of living. Weight: 20%.
• Safety and stability. Weight: 5%.
• Health care. Weight: 20%.
• Climate. Weight: 5%.
• Special benefits. Weight: 20%.
• Infrastructure. Weight: 5%.

Given these factors, here's the ranking of the best places to retire:

1. Ecuador
2. Mexico
3. Panama
4. Uruguay
5. Italy
6. France
7. Brazil
8. Argentina
9. Costa Rica
10. Australia
11. Malta
12. Spain
13. Belize
14. Chile
15. Nicaragua
16. Malaysia
17. Greece
18. New Zealand
19. Thailand
20. Portugal
21. Colombia
22. U.S.
23. Slovenia
24. Honduras
25. Dominican Republic
26. Ireland
27. Croatia
28. United Kingdom
29. South Africa

And some more interesting findings:

1. Brazil scored highest in real estate (92 out of 100) and the United Kingdom scored last (23).

2. Italy ranked #1 in entertainment/culture (100) while Honduras placed last (34).

3. Ecuador was best in cost of living (73) while Ireland (29) was worst.

4. Several countries scored a perfect 100 in safety including Uruguay, Italy, France, Argentina, Australia, Malta, Spain, Chile, Greece, New Zealand, Portugal, U.S., Slovenia, Ireland, Croatia and United Kingdom. Bottom of the list were Thailand and Colombia (71).

5. Best in health care was France (100) while South Africa was the worst (50).

6. Malta scored best in climate (96) while Malaysia was last (40).

7. Panama was tops in special benefits (86) while Croatia brought up the rear (20.)

8. The US was tops in infrastructure (100) while Malta and Dominican Republic tied for last (34).

9. The US was killed by a very low score in "special benefits" -- programs, etc. that made it easier for foreigners to move to the country. It scored a paltry 27 here.

10. The US beat out several countries when it came to costs, but many more beat it.

11. In order to be at the top of the list, a country had to have high to middle-high scores on all measures.

Obviously, different people value different things, so while one person may love Ecuador for the climate, safety and housing, another may prefer France for great health care and the culture. Still, the list is food for thought. Maybe a move to a foreign country isn't out of the question for many of us -- at least at retirement if not sooner.

Suggested 401k Reform

The following is an excerpt from America, Welcome to the Poorhouse: What You Must Do to Protect Your Financial Future and the Reform We Need, courtesy of FT Press, imprint of Pearson. Originally published in "America, Welcome to the Poorhouse." I don't agree with everything that's written in this book (you'll be able to see pretty clearly where we differ -- on many points in this particular piece), but I thought that this excerpt would certainly get the conversaion going. Hold on to your hats!!!!!

The bad news is that currently most Americans can’t afford to retire from a 401(k) plan. The good news is that there is a new administration in the White House and President Obama seems to understand that most Americans are under severe financial stress. On January 30, 2009, he announced the initiation of a Middle Class Task Force, headed up by Vice President Joe Biden, to address the financial stress facing most Americans, with its five goals including “protecting retirement security.” We need to communicate to Vice President Biden that the task before us isn’t simply “protecting retirement security” but to boost retirement savings so that people can actually afford to retire.

The reform that we need:

401(k) Security Act: “The 9% Solution”

1. Coverage mandate. Every employer with ten or more employees who doesn’t offer a regular pension plan—or whose plan is frozen to new hires—must offer a 401(k) plan and contribute the equivalent of 9% of pay as of 2010. If the 9% contribution rate is challenging in these recessionary times, then we should take a phase-in approach similar to Australia’s: start at 5% in 2010, increasing to 7% in 2016 and 9% by 2020.

2. Employees working in companies with fewer than ten employees would be enrolled in a Universal 401(k) featuring a government contribution. A new entity, a clearinghouse akin to the Federal Thrift Savings Plan (TSP), which manages very low-cost 401(k)-style accounts for three million federal military and civilian personnel, would receive all deposits.

3. Get rid of the low ceiling on 401(k) contributions: The limits are $16,500 for those under age 50, $22,000 for those over age 50 in 2009, indexed to inflation. It makes absolutely no sense to limit how much people can contribute, especially since most of us will have to contribute more to make up for lost time. Baby Boomer Australians can sell a home or another asset and add the proceeds to their accounts; workers over age 60 can make after-tax superannuation contributions of $150,000 a year, or $450,000 over three years.

4. Disclose the necessary employee contribution “co-pay.” Participants must be informed what their contribution rate should be depending on their age when they start to save, based on the new requirements. For example, even with the implementation of the new contribution equal to 9% of salary by employers, individuals who start contributing to their accounts at age 25 need to know they should contribute an additional 4%, another 7% if they start at age 30, another 11.25% at age 35, another 17.25% at age 40, and another 42% at age 50.

5. Employer contributions must start when the employee joins the company, not after one year. Twenty percent of employers surveyed by Vanguard require eligible employees to have one year of service before the employers match contributions to “minimize compensation costs.” This practice could deprive someone who changed jobs every four years of a total of 11 years of investment returns, causing a huge hit to the nest egg.

6. All employer contributions must be in cash, not company stock. As was the case with Enron employees, a stock match carries the risk that the contribution will be worthless if the company goes out of business. While the Pension Protection Act has required employers to allow employees with company stock in the plan to gradually diversify out of it, a recent Vanguard study of its clients showed that 8% of employees had more than 80% of their account balances in company stock, revealing a lack of understanding of the risks of not diversifying.

7. All employers must offer a Roth 401(k) option and the ability to transfer current balances to a Roth account.

8. Get rid of discrimination testing: If highly paid people have waited too long to start saving, they should have the opportunity to save.

9. Prohibit access to retiree balances until retirement: At the same time we want employers to contribute more to nest eggs, we want to limit opportunities for employees to “shoot themselves in the foot” by tapping into vested balances before it’s time to retire. There should be no loans, hardship withdrawals, or ability to “cash out” when changing jobs. Nearly half of job changers surveyed by Hewitt Associates cashed out of their retirement plans rather than leaving the balances in the old plan or “rolling them over” to an IRA or new plan.

10. All plans must include an index fund option.

11. All plans must include a target fund option, which gradually shifts from stocks to fixed income investments as the participants get closer to retirement. This should also be the “default” investment if the employee prefers not to choose an investment. Otherwise a participant may make an unwise decision to have a too high allocation in stocks or fixed income investments depending on his or her investment time horizon.

12. Employers must communicate to workers that they cannot afford to retire unless they have accumulated 10 times their salary in their accounts.

13. Workers who have accumulated enough should be encouraged to invest in a managed payout account rather than an annuity.

Action Plan: First, we need to send a message to Vice President Biden, who heads up the Middle Class Task Force, that the fix that’s needed is not simply automatically enrolling Americans in 401(k) plans or IRAs. Americans must deliver the message that only if employers are forced to kick in higher contributions will most folks be able to afford to retire. Along with contacting your own congressperson, go to the contact page on the White House website (http:/ /www. whitehouse. gov/ contact/) and submit an email asking Vice President Biden to support the Security Act mandating 9% employer contributions to 401(k) accounts. Here is the URL to the page on my company’s website that describes the proposed legislation that can be cut and pasted into your email: http:/ / www. retirement-solutions. us/ 401k-nightmare. htm.

Second, contact Rep. George Miller (D-CA), who is chairman of the Health, Education and Labor Committee, which oversees pensions, to seek his support: http:/ /georgemiller. house. gov/ contactus/ 2007/ 08post_1. html.

Third, we also need to send a message to AARP that the advocacy group for retirees needs to do more for would-be retirees who are currently can’t-be retirees. When I spoke with a spokesperson for AARP about the retirement crisis, he said that AARP has not been actively involved with retirement security because there hasn’t been a hue and cry from the general population. The spokesperson said that to date they have explored “ways in which we can expand access...such as the automatic IRA. We have promoted auto-enrollment. Adequacy is a tougher nut to crack.”

Sorry, AARP, as I pointed out in the first chapter, automatically enrolling people in an inadequate savings scheme, whether an automatic IRA or a 401(k), is like giving a cancer patient aspirin instead of chemotherapy. We need to send a “hue and cry” to AARP that if Australians can “crack tough nuts,” we need to as well. Contact AARP at http:/ /www. aarp. org/ about_aarp/ contact/ a2003-01-28-contact-issuesform. html and urge them to support my Security Act.

Finally, contact a new organization called Retirement USA that supports retirement reform and is looking for input. While the organization appears to have bought into Ghilarducci’s flawed assumption that 401(k) plans are risky, it does favor considering Australia’s superannuation system. I urge you contact them at [email protected] and ask them to consider my proposed legislation.

Tax-Friendly Places to Retire

Have you ever thought of moving when you retire -- you know, someplace that's warmers AND can save you a bundle on taxes?

MSN Money lists tax-friendly places to retire but says it's not as simple as looking at income tax rates. Their thoughts:

Seven states -- Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming -- have no state income tax. New Hampshire and Tennessee tax only dividend and interest income that exceeds certain limits.

But many of the remaining 41 states (and the District of Columbia) offer generous income tax breaks to retirees. If you qualify, moving to one of these retiree-friendly areas could be cheaper than relocating to a state with no income tax.

Plus, in tough economic times, states without a personal income tax have fewer sources of revenue and are more likely to raise property or sales taxes and other fees to shore up their budgets. State tax revenues plunged nearly 12% during the first three months of 2009, the sharpest decline on record, reports the Nelson A. Rockefeller Institute of Government. And it may take states years to make up the shortfalls.

So, I'm thinking:

1. If you can save a bundle on taxes AND improve other areas of your life (get closer to family, get a better climate, etc.), why not?

2. You have to be sure you don't increase other living costs when you move.

3. You'd probably have to have a really high income to make this a worthwhile effort, wouldn't you?

But this brings up a related topic -- are you thinking of moving when you retire? If you're like us, retirement is still some time away, so I really have no idea what we'll do. But for those of you who are retired, closer to it, or have talked about the issue, what are your plans?

Four Last-Minute Ways to Boost Your Retirement Savings

Here are some thoughts from the great personal finance book Grow Your Money!: 101 Easy Tips to Plan, Save, and Invest. They list four last-minute ways to boost your retirement savings as follows:

• Downsize your home
• Move to a lower-cost locale
• Delay retirement
• Phased retirement (work some)

My thoughts on these:

1. I think it's likely that we'll downsize at some point -- if for no other reason than a bigger home takes more time and effort to take care of. But it probably won't be that much of a financial windfall. Our home isn't that pricey and even a decent condo costs a fair amount plus we may want to move to a better location. So we'll probably net some gain but not much.

2. Not only is moving a great idea in retirement, but also a good strategy to save money while you're working. And don't forget we're not just talking moving from one part of the US to another. You may even want to move overseas to save a boatload more.

3. Time is the variable that most impacts your investment return, so the longer you can wait to draw that retirement savings (and thus let it grow), the better off you'll be.

4. I plan to work some in retirement anyway, so I guess that's a "phased retirement." Doing so will help me cut the cord a year or two sooner than I would have otherwise.

How to Retire Early

Here are some thoughts from the great personal finance book Grow Your Money!: 101 Easy Tips to Plan, Save, and Invest. They list secrets of successful early retirees as follows:

• Successful early retirees have their eyes on the early-retirement prize for decades in advance.

• Modest lifestyle -- before and after retirement. Being able to retire early almost always requires some financial sacrifice both before and after retirement. A high savings level, often as high as 30 percent of income, is required during the working years. A modest lifestyle continues after retirement, but by then, you'll be used to it.

• Aggressive investing. You can't afford to be conservative if you're amassing a portfolio that may need to sustain you for five decades or more.

• Part-time work in retirement.

Here's my take on these suggestions as well as this issue as a whole:

1. Yes, you need to save for a long time in order to retire early (unless you win the lottery, but that's unlikely.)

2. In order to save what you need, you must create the greatest gap possible between your income and expenses. So, of course, this means making the most of your career and other money-making ventures as well as keeping your expenses as low as possible. Sounds familiar, right?

3. You don't necessarily have to live a modest income, but the more modestly you live, the faster you can retire. For instance, let's say you make $200k per year. You spend $100k and save $100k. Now living on $100k is not "modest" by most definitions, and you're saving 50% of your income. I know this is an unusual example, but it can be done (I have friends that have numbers similar to this) -- if you grow your income and keep expenses relatively in check.

4. I'm not sure how much we all can count on "aggressive investing." I think we've all seen that high-risk investments can disappear pretty quickly. Besides, time is more valuable in investing than return (so plan for a longer investment period -- something you can better control -- versus taking on risky investments to hit a target.)

5. Personally, I plan to work part-time in retirement -- I don't see myself becoming a couch potato. But the difference between working at something you want to do (like refereeing soccer games, working for a non-profit you like, etc.) is HUGE compared to taking a job you HAVE to have in retirement (like working at a fast-food place, selling newspaper subscriptions, etc.)

This is what I've done (roughly) and I'm on track to retire before 60. Yes, I could have cut expenses even further and retired a few years earlier, but what's the fun in that? You have to enjoy life while you're going through it, right? And even with that philosophy, I'm still looking at early retirement in 10 to 15 years -- sooner if the market gets its act together. :-)

Five Ways to Make Your Nest Egg Last a Lifetime

Here's a list of five ways to make your nest egg last a lifetime from MarketWatch:

1. Delay claiming Social Security. One way to create the best inflation-adjusted source of income at the moment is to delay taking Social Security for as long as possible.

2. Consider purchasing an annuity. It's not right for everyone, said McCubbin. But for those who are retiring with a large nest egg and who don't have enough fixed and guaranteed sources of income to match their fixed expenses, an annuity might fit the bill.

3. Pay down your mortgage. Many would-be retirees should enter retirement debt-free, owning their home free and clear, according to McCubbin.

4. Allocate your assets wisely. Many retirees place large portions of their nest eggs in investments that provide a guaranteed return on capital. AARP's view is that retirees should build portfolios that are broadly diversified and based on one's tolerance for risk.

5. Withdraw funds carefully. Conventional wisdom suggests that you should withdraw no more than 4% of your savings during retirement. "In tough economic times, you may want to withdraw a smaller percentage of your savings, if possible," AARP said. "When the returns on your investments improve, you can increase your withdrawals."

Here's my take on how to make your nest egg last a lifetime:

1. Make a good income.

2. Keep your spending under control.

3. Become debt free. This includes your mortgage.

4. Sock away a boatload of money using various retirement savings options.

5. Don't count on Social Security for a penny. If you get anything, consider it a windfall.

6. Allocate your assets wisely. I think we've all learned (many the hard way) that the sooner you'll need the money, the more you need to put it in something safe.

7. Spend only what's necessary, especially in the early years of retirement. Of course you'll want to have some fun (and you should plan/budget for it), but you don't want to blow 10% of your nest egg in year 1 either.

At least this is my plan. So far, it's working out -- even with the slump in the economy and the investment losses over the past year.

Someone reading this is bound to be thinking "yeah, but that method eliminates having fun when you're younger -- all you'll be doing is saving and not enjoying life" (or something like this -- believe me, I get enough comments of this kind.) To that, I say: "No, you're wrong." If you do #1 well enough, you'll have plenty of room for fun in addition to covering your basic needs as well as savings goals. So, how do you do #1 well? You manage your career and/or work to make extra money where you can.

What to Do with Your Retirement Savings When You Change Jobs

Here are some thoughts from the great personal finance book Grow Your Money!: 101 Easy Tips to Plan, Save, and Invest. They give some thoughts on what to do with your retirement savings when you change jobs as follows:

• If you want to impair your future financial security...then cash out your retirement savings.

• If you like your former employer's plan...do nothing and leave the money with them.

• If you like your new employer's plan...move the funds into it.

• If you prefer to manage the money on your own or want more choice...rollover the money into an IRA.

Personally, I've always gone for the last option -- putting it into an IRA. Here's why:

1. It gives me control over the money (versus my former or current employer.)

2. I can invest it however I want (I'm not limited to the current and future choices in any specific plan.) For me, that means I can get the funds I want at the best prices possible.

3. Ease of management. I've had a few jobs and 401ks, and I've rolled them all over into the same IRA. So I have one retirement account, one statement, one account to manage, etc.

FYI, options #2 and #3 can also work, I just prefer the IRA for the reasons stated above. That said, option #1 is a very BAD idea and I would not recommend it unless you needed the money for an important emergency and there was absolutely no other alternative for getting it.

How about you? What have you done with your retirement when you've changed jobs?

Retirement Plan Priority List

Here are some thoughts from the great personal finance book Grow Your Money!: 101 Easy Tips to Plan, Save, and Invest. Their retirement plan priority list (in order) is as follows:

1. Employer plan with a match
2. Unmatched employer plan or Roth IRA (tie)
3. Self-employed plan
4. Deductible IRA
5. Nondeductible IRA
6. Buying and holding individual stocks and real estate
7. Tax-deferred annuities

Here's what my retirement savings compared to this list:

1. I have a 401k with an employer match. I put in the maximum allowed and have for years (almost 15 years now).

2. Don't have a Roth since I don't qualify.

3. I do contribute to a SEP set up for my home-based business.

4. Don't have a deductible IRA since I don't qualify.

5. Both my wife and I put in the max amount each year in a nondeductible IRA.

6. I buy index funds in my taxable accounts.

7. Tax-deferred annuities? Yikes!

I plan to keep socking away as much as possible in my current accounts, hoping to retire in 12 to 15 years.

What Do You Plan to Do in Retirement?

This piece from US News details what retirees do all day (basically they shop, relax, and volunteer). It's an interesting read (though not really that meaningful for most of us.)

I've detailed what I plan to do during retirement and thought it would be fun to ask you what you'd like to do with your free time once you stop working. What are your retirement plans?

Should You Have a Mortgage When You Retire?

This piece says that four in 10 households aged 60 to 69 in 2007 have a mortgage. Of those, one in two have enough to pay off their mortgage. But should they get rid of it?

The article notes that "in the current environment, your mortgage provides a better return on your money than other risk-free assets" and thus advocates paying a mortgage down. But what about having the flexibility that liquid assets provide? There's value to not tying up all your assets in a house, right? So maybe you shouldn't pay it down. But then again you can access any funds with a reverse mortgage, correct? So maybe you should pay it off. As you can see, the arguments, both pro and con, go back-and-forth rather easily.

I'll leave the debate to you all in the comments below. But here's my personal take on the issue of having a mortgage when you retire:

1. It doesn't impact me. I've had my mortgage paid off for over a decade now and I don't plan on going back.

2. If you buy your house using the proper financial guidelines, you should have no problem paying it off well before you get to retirement.

3. Personally, I think it should be a goal of every person to enter retirement with no mortgage whatsoever.

4. I'm surprised that so many have a mortgage at retirement. I would have guessed three in ten at most would have one. Then again, I'm regularly surprised by the (usually negative) financial habits in this country.

What's your take? Should not having a mortgage at retirement be a financial goal for all of us or is that too strict of a requirement?

Seven Termites That Eat Your 401(k)

The following is a guest post from Marotta Wealth Management. FYI, the seven termites eating your 401k are: 1. Wrap fees, 2. Subtransfer agency fees, 3. Mortality and expense fees, 4. 12(b)1 fees, 5. Share class, 6. Portfolio turnover, and 7. Market timing.

According to a Dalbar Financial Services study that tracks investor returns, from 1989 to 2008 the S&P 500 yielded 8.35% annually. But the average investor only earned 1.87% over the same period. This fact deserves restatement. The average investor received less than a quarter of the general market return and did not even keep pace with inflation.

The study suggests that average investors would enjoy better outcomes if they simply invested in bank certificates of deposit (CDs) rather than trying their hand at more aggressive investing. We certainly do not endorse abandoning the equity markets. Seeing so many people forgo their retirement dreams, however, is very discouraging.

We call the difference between the market return and typical investor returns the "termite gap." Termites eat away at the very foundation of your retirement plans. They hide in layers of financial intermediaries that all take a bite out of your portfolio. And the most dangerous termites lie within your emotions.

Fees are the strongest predictor of a fund's performance. John Bogle, founder of Vanguard Funds, commonly shares a simple and compelling mathematical equation that highlights the importance of managing fees. If the performance of all of the market participants make up the average return (A), then after fees (B), investors underperform the market by the amount of those fees (A - B = C). Thus the higher the fees, the higher the underperformance. And when you find out you have termite damage, the first thing you need to do is call the exterminator.

The obvious solution for average investors is to find proven investments with the lowest administrative fees. However, they are left in a very difficult situation. Most do not have the time or expertise to uncover these hidden costs. In a market with so many 401(k) options, we would expect highly competitive pricing. Instead, investors and plan sponsors of small to medium market cap companies display very little price sensitivity when making 401(k) investment decisions. The Government Accountability Office (GAO) found that 80% of 401(k) participants are unaware they are paying any fees.

Many mutual funds with annual operating fees more than 1% will likely underperform and should be avoided. Request a copy of each fund's prospectus and use a magnifying glass to uncover these first three hidden termites. Look for subjects like "wrap fees," "subtransfer agency fees" and "mortality and expense fees" (M&E). M&E fees are an extra insurance charge in annuity contracts. You may have heard that combining your investments with your insurance is a bad idea. Inside a retirement plan, it is a terrible idea.

The fourth hidden termite is 12(b)1 fees. These fees actually pay for a fund's advertising, which is strange. Consider the consumer outcry if grocery stores started charging an extra line-item fee to cover their advertising.

In addition to the standard investment management expenses, mutual fund companies have agreed to pay retirement plan providers so they can be included on a short list of available funds within a 401(k).

If we were describing the mafia, we would call these arrangements "kickbacks." Retirement plan providers have convinced the public they are merely "revenue-sharing" agreements. However, this is not the sharing you learned about in kindergarten. Mutual fund companies create a new "class" of shares, often called "retirement shares" in standard plans or "insurance class" inside of annuities. These new shares are created with higher fees than the standard fund to pay for these types of fee arrangements: the fifth termite.

Unless you are lucky enough to participate in a large corporate 401(k) plan, you typically will not find more than a small handful of no-load Vanguard funds or index funds in these accounts. You will find a large list of funds that try to justify their high expenses by raising their risk levels through active management. The cost of portfolio turnover is the sixth termite affecting expenses. Higher portfolio turnover increases the transaction costs of buying and selling the individual securities in a mutual fund or other investment account. These transaction costs are not separately identified but are netted with the investment return.

Management fees in the 401(k) industry run about 1.6% for the average equity fund. Add in portfolio turnover costs and the impact of sales charges, and another 1.4% of cost has been added. That brings the 1.6% management fee or expense ratio up to 3% a year for a typical 401(k) plan.

High fees do not need to be put on a 401(k) plan. We've designed dream 401(k) choices for our small business owners with less than half those amounts. Incentives always exist for the industry to hide these fees. So being an informed investor is critical.

The seventh and final termite is found within. Common sense tells us to buy low and sell high. The evidence of mutual fund flows suggests that many investors pull their money out of the markets when it is falling and reinvest it back as it is rising. Behavioral finance identifies and addresses these self-destructive actions. But solutions are lacking. Target date funds and managed accounts have helped guide 401(k) participants away from the folly of focusing too closely on individual fund returns. Unfortunately, the termite damage remains.

Imagine a world without financial termites. A person who makes $60,000 a year and invests in the company's 3% matching retirement plan would have $434,947 in 30 years at market returns (8.35%). If this same investor, subject to the termite gap, receives only average investor returns (1.87%), the portfolio would be worth $143,108, nearly $300,000 less than expected.

Average employees cannot make changes to their 401(k) provider. So here are a few words of advice. We usually recommend that people invest up to their match and no higher. Maximize other low-cost investment opportunities, including a Roth IRA, before saving unmatched money in a typical 401(k) plan. If you have left a job or are retired, roll your money over to an IRA that offers low-cost investment options unencumbered by excess fees. If you are currently employed, diversify your investments among index funds and, if necessary, actively managed funds with lower expense ratios.

If you are a business owner or HR director, seek a revenue-neutral investment advisor. In other words, find someone who does not accept revenue-sharing payments or commissions from mutual fund companies. When any mutual fund rebates these revenue-sharing payments, a revenue-neutral advisor will pass these payments back to the plan to offset fees. These investment advisors are more likely to choose low-cost index funds rather than high-cost actively traded funds. The best advisors are fiduciaries. Registered Investment Advisor fiduciaries must disclose fees in writing, invoice the plan sponsor or plan for those stated fees and credit any revenue-sharing fees back to the 401(k) retirement trust. The goal for all employees and plan sponsors should be to capture as much of the market gains as possible.

Ouch! Here's a Reason You Need to Be Very Conservative in Retirement Planning

CNN Money brings us this story of retirement planning gone wrong. Robert Bertrand had retirement all figured out. Here's where he stood:

• Retired in early 2006 at age 58 to live out his dream of playing on the Senior Professional Golf Tour.

• Had $425,000 socked away, plus another $500,000 or so in stock options.

• Wife earned $140,000 a year as a mortgage company executive.

Not bad, huh? $1 million saved and $140k income per year in income, plus whatever he earned on the tour. Should be safe, right?

Then the market went to pot. Here's the result:

• The savings tanked with the stock market.

• The stock options dried up because the issuing company went down.

• His wife lost her job -- she worked at the same place he had his stock options.

Ugh. And, as a result, things aren't looking very rosy:

They have monthly expenses of $8,000 but only $1,700 in income (from Susan's unemployment and Bob's annuity; having worked in Canada most of his career, he'll soon qualify for an additional $800 a month in pension benefits) and $13,000 in the bank. Making matters worse, they have little equity in their house.

Now they've gone through all their savings and he's looking for a new job. Some retirement, huh?

Ok, let's do a little review here. This isn't meant to criticize this family or kick them when they're down, but we all can learn something from this situation. Of course the (hopefully) once-in-a-lifetime market/real estate meltdown is something that very few avoided completely, but there are still things they could have done to set themselves up for a more solid retirement. Some thoughts:

1. They could have reduced their spending. $8,000 a month in expenses is HUGE! No, it's not bad if he's making $150k (his pre-retirement income) and she's making $140k, but once he quit that $8,000 was a good amount of cash flowing out based on their income. So when his wife lost her job, it was a crushing amount. But it sounds as if they've done a lot of spending throughout their lives. Yes, they saved a good amount (though not much for a family with $290k in annual income) but they also borrowed BIG (or at least big enough that when their home's value dropped they had zero equity left.)

2. Speaking of their home, why didn't they have it paid off? I think this should be a pre-retirement goal for everyone -- no mortgage. If they owned their home free and clear, I'm sure that $8,000 in monthly expenses would be much lower.

3. Too much risk in one company -- over half their savings (options) and her salary. This is why it's not a good idea to own too much stock in one company, especially one you or a spouse works for. Because if it goes down, you go down with it big-time. Now maybe he couldn't sell the options for some time. If so, his retirement never was that secure (he retired with $425k in savings and that's all.) He needed to wait until he saved more to leave his job.

4. Leaving a career is a huge, huge decision, and once you step off the train, it's hard to get back on again. He's now  62 and out looking for work. he's got a lot of good experience, but in an economy where jobs are hard to find, he'll be competing with much younger (and maybe as experienced) executives. It's going to be tough for him. Couldn't he have awaited a few years, bagged his salary in savings , and then gone off to pursue his dream? Of course, he worked for the company that tanked (again, see point #3), so this probably wouldn't have worked either.

5. Why was his $425k in savings in stocks that went down with the market? A 30-year-old should probably be mostly in stocks since he has time to recover if the market tanks. But a 60-year-old is being very risky with savings in such potentially volatile investments.

So, what's the answer? You have to be VERY CONSERVATIVE when planning your retirement. If you think you need a certain amount, add 20% to it. If you think your expenses are going to be a certain amount, add 20% to them. Don't count on Social Security. Assume you can never work again. Make all the conservative assumptions possible (within reason, of course, if you go too wild, you'll never retire) and if you can retire given their results, you should be fine. And be sure you protect your income/savings. If you're counting on it, you have to be sure it will be there and you have access to it. Don't count options you can't cash, don't put too many eggs in one basket, and don't take needless risks with your nest egg.

Here's what I'm doing along these lines:

• Assuming I get nothing from Social Security. It's likely I'll get something, but assuming I'm not will encourage me to save more as well as provide a measure of safety in case I miscalculate in other areas.

• We're keeping our expenses low. House is paid off, on-going bills are way below our income, and we're keeping things as tight as possible while also enjoying life.

• I plan to work as long as needed, then transition to a decent part-time gig in retirement (still TBD). I don't plan to quit altogether or join the senior's golf tour.

For details on my retirement plans, see How Long Before I Can Retire? and What I Plan to Do During Retirement.

So, what's your take on this issue? Anything I missed or got wrong?

The Cost of a New Home

As many of you know, we've been looking for a new house for three years now (this is the third summer we've been "shopping".) From the beginning, we said we'd consider moving if we could find a great place at a big discount. Now after looking for quite some time, I'm not sure it's "worth it" for us to move after all. Let me tell you why.

What we're really looking to upgrade on is the location (city of residence) as well as the outside (acreage) of our current home. We'd like to live in a nicer township (with better schools, closer to church and friends, etc.) as well as have a bit of land to do some gardening, have a place for the kids to run around, have a dog (yes, an expense, I know), etc. We like our current house and have said several times that we'd be satisfied if we could simply move our current home onto seven acres in the township we want to live in.

But it's not that simple, of course. In real estate, every property is different from every other one. And we can't move our home (I guess we could, but we're not going there.) So we're looking for the combination of a nice house, a decent amount of land, and a location that's in our targeted area. Oh yeah, and we want it at a discount (as noted above.) Finding such a place is turning out to be a lot harder than we expected.

Granted, we're being picky. But why not be picky? We have a house we like, that's 100% paid for, and that’s in a neighborhood that's "fine." So we can afford to be choosey. And we have been. In all our searches, we found only one place that we liked enough to place a bid on, but the sale didn't go through (FYI, it sold this spring for $20,000 below what we were going to pay for it.) But we did learn a lot from the process.

To give you a feel for our situation, here's a quick summary of what we're facing:

• Homes that are comparable to ours in the city we like on the acreage we want are about $250,000 more than the value of our current home at current market rates. Is the extra amount worth paying? More on this later.

• NO ONE that has a home that meets our criteria is in the desperate/"let's unload it at any price"/foreclosure sell-off phase. No one. And rest assured that after three years we know the area well, what's being offered, and what's being sold. There's nothing that's met our discount criteria out there (even the home we bid on was much more than we wanted to pay and certainly was nowhere near a firesale price.) Now these homes are dramatically discounted from their one-time values, of course, but we're not really looking for that. We're looking for an almost unbeatable deal that's below current market value. Again, we're being picky and only buying if the right opportunity comes along.

• That said, we did see two homes recently where the seller's agent simply said the price was "write up an offer." One of the homes had been on the market for $750k (an outrageous price) and was down to $499k. The other was similar. But even a lowball offer is going to put these homes $150k above the value of our current place unless we go with the we're-too-embarrassed-to-even-bid-this price. Besides, we're not so sure that we like either of these homes anyway.

So now that you know what we're up against, let's look at the costs of a move and how they could impact our finances. Here's a quick review:

• As I noted, any house that meets our criteria, barring a miracle purchase, will cost between $150k and $250k more than our current home.

• If we move, I estimate we'll have $20,000 in one-time costs associated with the move. This includes everything from work on the new house we'd likely want done, paying movers, buying new items needed for the new home (for instance, our 15-year-old push mower isn't going to do the job on three acres of lawn), etc. This estimate is obtained from a detailed budget I laid out when we thought we were going to move to the last hose. So while it could be off one or two thousand dollars, it's not off by much.

• A new house like the one we're thinking of would add about $5,000 extra in expenses to our budget. Taxes will be more, heating will be more (most places are heated with propane), yard care will be more (someone will need to plow the usually long driveway in the winter), and so on.

Now we can afford this, but the question is do we want to pay this much? After all, the cost is pretty high. For instance:

• Assuming the cost of the house is $150k more than the value of our current home, we'd have almost $400k less (assuming an 8% return) in net worth after ten years by buying the home (I'm assuming we'd invest the difference.) Over 20 years, we'd have almost $935k less.

• If the cost of the house is $250k more than the value of our current home, we'd have almost $600k less (assuming an 8% return) in net worth after ten years by buying the home (I'm assuming we'd invest the difference.) Over 20 years, we'd have almost $1.4 million less.

• Now, of course, the new home would increase in value (theoretically), so some of these losses would be offset. Let's say the home would appreciate at 4% per year versus the 8% if the money was invested. At $150k cost of new house over old, we'd still be out $86k after 10 years and over $330k after 20 years. At $250k incremental cost, the numbers are down $144k after 10 years and $552k after 20 years.

• That said, the gains in the house are very illiquid while the amount, if invested, would be very liquid. Big difference.

The biggest financial impact of this decision is how it affects the year in which I could retire. Even at $150k extra cost, I'd need to work several more years than I would if I kept and invested the money. At $250k, I'd have to work much, much longer.

So, where does that leave us? First of all, we need to think about the costs associated with the move. If we can get the low price we initially planned for, the cost isn't that big of a deal given we'd pick up the benefits that made us start looking in the first place. But if we have to pay a premium versus our plans, it's likely not worth the cost. I'd rather have the money, the financial flexibility, and a much earlier retirement.

How to Check Your Retirement Assumptions

The following is a guest post from Monty Hothersall, co-founder of Financial Fate.

If you’ve ever projected your financial or retirement planning numbers using an online calculator, you might be surprised how much those results have changed over the past 12 months.  But this probably makes sense given the market’s free fall, right? 

Well, not exactly.  Since most of these online calculators use a statistical program called Monte Carlo Simulation (MCS), you might easily get a false sense of the future due to the problematic assumptions which drive the MCS results.  To use an example, let’s say your results from last year’s MCS planning said you had a rock-solid 98% chance of successfully meeting your retirement goals.  (But today it’s a much different story.)  So, was the 98% result a realistic number and you just had some unfortunate luck? 

Not likely.  The problem is that MCS is based on a risk model where the future market returns are projected to be “normal.”  Where in reality, market returns are far from normal because they are “uncertain.”  And since the underlying assumptions of MCS are not valid, the 98% result was not valid.  Maybe it should have been 68% or even 38%, who knows? 

Instead of using MCS based tools, you need predictive financial-modeling tools (like on my free site, FinancialFate.com, or others like ESPlanner's non-MCS solution) which allow you to challenge the rates of return by asset class and question the targeted future asset allocations.  And you must be able to realistically forecast the volatility of your free cash-flows which will be available for future investing.  This would allow you to control your scenario planning rather than "flying on auto-pilot" with MCS technology that wasn't designed for predicting market returns with all its inherent uncertainty.

Also, when developing a long-range financial plan remember that it will take 3 to 5 hours of your time.  But it usually requires only one planning session per year unless something dramatic happens, and each subsequent year should take less time than the previous year.  Tools like Fidelity's My Plan which take less and 5 minutes to generate a plan are akin to taking diet pills to lose weight instead of dieting and exercising; it's easy but it just doesn't work.

Once you allocate the appropriate amount of time, the next step is to find software or an online tool that utilizes rules-based forecasting to automatically project all your "sources and uses" of cash-flows.  These projections should be in line-item-detail and projected year-by-year into the future with total transparency.  If the output reports that support your results are not fully disclosed and available for your review, don't believe the results.  (Even if you don't plan to actually scrutinize the projections, it's nice to know they could be audited.)  And you should bear in mind these four categories that all impact each other as you plan for your financial future:

• Income Taxes:  While most solutions determine future tax bills based solely on a percentage of future income, that’s not how taxes are calculated.  This short-cut methodology neglects significant adjustments in your AGI, deductions, exemptions, tax credits, and the actual tax tables (both state and federal).  For example, if one plans to move from California to Texas in 2 years, it would have a huge impact their state tax bill.

• Expenses:  Each expense line-item will behave differently in the future.  For example, when projecting healthcare premiums, fluctuations will be due to: 1) a changing family size, 2) a future retirement, 3) future Medicare benefits for each spouse, 4) Flexible Spending Accounts, 5) tax implications, and 6) medical cost inflation.  You should be able to view these cash-flows and change underlying assumptions such as the age that Medicare kicks in, if desired.

• Income:  If one plans to retire early, go part-time, or start a company in the future, this will impact such things as Social Security and pension benefits.

• Investments:  In order to allow dynamic "what-if?" analysis to be preformed, you should be given the flexibility to select long-term expected annual returns (growth &/or income) by asset class.  You also should be able to select investment risk tolerances (asset allocations) that shift as your time horizon changes for goals like retirement and education.

Should Retirement Savings be Required?

Here's an interesting question from US News: should retirement savings be required (update: over and above Social Security, which I think we can all agree doesn't cover people's needs in many cases -- thanks for the catch, Dog)?

This question leaves me in a quandary. Here's why:

• I have an aversion into forcing (especially the government forcing) people to do something that isn't 100% necessary. For instance, of course law enforcement is needed to prevent crimes (a good use of "forcing"), but many other issues, while likely not wise, should be left up to personal freedom if they don't harm anyone else. For instance, people should be allowed to smoke themselves to death if they like as long as their second-hand smoke isn't inflicted on those not wanting it. "Saving for retirement" seems to fall in the latter group.

• That said, what often happens is that people aren't rationale/wise/able to exhibit self-control, and thus don't do "what they should." Then, in the end, the costs of their poor decisions end up biting the rest of us as we have to pay for their failures. With smoking, the ones who don't smoke have to pick up much of the medical costs (or at least deal with inflated costs) for those who do smoke. And if one group doesn't save for retirement, guess who picks up the bill for them? Yep, the rest of us who did save in the first place.

So we're caught in a "pay now or pay later" cycle. It seems like a no-win situation. As such, I'm not sure what I think we should do.

Anyone out there have a viable solution? Anything that allows personal freedom but also forces people to take retirement saving seriously?

What I Plan to Do During Retirement

When I talked about how long before I can retire, one reader asked what I plan to do during retirement. I said I'd write a post on it, and this is that post.

Before we get started, remember that I have at least 10 years before I retire, so for now, this is all speculation. It's likely to change. That said, the following does represent what I'm considering as of now.

I'll highlight my current retirement plans in light of this US News piece that gives four questions for retirement readiness as follows:

1) What is your vision for retirement?
2) When would you like to retire?
3) Where will you live?
4) What are your income sources in retirement?

Here's what I'm thinking for my own retirement:

1. I don't see myself quitting work completely. I think that once I "retire" from my career I'll either work part-time for a business or non-profit I enjoy or work at my own small business that I'll develop between now and then. Whatever I decide, I can take a huge reduction in pay from my current salary (50% decrease or more) and live on that amount without dipping into my retirement savings (the key to this: spending way less than what I earn.) This will allow me to go several non-peak/part-time work years without having to spend retirement savings and thus allowing that amount to grow even larger.

2. As far as funds, I'm counting on saving it all myself with no other help. If I get Social Security (which I should -- I've paid a TON into it), that will be icing on the cake.

3. I'm not so sure about "when" I'd like to retire. Part of that answer is based on when I'll have the funds but another part is based on when I get tired enough of what I'm doing now to make a change. I love my current job, so unless things change here I could be around for a long, long time.

4. The biggest question: where will I live? I think that depends on several factors such as:

• Where will my kids be living? If they come back here after college, we'll probably want to stay here.
• Where does my wife want to live? Obvious reasons for this one.
• What's the cost to live in alternative locations? If we move to a more expensive place, then we'll need to save more. A less expensive place would allow us to make the move sooner rather than later.
• What are the pros and cons of other places? (Weather is a big pro of almost anyplace we'd move to.)
• Where can I find work? If I have my own business, can I take it anywhere? If I work for a company, I'll need to live where they are.
• Where will my parents live? It's possible that they'll still be alive when I'm in retirement and where they live might factor into where we live.

5. I think I'll want to do one of two things housing-wise when I retire: either move to a place with more land in a bit more rural setting (if we haven't done this in the meantime) or more to a condo with zero commitment to lawn care, etc. Both options have their pros and cons.

This is what I'm thinking as of now, but as I said, it could all change between now and then. BTW, my "Plan B" is to wait until the kids are out of the house, send my wife to work, and quit and take up golf myself! Ha! I'm sure my wife would love that suggestion! ;-)

So, any thoughts, comments, or suggestions? And how about you? What are your plans for retirement?

How Long Before I Can Retire?

I set my retirement number a few years ago and I thought it would be interesting to revisit how close I am to reaching it. You may recall that I built my retirement number assuming a few things:

• I wanted to cover my expected retirement expenses.
• In addition, I wanted a reasonable margin of safety in case my expenses were higher than what I estimated.
• I would get nothing from Social Security.

I assumed that the market downturn put a bit of a kink in my plans regarding when I could retire, but I wanted to see how long it would take given where I was now. Of course, this is a function of the following:

• How much I have invested now.
• How much I plan to contribute each year.
• What rate of return I expect to get on my money.
• How long the money is invested.

The first on is set and the second is relatively set (I have much of my savings on autopilot). Given these, if I simply plugged in various return rates, I would have the number of years needed before I hit my retirement number. So I did that, and here are the results:

• At 7% annual return, I can retire in 17 years.
• At 8% annual return, I can retire in 15 years.
• At 9% annual return, I can retire in 14 years.
• At 10% annual return, I can retire in 13 years.
• At 11% annual return, I can retire in 12 years.
• At 12% annual return, I can retire in 11 years.

While I don't think I can get 12% per year over the next 11 years, I think I'll do better than 7% as well (partly because I fudged a bit on the amount I can really save each year). My best guess is I can average 9%, which means I'll be looking at retirement in 14 years. I'll be below 60 years old and my kids will be out of college. Happy days all the way around!!!!! ;-)

Now if I up my annual savings to the level I think I can really contribute, then my 14 years becomes 12 years (at 9%). And remember that all of this assumes I get NOTHING from Social Security. It's likely I'll get something (not much, but any little bit helps.) In addition, I'll probably want to have at least a part-time job in an area of interest to keep life exciting. Put all these together and retirement isn't very far off at all.

Man, I feel old...

Roth Segregation Accounts

The following is a guest post from Marotta Asset Management.

The world of retirement accounts is a confusing tangle of IRS codes. The average family does not take full advantage of the tax laws. They can find financial tax planning equally bewildering.

A complex technique called "Roth segregation accounts" could earn your investments an extra 30% over the next two years, so you'll have to study this column carefully to understand how it works. But trust me. Learning about this strategy will be well worth the time.

There are two types of individual retirement accounts (IRAs): traditional and Roth. With a traditional IRA, contributions are tax deductible for middle- and lower-income families and the values grow tax deferred. But as you withdraw the money, you have to pay ordinary income tax rates on it. If your tax rate is lower in retirement when you take the money out than it was when you originally received the tax deduction, a traditional IRA account can offer great benefits.

Upper-income families don't get a tax deduction if they are an active participant in an employer plan. However they can still contribute to a traditional IRA. Money they put in that didn't qualify for the tax deduction still grows tax deferred. But when they withdraw the money their tax liability is lower. Imagine they contributed $10,000 that was tax deductible and $5,000 that was not because their income had risen above the limit. After many years their $15,000 contribution has grown to $100,000. When they withdraw the money in retirement, 5% of it is not taxed because of that $5,000 after-tax contribution.

Traditional IRAs are also subject to required minimum distributions (RMDs). Starting at age 70 1/2, owners of traditional IRAs must take a certain percentage out of the account and pay ordinary income tax. The government requires the withdrawals because it wants to start collecting tax on the money. But because account values have dropped so much lately, Congress has waived the RMD in 2009. (The government evidently wants account values to recover to maximize the taxes collected.)

With the second type of retirement account, the Roth IRA, there is no tax deduction when you deposit the money. You must pay the tax on the income first and then contribute to the Roth. And only middle- and lower-income families are permitted to contribute. The investments grow tax free rather than tax deferred. Qualified distributions from Roth IRAs are not subject to any income taxes. Roth IRA accounts are to your advantage if your tax rate is higher in retirement when you withdraw the money than it was when you contributed.

With a Roth IRA, you pay tax on the acorn. With a traditional IRA, you pay tax on the oak. Many families have actually lost money by investing in their traditional IRA when they were young and in a lower tax bracket only to find themselves in a much higher bracket during their retirement. In fact, so much money has accrued in retirement accounts that if it were all withdrawn today, it could pay off a significant percentage of the federal deficit.

In fact, you can do just that. In a "Roth conversion," you take money from your traditional IRA, pay tax as though that money is ordinary income and convert it to a Roth IRA. Currently only middle- and lower-income families can do this. But the law will change in 2010, allowing families with any level of income to convert to a Roth.

If you execute a Roth conversion in January of year 1, you may not have to pay the tax on that conversion until April 15 of year 2. You also may change your mind. If you decide the conversion wasn't worth it or you were over the income limits allowed for a conversion in 2009, you can move the money from the Roth account back to a traditional IRA account. This is called a "Roth recharacterization."

Recharacterizing a Roth conversion can be done any time before you file your taxes, including the filing extension. So you can change your mind any time before October 15 of year 2. And you can decide to recharacterize part or all of what you converted.

In the midst of all these changing tax laws, the tax rates are also in flux. At the end of 2010, the Bush tax cuts will expire. The Obama administration is not expected to alter the rates significantly before then. They don't want to be blamed for raising taxes before the midterm elections. They would rather implicate the previous administration for a crazy expiring tax law.

Until then, tax rates are at a historic low. After 2010, counting all the tax changes, top marginal tax rates will probably rise from 44.6% to 62.4%. Thus you will only have to pay a maximum of 44.6% on income you can take before 2011, but after that you may have to pay 17.8% more in tax.

The upside is that you can use all these laws and changes to gain an extra 30% on your investments. During the next few years, tax planning and management will be a significant part of wealth management. But it needs to be put together as part of a larger plan.

Here's the timeline of how to use a Roth conversion to maximize your investments. Early in year 1, do five Roth conversions of equal amounts into five separate accounts. You aren't going to keep them all, so you can convert five times as much as you want to end up keeping and actually paying tax on. Invest each Roth account in a different asset class (e.g., large-cap U.S. stock, small-cap U.S. stock, foreign stock, emerging markets and hard asset stocks).

The five accounts will appreciate differently, but the entire portfolio will be fairly well balanced. Before April 15 of year 2, decide if you will be keeping only one account or more than one. If more than one has appreciated significantly, you may want to keep more than one account's conversion. Compute your tax liability for the year and pay the tax, but instead of filing your return, file an extension.

Before the October 15 extension deadline, decide which of the five accounts you are going to keep. By now, nearly a year and three quarters has elapsed. You can easily determine which account has appreciated the most. Keep that one and recharacterize the other four. Because you only have to pay taxes on the amount you originally converted, it's like betting on the horse race after the winner has already been determined. After recharacterizing the accounts, file your tax return before the October 15 extension.

If all of the accounts decrease in value, recharacterize them all and pay no tax. Financially you are none the worse for having filled out a folder of paperwork. If only one account appreciates significantly, you only keep one conversion. But you have increased the odds of your Roth account going up by five times.

The average return of the S&P 500 is about 11%, but the standard deviation is about 19%. All of the other asset classes have an even higher standard deviation. It is likely, for example, that emerging markets will be either the best or the worst performing asset class over any two-year period. Using this technique you can guarantee that the Roth conversion you keep will have been invested in the best asset class during that year and three quarters.

Segregating each of the five conversions into a separate account allows you to decide to recharacterize or let each account stand separately. The difference in returns between the average and the best account is liable to be 20% or more over the year and a half before you have to choose which accounts to keep. Coupling the 17.8% tax savings and this Roth segregation technique could boost your returns by 30% or more.

In the quite likely event that all five accounts have appreciated significantly, you may decide to keep them all. Once you have reached the maximum tax rate, the top marginal rate does not increase from there. Those most fearful of expectations of higher tax rates soaking the rich after 2010 would be those most likely to benefit from converting everything.

If you are under the threshold for Roth conversions for 2009, you can start this year. This is especially appropriate for people older than 70 who are forgoing their RMD withdrawals. At least convert the same amount as you would have been required to withdraw anyway. Better yet, convert five times that amount in five separate accounts and keep the one which performs the best.

If you are over the income limits for Roth conversions this year, those limits go away next year. You can convert in January 2010 and you'll have until October 15 of 2011 to decide which accounts to keep and which accounts to recharacterize. If you do not qualify to make either Roth or deductible IRA contributions, you can still contribute $5,000 to a traditional IRA for 2009 even though you are ineligible for any deduction. Contribute another $5,000 in the beginning of 2010. Then immediately convert the entire $10,000 to a Roth IRA in 2010. If you do not have any other traditional IRA accounts, you will only have to pay tax on any growth over the $10,000 you contributed but for which you received no deduction.

As if tax matters couldn't get any more complex, Roth conversions during 2010 are taxable 50% in 2011 and the other half in 2012 unless the taxpayer elects to have them taxed completely in 2011. Generally, with rising tax rates, paying the tax in 2011 could be best, but individual situations may warrant spreading the tax over two years.

Even thought this technique could boost your after-tax returns by as much as 30%, be careful. Executing a Roth segregation account requires professional assistance. Such a technique should be just one small part of a larger comprehensive financial plan. And you should seek the guidance of a personal fee-only financial planner and certified public accountant (CPA), who have a legal obligation to act in your best interests. The laws are changing annually, and as a result so is the optimum path.

How to Improve the 401k

After our recent discussion on blaming the 401k for many of the retirement savings problems existing today, I found this article that suggests how we can fix the 401k to make it better, revamp it completely, or even do away with it. The options they present:

• Make 401(k) plans automatic. Most people agree that, given enough time, 401(k) accounts can recover from market losses. What’s impossible, however, is building more savings if you don’t save enough to begin with.

• Make 401(k)s more user-friendly. Reps. George Miller, D-Calif., and Rep. Rob Andrews, D-N.J., introduced a bill last week that would require financial service providers to disclose all fees associated with 401(k) plans. Such “little” fees can add up big, according to the Government Accountability Office: A report found that even one percentage point in excessive fees can bring down a 401(k) account balance by about 20 percent over the course of a worker’s career.

• Forget 401(k)s and create a supplement to Social Security. In [Ghilarducci's] proposal, employers and employees would be required to invest a combined 5 percent of a worker’s income into a program administered by Social Security and would also get an annual $600 government tax credit, adjusted for inflation. Contributions would be invested in a special breed of government bonds, offering a roughly 3 percent annual return. Ghilarducci proposed paying for those subsidies by cutting most tax breaks related to 401(k)s and IRAs.

• More cash-balance plans. These hybrids of pensions and 401(k)s have the employer contributing to accounts in the worker’s name, but the employer controlling (and assuming risk for) the pooled accounts’ investments. As years pass, you can see your account total growing, and when you retire, you often have the option to take the balance in a lump sum.

• Create a new program where the government, an employer and employee share responsibility. A new initiative called Retirement USA — including public policy, union and consumer advocacy groups — is working on a proposal that would create a program that is “universal, adequate and secure.” Its working paper points to various models as worth exploring, including Ghilarducci’s proposal, TIAA-CREF’s retirement plans for doctors and academics, and a few programs outside the U.S.

Here are my thoughts on the situation:

1. My preference would be to leave things as they are. Personally, the current system is working well for me.

2. I realize that many people are not having the same sort of success I am and would be better served, even if many don't think they would be, by a different savings program. In fact, many of these people are their own worst enemies and somehow need to be protected from their own stupid decisions. I know that grates against the "I can do it myself" American freedom mentality. It also grates against my personal belief that people should have freedom to make decisions and then be held accountable for the consequences, good or bad. But for some reason, we believe in this country that if people make bad decisions they somehow shouldn't be held accountable for them (example: borrowing money for a home you can't afford). Given that, isn't a new plan the only option?

3. The clash between #1 and #2 is where this whole issue gets very messy.

4. I think involving the government even more in retirement planning and saving -- whether it includes a supplement to Social Security or something else -- is a bad, bad idea. Was there ever a problem where government got involved and people said afterwards, "Wow, now things are a lot better"? Nope, never. Ok, maybe once or twice, but that's it. IMO, involving the government has a better chance of making things worse than making them better.

5. Personally, I'm hoping for the traditional Washington gridlock on this issue for several more years by which time I should be old enough to avoid most of whatever mess they come up with to "solve" the problem.

Alright, I realize that some of my comments above are cynical, but I'm cynical on the whole issue. My suggestion would be to modify the current 401k so that people were forced to participate, that they had better access to guidance and education, that investment choices were simpler and better (more cost-effective), and that fees were fully disclosed. If these things happened, I think we'd see a solid improvement in the situation and 401ks would become a much better option for a much larger number of people.

How to Afford Retirement: Move to a Foreign Country

In addition to moving from one American city to another (either now or at retirement) to save money, I've also suggested that some people may want to consider moving to a foreign country in order to be able to afford retirement. For some background on what I've said, see these posts:

• Can't Afford Retirement? Move to Mexico

• The Best Foreign Country for Retirees

• 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

Admittedly, there are challenges in moving to a foreign land. However, US News brings up the idea (again) of retiring in a foreign land saying:

• “In Nicaragua or Ecuador, you can live on somewhere between $18,000 and $25,000 a year.”

• “If you’re going to go to Costa Rica or Panama, you’re not going to be happy with much less than $30,000 a year.”

No matter which of these you choose, you're going to spend a LOT less than retiring here in America.

They then list eight tips for making the move to a foreign land:

• Take a test drive. Before making any major purchases, rent and spend a few months in the country.

• Practice your foreign accent. It's no surprise that some retirees gravitate to foreign countries with large English-speaking communities. “I recommend that anyone who wants to go to a foreign county makes sure they go to place where there's a big English-speaking enclave, so [there is] a support group.”

• Streamline your standard of living. Some Americans will find that they can afford luxuries in other countries that they couldn't in the United States. But if your objective is to make your nest egg last longer, don’t go overboard with luxuries.

• Embrace the relaxed pace. It's relatively easy to open a bank account or call a plumber in the United States. But that's not always so in many parts of the world. “A main misconception is that life is going to go as smoothly as it does in the U.S.,” says Golson. “Often, life in these countries is more like a Department of Motor Vehicles [experience] with lines and inefficiencies.” Adjusting to a more relaxed pace may take some adapting.

• Get health coverage. Generally, Medicare doesn't cover health services outside the United States (although the hospital insurance part of Medicare is available to most Americans who return to the States.) So you'll need to hunt for an insurance policy. Luckily, quality health care is typically much more affordable outside the United States.

• Consider taxes. Some foreign governments offer tax perks to retirees.

• Maintain several bank accounts. Banking abroad presents a unique set of challenges when your Social Security payments, pension, and investment income are in U.S. dollars. “It’s wise to keep your money in dollars,” says Golson. But you don't want to get hit with currency exchange fees and ATM withdrawal charges every time you need some cash. It’s also a good idea to set up a local account for everyday expenses.

• Keep in touch on the cheap. A common drawback of moving abroad is watching your grandchildren grow up through photographs. Fortunately, E-mail and Internet phone services make it easier and more affordable than ever to keep in touch with friends and relatives still in the United States.

Here's my take on these issues:

• By all means, don't pack up everything and move to a new place sight unseen -- or even with a week (or two) on a vacation as a guide. Move down for a decent amount of time (call it an extended vacation if you like) to see if you really like it. If you don't, you could try another location in the same country or a different country altogether.

• Unless I knew the language VERY well, I'd move to a place where almost everyone (if not everyone) spoke English.

• Another option, if you want a higher-standard-of-living retirement, move to a foreign country. You can spend what you would have spent here and instead of "getting by" you'll be "living it up!"

• Going at a sloooooow pace would probably be the hardest part for me. Throw "service" and "speed" out the window.

• Fortunately, if you move to a foreign country you may be in the best spot for healthcare from both a cost and quality standpoint as more and more people are traveling overseas for medical procedures.

• Not sure about the tax implications of here versus there. I'd need to do a bit more research in that area to see the real trade-offs.

• Good idea on the bank account suggestion. Besides, it may offer another level of safety for your finances.

• One word: Skype. Besides, just because you're living in a foreign country doesn't mean you're farther away from family. If you live in New York and your family is in Arizona, a move to Mexico will put you CLOSER to them.

Of course moving to a foreign land is fraught with many issues and trade-offs that many Americans might not be willing to make. But with the market where it is and people's retirement accounts taking a hit, many people will need all the creative retirement funding ideas they can muster. This is simply one to consider.

When Should You Take Social Security?

We've debated here several times on when it's the right time to take Social Security -- as early as you can (despite getting less than the total benefits due to you) or once you reach "retirement age" (so you can receive full benefits.) CNN Money recently weighed in on this issue with the following:

Should you start collecting Social Security checks at 62 or should you wait? Go to Met Life's free calculator, answer three questions, and voila: the age at which you'll have the best chance of maximizing your take, plus a clear explanation.

I used the calculator and it was easy (not to mention fun since Snoopy was there.) Here's what it told me:

• If I waited to get Social Security benefits, I would eventually earn more as the higher amount per month caught up with the fact that I'd receive benefits for more months if I started later. (No duh, Sherlock. This is the basis of all the on-going debate about when to take Social Security.)

• My breakeven age was 78. This was new, useful information to me.

• I have a 70% chance of living to be 78. Very, very useful information to have. They also showed me that I have a 50% chance of living into my mid-80s (I think it was 84.) Having this info seems to make my choice clear: wait if I can.

• For specific details, I should talk to a MetLife rep. :-)

Overall, a simple, useful calculator. It's not a one-stop piece to make a final decision, but it can certainly help point you in the right direction.

If you use the calculator, stop back and let me know what you think of it.

Is the 401k to Blame?

60 Minutes recently did a story on the poor economy and the impact on people's jobs and retirement savings. I found much of the report to be "typical 60 Minutes coverage", a biased view, looking for someone to "blame", and very little reporter knowledge on the issue he was covering. That said, it wasn't all bad, and it had some good points along the way. 

Anyway, I thought I'd comment on several of the 401k-related topics covered in the piece. Here goes:

• 401ks are not the problem. 60 Minutes tried to blame the fact that retirement funds for 50 and 60 year olds were down so much because 401ks had somehow failed/were somehow bad. A 401k lobbyist tried to explain that it wasn't the 401k, but the asset allocation of the funds in any particular 401k that was the leading cause of how much someone was up or down (a 60-year old shouldn't be 100% invested in stocks!). He also said that no matter what you were invested in, the overall poor performance of the economy probably took you down and this wasn't the 401ks fault either. I agree with him, but the reporter seemed to not understand the issue/difference.

• 401k freedoms can be an issue. The 401k lobbyist talked about how Americans like the freedom to invest, but many invest without proper knowledge. Hence, they can end up losing a ton. Personally, I like the freedom myself and am willing to take the blame/reward for how my investments perform. But what happens if we have a ba-zillion people investing that know nothing about investing, and they lose everything (or much of it.) Who's going to pay to take care of them? Maybe Social Security? Is that the safety net? Or will the rest of us be on the hook for people who don't know what they're doing?

• 401ks are confusing to many people, investing education isn't enough/working, there are way too many expenses that are hard to determine, and many fund choices are dogs. Agree on all of these. Good luck getting anything changed against the powerful financial services industry lobby. Hopefully the new administration will take on this issue.

And here are some non-401k issues for comment:

• Some of the people they profiled were supposed to be hard luck cases -- impacted terribly by the poor economy -- but they really seemed to be simply people who had made poor financial choices. For example, one couple had problems because their second/vacation home was now worth less than their mortgage. Do I even need to tell you why this couple may be in financial trouble? Another guy, in his late fifties, lamented that he would now need to work many more years instead of retiring at 62 because he'd lost $140k in his 401k. Ok, $140k isn't a small amount, but it's not enough to make or break your retirement that much, is it? If that's the amount that derails your retirement, then you probably didn't have enough saved in the first place.

• I was struck by one lady who had given her whole life to her career, was recently laid off, and now she'd lost everything that meant anything to her. She has no family and is all alone. It certainly was sad to see her.

Personally, I still like my 401k, am still contributing the maximum, and still expect it to recover in the years to come. In addition, I still have more in my 401k than what I have personally contributed (a fact that 60 Minutes said is common for many people), so I'm still ahead overall with what I feel is BIG upside left when the economy recovers.

Six Social Security Issues

I recently ran a series of guest posts on making the most of Social Security that was very well received. As such, I thought it would be useful for those of you who missed the series, to see all of the posts in one place, so here they are:

• Social Security 1: Planning Is Crucial

• Social Security 2: File Early If You Plan to Die Young

• Social Security 3: Delay Filing for Younger Wives and Homemakers

• Social Security 4: File, Repay and Refile to Get an Interest-Free Loan

• Social Security 5: File and Suspend for Soon-to-Be Widowed Homemakers

• Social Security 6: The 70-66 Strategy

Click on the one(s) you'd like to read. Or if you want to start at the beginning and read them all, click on the link at the bottom of the first post and keep going.

Social Security 6: The 70-66 Strategy

The following is a guest post from Marotta Asset Management.

Every retiree has significant choices to make regarding Social Security benefit options. One way to analyze the possible scenarios is by calculating the joint lifetime benefits for couples. This method suggests the higher wage earner should often delay filing to receive a maximum benefit at age 70.

If a higher earning husband opts to delay his retirement, the next decision involves when a lower earning wife should file. Let's consider the case of James and Betty Butterworth again. We have already established that if James is healthy, he should delay his filing. He should only consider the file-and-suspend option if his family history and/or personal health implies a premature death. Betty's short working life means she is only entitled to a small benefit of her own. Thus she will receive a spousal benefit from the point that her husband files, preferably at age 70, for the rest of his life.

You might assume Betty should file as soon as possible because she most likely will inherit James's increased benefit. But this decision may overlook the 25% penalty carried over from Betty's reduced personal benefit to her spousal benefit. Current retirees who file at age 62 have their monthly Social Security check reduced by 25%. If Betty files at 62 for her own reduced benefit, this 25% cut will apply to her spousal benefits. So instead of receiving half of James's increased benefit (e.g., $1,533 = half of $3,066) when he files at age 70, she will only get $1,149 monthly. If she waits until age 66 to file on her own record, her spousal benefit will not be reduced. The 25% cut does not carry over to survivor benefits. So in any case Betty will assume James's full $3,066 monthly benefit when he dies.

To avoid this reduction on both the personal and spousal benefit, Betty should file at age 66. This 70-66 strategy is a smart and very common way to maximize Social Security income for healthy couples. Waiting until age 66 means that Betty will receive her the full spousal benefit when James files. The 70-66 strategy can increase a couple's income 14% over filing early and 22% over both filing at full retirement age.

There's no incentive for a lower earning wife to delay her filing beyond age 66. Because a spouse can inherit no more than 100% of a benefit, filing at age 66 maximizes both spousal and survivor benefits. Thus no benefit accrues if both James and Betty wait until age 70 to file. He should file at 70 and she should file at 66.

If the wife is the high wage earner, her incentives are quite different. Unless she is much older than her husband, she will most likely outlive her spouse. But even in this case the wife should still consider delaying her own filing to secure maximum benefits for herself.

Interestingly, a higher earning married woman's Social Security income maximization incentives resemble those for a single person. Single people and higher earning wives should only consider their own life expectancy when making filing decisions. If healthy, they should delay filing. Filing early only makes sense for people who have reasons to doubt their longevity. Informed decision making should take all these calculations into account.

Delaying your filing means you could likely have a reduced income during these gap years. You may want to use that time to convert some of your pre-tax investments to a Roth IRA.

Converting some of the money in a traditional IRA to a Roth IRA requires paying ordinary income tax rates on the amount in question. If you can orchestrate some years in which your income is as low as possible by delaying Social Security benefits, you can minimize the tax required when the money comes out of your IRA.

To maximize your family's Social Security benefits, you must integrate Social Security legislation with your personal situation: your ages, earning histories and your best guess at life expectancy. Careful tax planning to anticipate future earnings and the potential for Roth IRA conversions should be part of your plan.

Finally, if you are eligible for Social Security disability or have been divorced, the rules become even more complex. Don't make these decisions quickly or carelessly. How you handle your choices about Social Security benefits can be worth more than a quarter of a million dollars.

Click here to read part 1 of this series.

Social Security 5: File and Suspend for Soon-to-Be Widowed Homemakers

The following is a guest post from Marotta Asset Management.

Our own death or the death of a loved one can be difficult to face. But mortality is one of the most critical factors to consider when making decisions about your Social Security. If you have little earnings of your own and your spouse is in failing health, there is a unique way to maximize benefits.

Don't dismiss this scenario out of hand. It is much more common than you might think. For example, David's grandfather died at age 72 and his grandmother lived until she was six months shy of 100. Men on average are slightly older than their spouses with significantly higher incomes. And we know they tend to die at a much younger age than their wives. When that happens, the difference between the best and worst Social Security choices can be worth over $90,000.

Healthy spouses with little earnings of their own should always encourage their partners to delay filing for Social Security. What changes in this special case is what they should do concerning their own filing.

Take the case of James and Betty Butterworth. James is four years older than his wife. Betty worked to help put James through law school, and then he started his own estate planning firm. She raised their five children and served on the boards of three local charities. Despite her lifetime of achievements, Betty is not eligible for Social Security benefits because to qualify requires earnings in at least 40 quarters.

James has just turned 66 and Betty is 62. Their plan was to file for Social Security when James turned 70, which would increase their annual income by more than 46% compared to filing when James is 66 (full retirement age). When James is 70, Betty will start receiving half of her husband's benefits until her husband dies, and then she will inherit his full payment as the survivor. Normally this is the best option, but then the Butterworths' circumstances take an unfortunate turn.

Betty is healthy, but James has just been diagnosed with cancer and probably will only live another five years. Assuming her husband dies in five years at age 71, Betty will begin receiving his full survivor benefit earlier than is typical for a spouse. In this situation, Betty only expects to receive one year of spousal benefits before jumping up to the survivor benefit. This would mean she would receive just a year of half spousal benefits (when she is age 66 and James is 70) before getting full benefits.

But there is a way for Betty to start receiving spousal benefits at age 62 and still inherit all of the increased benefits from her husband's delayed filing.

The Senior Citizens' Freedom to Work Act of 2000 provides an option that can boost total benefits payments for the Butterworths by as much as 10% over the second best choice. This new option is called "File and Suspend." It works this way: When James reaches his full retirement age of 66, he files for Social Security but suspends receiving any benefits.

Now that James has filed, Betty is entitled to apply for spousal benefits when she is 62. She will collect an extra four years of spousal benefits by using this strategy.

By suspending, James continues to earn delayed retirement credits of 8% a year. These delayed retirement credits allow his benefits to grow from 100% of full benefits when he is 66 to 132% of full benefits when he turns 70. And Betty will inherit this amount after he dies.

Betty is not able to step up to a higher benefit when her spouse files at age 70 because she is already receiving spousal benefits. But she will soon inherit a large survivor benefit, and those early years of spousal benefits really add up. James would have to live to at least 75 before Betty would have benefited from delaying her own filing.

Sadly, James loses his battle with cancer a year earlier than expected. He dies at age 70 and Betty inherits his stepped-up survivor benefit. But because they used the file and suspend option, Betty receives an additional $37,582. If she had waited until James turned 70 to file, she would not have received any spousal benefit.

In summary, the primary earner should often delay taking Social Security when the spouse's income has been significantly smaller in order to increase the survivor's benefits. And if the primary earner's health is questionable, consider file and suspend to allow the spouse to collect additional years of spousal benefits.

Click here to read part 6 of this series.

Social Security 4: File, Repay and Refile to Get an Interest-Free Loan

The following is a guest post from Marotta Asset Management. 

About half of retirees file for Social Security benefits early at age 62. By doing so, they receive only 75% of their full retirement benefits. And unless they die prematurely, they could lose out on more than $250,000 they might have received otherwise. So for many people, filing early is the worst possible decision.

Retirees who delay filing for Social Security until age 70 receive annual payments equal to 132% of full retirement benefits. If you don't mind some added risk, you can combine these file-early and file-late strategies by filing, repaying and then refiling.

To refile, you must repay everything you have received in benefits after you submit the Request for Withdrawal of Application, which also allows for a refund of the taxes you have paid. You can use this opportunity to file, repay and then refile in at least three ways.

First, if you have made the mistake of filing early, you can repay what you have received and then refile at your full or delayed retirement age. This ability to undo your selection will raise your monthly payment by 33% at full retirement age and by 76% at age 70. Some people who were expecting to retire at age 62 may want to repay their benefits because they are still working full time and being penalized on their work benefits.

Here's the second way this method is worth considering. You simply use it to gain a tax-free loan from the government. The only difference between filing late and filing early, repaying and then refiling is an eight-year interest-free income stream of payments from the government.

Refiling at age 70 can offer the best of both worlds. If you die before age 70, you have enjoyed benefits you would not have received otherwise. If you live to age 70, you will have succeeded in getting an interest-free loan from the government.

Consider the case of Leland Rockefeller again. If he files early, he will receive a monthly benefit of $1,742. Between age 62 and age 70, he could receive interest income. Even at just a 4% return, Leland could earn an additional $28,402 of interest before repaying and refiling at age 70. After refiling he will start receiving increased benefits in the amount of $3,066. The survivor benefit for his wife Candy will nearly double. The break-even point will come the year Leland turns 79. The benefits will continue beyond his death for as long as Candy draws a survivor's check.

But filing, repaying and then refiling does have a downside. Significant risks must be considered.

For example, Leland might die at age 69 before being able to repay and refile, having received only seven years of early payments. If Leland was single, his filing early at least would have resulted in getting some money. But because he is married, his young widow Candy could get stuck receiving his reduced benefits simply because he didn't live long enough to repay and refile.

This is not a trivial concern. Any threat to repaying means you might be saddled with one of the worst filing methods and miss one of the best. Before filing early with the intention of repaying and refiling, you must consider the worst case scenario: what will happen if you never get the chance to repay and refile. If Leland and Candy's Social Security benefits were both equally high, Candy would not be hurt too much by Leland filing early and then dying before he had a chance to refile.

Another danger of the refiling scenario is that when it comes time, you may not have the money. If you've invested poorly or spent the money, you may be shackled with reduced benefits for the rest of your life. Given the tendency of most retirees to file early because they can't wait to start spending their Social Security checks, the danger of not having the money when it comes time to repay is too risky for many households.

The potential benefit of filing and repaying is greatly reduced if you continue working beyond age 62. When you take Social Security, any income over $14,600 reduces your benefits by $0.50 for every $1 above that limit you receive as wages. It also doesn't work if you are trying to use the time between age 62 and 70 as low-income years to convert some traditional IRAs into Roth IRAs and thus minimize taxes during retirement.

Finally, a third reason to consider this file, repay and refile strategy is to gain an inflation-adjusted income stream starting at age 70. Repaying Social Security is a better return on your money than any commercial annuity you could buy. In the case of Leland, repaying his Social Security will provide him the benefits of a joint and survivor annuity at nearly half the price of commercial annuities offered through an insurance company.

The Withdrawal of Application asks you to explain why you are withdrawing your initial benefit application. You can simply respond that it's better for you financially or you are now working. About 100,000 people file a Withdrawal of Application each year.

Although filing early and then repaying can be risky, it is the least dangerous for a husband and wife whose benefits are roughly equal. In this case, either partner dying before refiling won't jeopardize the other's benefits. Additionally, both should have stopped receiving any income when the first one reaches age 62. This most commonly happens when spouses are the same age. Also, they should be fairly well off with no temptation to spend what they receive, and they should invest in stable vehicles, such as CDs that mature the year they turn 70.

Although this option of refiling is both riskier and more complicated than the more traditional choices, it can boost your benefit by an additional 3%. For the faint of heart, however, simply filing late provides 97% of the benefit with little of the risk. It also opens up the possibilities of working until age 70 or using those years to take advantage of Roth conversions.

Click here to read part 5 of this series.

Pay Down Your Mortgage or Sock Money Away for Retirement?

The following is an excerpt from the book The Sound Mind Investing Handbook - A Step-By-Step Guide To Managing Your Money From A Biblical Perspective 5th Ed.

“If we can’t afford to make extra principal payments on our home mortgage and at the same time put money into our retirement plan, which should have the priority?” . . .

. . . is a question I receive quite often. Unfortunately, there’s no one-size-fits-all answer—your age, your tax bracket, what you would do with the tax savings from your mortgage interest, how long you expect to live in your home, and your general attitude toward being debt-free all play significant roles.

Let’s say that two readers of this book who have different goals are each wrestling with this question. Rob is leery about the long-term health of Social Security and wants to begin building his retirement funds immediately. Mort thinks being in debt is more of a concern and plans to use any monthly surplus to make additional principal payments on his mortgage.

For comparison purposes, let’s make their two situations identical: They both have new $120,000, fifteen-year 6% fixed rate mortgages; both can set aside $1,100 out of each month’s paycheck (their monthly mortgage payment is $1,013, leaving them each an extra $87 for payment of the principal or investment in a retirement account); both are in the 31% tax bracket (25% federal plus 6% state), and both have the opportunity to contribute to a retirement plan at work that will earn 8%, which is 2% more than their mortgages are costing them.

When they make their first month’s mortgage payment, $600 of it is tax deductible as interest expense. This will lower each of their taxes by $186 a month (31% of $600). What they do with that $186 savings can make a big difference.

Let’s assume that both Rob and Mort would like to get their hands on that savings sooner rather than later. They would get it back when they filed their income tax returns anyway, so why wait? So, they both change the withholding instructions they give their employers so that about $186 less is withheld for income taxes each month. By adding that amount to the extra $87 left from their monthly surplus, they each now have an extra $273 to work with. Rob contributes his $273 into his company’s 401(k) plan while Mort takes his $273 and makes an extra principal payment on his mortgage.

Now here’s where it can really get confusing. To construct an accurate picture, we have to recognize that Rob gets a second tax deduction—this time for putting money into the retirement plan. Rob’s $273 contribution is worth another $85 tax savings, which he could then also put into his 401(k). But then that $85 contribution would save him an additional $26 in taxes, which he could also put into his 401(k). But then that $26 . . . well, you get the idea. If Rob took maximum advantage of this, he could ultimately put $396 into his company retirement plan that first month (his $87 monthly surplus plus the tax savings of $186 for mortgage interest plus another $123 in tax savings for contributing to the company 401(k)).

Assume that both men are able to take the maximum advantage of the available tax savings as the years pass. Mort pays down as much extra on his mortgage each month as he can and pays it off completely in a little over 11 years. At that point, he shifts all the money he formerly put toward his mortgage each month into his retirement plan. He also adjusts his withholdings to take maximum advantage of the tax savings his contributions create.

At the end of fifteen years, their experiences can be summarized this way. Both men had the same out-of-pocket expenditures—$1,100 per month over fifteen years, totaling $198,000. In return, they both accomplished paying their $120,000 mortgage loans in full and were able to invest for retirement. It’s interesting to note that, although they proceeded according to different time tables, Rob and Mort ultimately saved an equal amount ($35,043) on their taxes. This was due to each of them always taking full advantage of the tax-deductibility of mortgage interest and 401(k) contributions with their surplus dollars.

The important difference in their financial situations after 15 years is found in the value of their retirement accounts. Rob’s 401(k) grew to $107,092 and Mort’s to $79,392. Although they had both saved the same amount in taxes which could then be invested for retirement, Rob’s savings were “front-loaded.” That meant he could put them to work in his 401(k) earlier than Mort could. In this way, Rob was able to take greater advantage of the tax-deferred compounding of profits. The difference in his 401(k) would have been even greater if Rob’s employer contributed matching funds. Mort’s retirement account later came on strong, but Rob’s head start was too great.

Should you follow Rob’s example? Perhaps, but not necessarily. To make it work, you’ve got to be able to aggressively use all of the tax savings, and more important, you need 15 years of relative stability in your job, the economy, and the tax code. That seems to be asking a lot from the next decade.

The advantages of following Mort’s approach are: It more quickly provides the security of debt-free home ownership, which will better enable you to weather any economic storms; in case of an emergency, the wealth in your home is more accessible than assets tied up in a retirement plan; and while Rob’s return in the 401(k) could fall or (even turn negative), Mort’s interest savings on his mortgage is guaranteed.

Roth IRAs for Children

The following is a guest post from Harvey J. Poorbaugh, Editor of Fidelity Select Fundranker.

There is plenty of controversy over the relative merits of traditional IRAs and Roth IRAs for worker-age individuals who qualify for both.  In general, you get to deduct contributions to a traditional IRA up front, but you pay taxes when you withdraw money from it after age 59½ on both your contributions and whatever gains accrue; you don’t get to deduct contributions to a Roth IRA up front, but you don’t have to pay taxes after age 59½ when you withdraw money from it on your contributions or any gains that accrue.  Many variables make the decision very difficult to quantify, and some of the questions that arise can’t be answered without a crystal ball, such as what tax rates may be like in the future when you withdraw money from your IRA.

But what about that babysitting money or lawn mowing money your child makes while they are in middle school or high school?  What about that first part-time job they get at the corner drugstore?  It’s pretty likely that with their income level, they won’t even have to file an income tax return, and yet this income is considered after-tax income.  You couldn’t ask for a better situation for a Roth IRA to make sense.  Your child won’t pay income taxes on the income, but she can take full advantage of a Roth IRA.  Plus, that money will be in your child’s Roth IRA for a long, long time; time during which it can grow and grow and grow.

Your child’s Roth IRA contribution for 2008 (contribute by April 15, 2009) is limited to her earned income or $5,000, whichever is less.  With the jobs we’re talking about, she is likely to earn less than $5,000.  So do you ask her to give up her hard-earned money, which, since she made the effort to earn it, she must want for something else?  Well, that depends on your situation.  If you think getting your child set up with a life-long investment is important, and you have the means, you can spring for all or most of the money to put in it (you can give up to $12,000 per year to an individual without the gift being taxable).  After all, it probably won’t be a large amount the first few years.

You are probably asking, what if my kid only makes $50 babysitting the first year she makes any money?  Check with your bank or credit union to see what their minimum requirements are for opening a Roth IRA.  Many have very low minimums, so you can start very small.  Again, you can still open a Roth IRA for your child and make a 2008 contribution through April 15, 2009.

One of the advantages of a Roth IRA over a traditional IRA is that your child can make certain withdrawals from her Roth IRA before age 59½ without including the amounts as taxable income or having to pay a penalty:  for example, she can withdraw any or all of the contributions she makes over the years, or she can withdraw up to $10,000 for qualified first-time homebuyer expenses, even if they exceed all of her contributions.  Investment earnings that accrue in a Roth IRA are another story; if your child withdraws earnings (other than as qualified first-time homebuyer expenses) from her Roth IRA before age 59½, she will have to include those amounts as taxable income and will have to pay a 10% penalty, as well.

This is a great opportunity to teach your child the importance of saving for the future.  Show her how her Roth IRA may grow over the years from her contributions as well as investment returns.  Review various ways her Roth IRA can be invested and decide together which to use.  If you want your child to feel more ownership of her Roth IRA, you and your child could agree on a “company matching” strategy, where you play the part of the company and do the matching (probably way more generously than your company matches your 401K), and your child puts in some part of her earnings.

Why the Roth Conversation Is A Bad Deal For You

The following is a guest post by Neal Frankle from Wealth Pilgrim.  
 
Some very smart people advocate converting your IRA to a ROTH right now but I can’t understand why.

To be sure, if you convert your traditional IRA into a ROTH, your distributions from the ROTH will be tax free (assuming you had the money in the account for at least 5 years and you are over 59 ½) and you don’t even have to take distributions if you don’t want to.

With a Deductible IRA, you must pay taxes when you make withdrawals and the withdrawals are mandatory.

That’s all in the ROTH’s favor of course.

On top of that, account values are very low right now.  So even though you’d pay taxes if you convert to a ROTH, the taxes are lower because of the depressed values.

Sounds like a no-brainer in favor of converting….right?  Wrong.  It’s far from a no-brainer…..its very much a “brainer” in fact.

Let me explain by way of example. Assume the following:

1. You are in the 30% tax bracket (both before and after you retire).
2. You have $100,000.
3. You will generate retirement income from your account starting in 20 years.
4. You will earn 8% on your account until you retire.
5. You will earn and withdraw 5% of the value of your account starting in 20 years.

	Traditional	ROTH IRA
	IRA	Conversation
Initial IRA Investment	$100,000	$70,000
Rate of Return	8%	8%
Value in 20 Years	$466,000	$326,000
Withdrawal Rate	0.05	0.05
Gross Income	$23,300	$16,300
Percentage to You After Tax	70%	100%
Net to You	$16,310	$16,300

The first column illustrates what happens if you don’t convert your IRA.  We assume that this person’s total net worth is $100,000 and it’s all in his IRA. He invests his $100,000 at 8% for 20 years.  It grows to $466k which generates $23,300 in annual income on which he pay taxes and is left with $16,300 in annual income.

The second column illustrates the poor sap who converts to a ROTH.  This person starts out with $100,000.  He had $70,000 in an IRA and $30,000 in a checking account.  He converted the $70,000 to a ROTH and needed to write the Treasury a check for $30,000 to pay the tax. (Had he paid the tax from the Traditional IRA, the comparison would even be more lopsided against conversion).  So his ROTH is $70,000 and his checking account is empty.  He also grows the money at 8%.  After 20 years the account grows to only $326k and that only earns $16,300 but he takes that money and pays no tax on it.

As you can see, the income amounts are just about the same.  So why do I say that the Conversation is a bad deal?  Two reasons:

1. If you keep your traditional IRA, you get the tax break now.  If you go with the bird in the bush (otherwise known as the Roth IRA) all you get is hope that you’ll get a tax break at some point in the future -- maybe 20 or 30 years from now. You get to spend the next 20 years praying that Congress doesn’t change its mind.  Well…..after all….they’ve never changed the rules before….right?

2. Even though you MUST pay taxes on the ROTH conversion, you may actually never pay taxes on the Traditional IRA. Think about it.  What if you never withdraw the money? Even though you do have a required minimum distribution amount, you may actually outlive the IRA.  It happens all the time.  And if it does, you can pass the IRA to your beneficiaries and stretch out that tax deferral for decades to come.

The only time you might want to choose to convert is if:

a. You are in a low tax bracket now.
b. You speculate that your tax bracket will be much higher when you retire.

Instead of making this decision based on how much tax you’ll end up paying, make the decision based on which will create the most income for you over your lifetime -- net of taxes of course.

The example above shows that the net cash flow to you will be about the same regardless of the decision you make. That being the case, why take the chance that Congress will change its mind?  It just doesn’t pay.

Social Security 3: Delay Filing for Younger Wives and Homemakers

The following is a guest post from Marotta Asset Management.

Most retirees believe their only choices for Social Security are to file early or to file when they reach full retirement age. Furthermore, married couples make the mistake of only calculating benefits on each person's personal life expectancy. If you are married, look at joint mortality. With a little planning, you can boost your benefits significantly.

Social Security options are complex for married couples. Each spouse qualifies for three different types of benefits. Option 1: They can file for their personal benefit based on their own record of earnings. Option 2: They may file for spousal benefits based on half of their spouse's earnings. With each of these options, they have three choices: file early, file at full retirement age or delay filing and receive up to 132% of full retirement benefits.

Option 3 is for retirees who meet requirements for a survivor's benefits after their spouse predeceases them, based on their spouse's earnings record. Don't overlook this survivor's benefit when you are deciding when to file. Computing how long you must live to take advantage of late filing requires including the projection for survivor's benefits and considering the likelihood that each spouse might be the first to die.

For any couple in a situation where one should take the other's spousal benefits, joint longevity as well as the difference between their ages affects the filing options significantly. There may be many more years to collect survivor's benefits than personal benefits. Because women typically live longer and are more likely to have earned lower personal benefits, many men delay their benefits until age 70. Their wives thus inherit a larger benefit to use through possibly long years as a widow, a wonderful way to protect a loved one from running out of money.

For example, consider Leland and Candy Rockefeller. Candy met Leland in her tai chi class at the country club. Leland's wife had passed away two years earlier, and Candy was just beginning to think about marriage. They fell in love over a couple of bento boxes after class. She'd always wanted to see Tokyo, and he owned a penthouse suite on Shibuya Street. They honeymooned in the Far East.

Despite their age difference, they have been happily married for seven years. Leland is now 62 and considering filing for Social Security; Candy is 25 years younger. Second marriage has kept Leland in good shape, but the men in his family did not live to old age. He may not need the money either way, but he is tempted to take early benefits and get as much as possible while the system is still viable.

Candy, in contrast, has youth on her side. She enjoys excellent health and exercises regularly. And the women in her family have had impressively long lives.

When Leland dies, Candy can begin receiving a survivor's benefit as earlier as age 60. If he files early, she will receive a monthly benefit equal to $1,661 in today's dollars, but if Leland waits until age 70, she will receive a monthly benefit of $2,192. Her many years of receiving benefits far outweigh the possibility that Leland will die too young to enjoy his increased benefits. Clearly he should wait until age 70 before he files for Social Security.

Even if Leland dies at age 70 and does not receive a dime of benefits, so long as Candy lives past 76, it will have been worth it. Candy finds it enormously reassuring to know that even if she lives to be 100 she will have received $1,052,160, or 11% more benefits, because of Leland's wisdom in waiting to file. And if Leland lives to an average life expectancy of 81 and Candy lives to age 84, which is typical for women in retirement, they will collect $182,664 more because of Leland's delayed filing.

Healthy spouses with little earnings of their own should always consider encouraging their partners to delay filing for Social Security. Having little, if any, benefit accrued on their own work record, they will need to rely on their spousal and survivor's income benefits. This is a situation that homemakers and younger wives share. Only in a situation where both the spouses have a shortened life expectancy does it benefit a couple to file early. Delaying your filing for Social Security also allows you to earn additional income and save money without penalizing your benefits.

Another reason to delay filing is to gain a measure of longevity insurance. Dying young never jeopardizes a retirement plan financially. It's only when you live a long time that you risk running out of money. Filing late increases the money you will receive. And if you live a long life, the benefit of a later filing increases the longer you live.

Anyone who delays filing for Social Security should also consider another choice: filing, repaying and then refiling. This option is both riskier and more complicated, but it can boost your benefit by an additional 3%. We discuss this scenario in next week's column.

Too many impatient retirees take Social Security as soon as possible and miss out on thousands of dollars. Run the numbers and consider all your options before you make the decision when to file.

Click here to read part 4 of this series.

Social Security 2: File Early If You Plan to Die Young

The following is a guest post from Marotta Asset Management.

Social Security may be a Ponzi scheme, but it differs in one important way. Those who get paid early won't have to give the money back. Perhaps this explains why many people choose to start taking payments as soon as possible.

About half of all Americans file early for Social Security at age 62. In addition to their concern that promised payments may dry up in the future, many other factors motivate them. Some are behavioral finance mistakes, but others are legitimate.

Filing early exacts a steep price. Your Social Security benefits are permanently cut to 25% less than the amount calculated at full retirement. In 2009, full retirement benefits require waiting until age 66. So filing at age 62 translates to several years of early payments followed by getting 25% less for the rest of your life. Waiting beyond age 66 means getting extra benefits above the full retirement amount. Waiting until age 70 results in receiving 132% of full retirement benefits. People who file early receive about 44% less Social Security income over their lifetime than those who wait until age 70 when the maximum benefit is available.

Consider the case of aging rock star Capitan Danger. After decades of free love and rocking on, he finally began working steadily after he reached 50. By recording soundtracks for video games, he now has more than 10 years (40 quarters) of on-the-books income that has qualified him for Social Security benefits at age 62. At this point Danger has to decide if he wants to take retirement benefits early or wait until as late as age 70 to receive the highest benefit.

Studies show that if we refrain from smoking, exercise regularly, only drink alcohol moderately, and eat five servings of fruit and vegetables a day, we will enjoy an average of 14 additional years of life compared with people who adopt none of these behaviors.

Capitan Danger adopted none of those behaviors.

Although the average 62-year-old might live another 19 years, Capitan Danger will be lucky to survive more than 5 years. His body is beat up from his heroin addiction in the 1970s, and alcohol abuse has damaged his liver. And of course he doesn't ever pay much attention to the future consequences of anything.

Capitan Danger should file early for Social Security benefits. He can make his decision independently. Although he has known the love of many women, he never married any of them. One of the characteristics he seeks in a partner is her ability to support his lifestyle. Accordingly, his current girlfriend is years from retiring and earns more than he does anyway. She certainly won't need or be eligible to claim his Social Security benefits when he dies.

During retirement the Capitan has a disincentive to work. He must not earn more than $14,160 in 2009. Any overage will be taxed at 50%. That's fine with Danger because working too hard cramps his musical style.

He would have received a monthly benefit of $1,562 if he had waited until age 70. Beginning at 62, however, Danger will only get $887. By starting his Social Security payments early, he will realize $95,823 in today's dollars by age 70. It takes a while for the larger benefit that comes from delaying filing to overcome the immediate windfall of starting early.

Danger's break-even point is at age 80. He will receive the greatest benefit from filing early if he dies exactly at age 70. After that, no benefit will accrue in delaying his retirement income. He will no longer receive the delayed retirement credits that increase his benefit 8% in addition to the cost-of-living adjustment for each year he waits. If the Capitan lives to 82, he will have lost $20,016 by taking benefits early. At age 90, he will be $84,750 behind, and by age 95 his present hedonism will have cost him $125,209.

Sadly, Danger's hard living catches up with him and he dies at age 69, having used his extra retirement money as deposits on costumes and venues for a failed reunion tour of The Thankful Corpse, his former band.

People with shorter life expectancies and singles who will not be passing their benefit along to a surviving spouse are the best candidates for filing early for Social Security. Others are better off looking at other options. Women obviously tend to live longer than men. But Social Security does not discriminate by gender, so single men have an actuarial incentive to file before single women. Both minorities and poor people typically live shorter lives, which is also an incentive to file early.

You can see how critical it is to plan carefully before you file for Social Security. Because of all these moving variables, maximizing benefits changes every year as the age to file and receive full benefits keeps advancing upward. And it changes with every retiree's specific situation. But in each case, analysis begins with an estimate of projected benefits for both you and your spouse.

If you do not have a copy of the benefits estimate that Social Security sends out annually, you can request it at www.ssa.gov/estimator and then print the results. Or call the Social Security Administration at 800-772-1213. You can also get a copy of "Retirement Benefits" (Publication No. 05-10035) online.

Click here to read part 3 of this series.

Social Security 1: Planning Is Crucial

The following is a guest post from Marotta Asset Management.

Social Security benefits can represent a big stack of cash. A typical monthly benefit of $2,200 has a present value well over $500,000. Consider all your Social Security options carefully to avoid making a costly mistake.

Like all government law, Social Security is not a simple piece of legislation. Since the Social Security Act became law in 1935, hundreds of amendments have added to the complexity. To make the best decision, you must consider health, income before retirement, income during retirement and taxes.

Retirees cannot rely on commonly held beliefs. Don't assume that simplistic rules such as "Always file for early benefits" or "You need to stop working to receive benefits" are correct. There are specific cases that break every rule of thumb. And these one-size-fits-all answers leave many retirees failing to maximize the benefits they have earned.

At least four methods are used when electing how to take Social Security. And if you are married, the two of you can mix and match these in more than 16 different ways. Each one results in a different cash flow. By using the cash flows and the time value of money, you can determine which method will result in the highest net present value and offer you the best maximum value.

These methods differ significantly. They depend on your historical earnings, marital or divorce status, continued work in retirement, longevity and rates of return. The choice may be worth $250,000 of income or more. Filing options include "early filing," "standard filing," "delayed filing," "file and suspend," and many combinations of these options for married couples. It is certainly worth careful study and analysis of each one. Yet a majority of Americans make their choice impulsively and emotionally.

The decision is even more critical for women. For 42% of single women older than 62, Social Security is their sole source of income. Women on average outlive men. Thus planning for retirement is much easier for men, who tend to have more assets and die young. Widows are twice as likely to live under the poverty line as men who have lost their wives. And the poverty rate for elderly single women is 23% compared with just 5% for retired couples.

Couples must take their joint longevity into account before either one files for benefits. The person with the longer life expectancy will inherit either a wise or a foolish decision that will last a lifetime. Given that a husband's benefits are often higher and the wife's life expectancy longer, each case needs to be analyzed carefully.

Unfortunately, many people file after considering only one or two options in isolation. The Social Security Administration's new online filing system enables quick decision making. People can easily submit their request without any professional advice or planning.

Before filing, then, you obviously should be informed about all the options. To begin, you need to know your personal Social Security earnings and the projected benefits for both you and your spouse. You can request an estimate at www.ssa.gov/estimator and then print the results. Or call the Social Security Administration at 800-772-1213. You can also get a copy of "Retirement Benefits" (Publication No. 05-10035) online.

Social Security planning is crucial for everyone. People with significant assets should carefully consider both the lifetime benefits and tax consequences of Social Security in light of their overall portfolio strategy. For the less well off, Social Security benefits will dictate their retirement lifestyle. Proper planning could well determine what they can afford to eat.

Click here to read part 2 of this series.

Five Steps to Saving & Securing Your Retirement – That Work!

Here's a guest post from CFP Neal Frankle from Wealth Pilgrim.

If you are like a lot of people I know, your financial anxiety level is running rather high these days.  That’s understandable given the kind of turmoil our economy and market is going through.  Here is a list of 5 steps you can take to take a huge bite out of that anxiety today.

1. Don’t get ripped off.   This may sound obvious in the wake of recent scandals, but people are still getting ripped off – even after the exposure of the $50 billion Ponzi scheme allegedly run by Bernie Madoff.  There are 3 actions you must take to make sure you never become a victim of these fraudsters.  First, never make a check out to your financial advisor or give the advisor custody of your assets – no matter what. Free Money Finance had a good article that explained this issue not long ago.  The second step is to never give your financial advisor general power of attorney over your account.  If you have an advisor, you may have to give them limited power of attorney so they can trade. That might be ok.  But a generally power of attorney opens the door for them to clean your clock.  Never sign this document over to your advisor.  The third step is to insist on getting monthly statements from the custodian (TD Ameritrade, Fidelity, Schwab, etc) rather than only getting statements from your advisor.  This keeps everybody honest.

2. Forget about predicting the future.  If you predicted this market meltdown, call me immediately - I want to buy your crystal ball.  But if you are like most people, you didn’t see this coming.  Very few people did.  Since you didn’t see the top of the market cresting, don’t expect to know when the bottom will be reached.  Regardless of how bad our economy looks, you can’t predict what the market will do or when it will do it.  Don’t drive yourself nuts trying.  If you think back to March of 2003, market conditions were terrible.  The market had experienced 3 terrible years (2000, 2001, 2002), accounting scandals were a daily occurrence and….oh yes…we were about to invade Iraq.  Nobody would have expected the market to soar in 2003 – but it did.  Please don’t try to predict the stock market.  It will probably end up costing you more than you can imagine.
  
3. Invest 5 minutes a month and know exactly what you spend.  This is not as difficult as it sounds.  The best way I know to do this is to simply track your total withdrawals from your checking account.  As long as you run all your income and expenses through your checking account (and don’t work for cash and/or live off an ever expanding credit card bill) you can track this one number on your checking account and you will know what you spend.  Go back over the last 36 months and calculate your average monthly spending.   Get everyone in your family involved in this process.  Talk about how important this is and have a monthly meeting to discuss how you are doing. You’d be surprised how this step alone will help reduce spending.   Knowing what you spend is a super important number to have if you want to have a secure financial future.

4. Make sure you are not withdrawing too much from your investments.  If you have a balanced portfolio, it’s generally safe to withdraw 4% to 5% annually.  If your accounts have taken a hit over the last 12 months you have to re-evaluate your withdrawal rate.  Just because you could safely take $2500 a month out of your account 12 months ago doesn’t mean you can safely do this now.  If your withdrawal rate is too high, you run the risk of running out of money faster.  If your accounts have dropped 40%, your withdrawals may have to be reduced.  Don’t ignore this.

5. Understand your investment time horizon.    It’s easy to be very anxious about finances these days – but it may not be necessary. If you are very near retirement or even well into your retirement, you investment time horizon may still be longer than you think.  Here’s what I mean.  Let’s say you are 60 years old.  You plan to retire next year and you will withdraw 5% of your investment account to help make ends meet.  If you are female, you can expect to live another 20 years.  While you may not like what’s happened to your investment accounts, the only question you really need to ask yourself is if your money will last as long as you will. In this example, you should invest in such a way that your portfolio will last at least 20 years and keep paying out that 4% to 5% (plus inflation).  As painful as this sounds, the truth is, a person in this situation really must have equity in their portfolio.  If you think about it, a person in this situation really has plenty of time for the market to come back.  Just because you will retire next year doesn’t mean your investments should.   Your money still has plenty of years to work for you. Make sure you don’t squander those years by allowing your money to lounge around in low-paying CD’s.  If you have 10 years or more to invest – and most people reading this blog do – chances are that equity investments still have an important place in your portfolio.

These are all easy and common sense steps.  If you take the time to protect yourself, refuse to try to predict the future, track spending, make sure your withdrawals are appropriate and understand your investment time horizon, you’ll be far ahead of the game.  More important, you can eliminate financial anxiety.

Frugal Millionaires on Retirement and Credit Cards

Here's an excerpt from the book The Frugal Millionaires: 70 millionaires anonymously share their ideas about money to help each other and you. Today we're seeing what the millionaires have to say about retirement and credit cards. There's lots of good advice here -- as you would expect. After all, these people are doing pretty well financially.

FYI, these are some representative tips from The Frugal Millionaires. There are over 800 tips in the book. The frugal millionaires are only referenced by their initials. The author signed a confidentiality agreement that the millionaires' identities would never be disclosed in exchange for them saying whatever they wanted. If they chose not to have their initials used they were given the initials AFM which is an acronym for Anonymous Frugal Millionaire.

RETIREMENT

AFM – To have a great retirement work hard at keeping your marriage healthy and fulfilling. Not only is divorce unhealthy for your emotional and physical well-being, but it also devastates one’s finances. Think defensively when it comes to inheritances because of high divorce rates (approximately 50%). You cannot stop your spouse if they want a divorce. Always keep your assets separate; do not co-mingle them with joint marital assets!!! Will your assets to your kids. Otherwise you may see a portion of your estate going to your ex and even to their future spouse and their heirs. That sucks.

J&CB – The best thing one can do to prepare for retirement is to remove “stuff” from your life. Instead of “retiring” you free yourself to really enjoy life. In other words when you don’t have stuff holding you down there is the opportunity to retire often and whenever you want. Our goal these days is to maintain a small foot print so that we can live large (this is not a money thing). However, most people wait too late in life to realize how much “stuff” is impeding on their happiness.

VTN – People that develop a sense for money, building wealth, investing and retirement planning when they are still in their 20s seem to do well. (Not a scientific view, just my opinion.)

AFM – Retirement Planning Tips:

1) Create a plan working with, but not blindly relying on, a reputable fee-based third party you trust. They should provide objectivity and question your
sanity when needed.

2) Review the plan at least annually.

3) Know what you own and why you own it.

4) Have a disciplined plan to sell and stick to it (see 1 above) and take the emotion out of your investment decisions.

5) Make sure you have a will and review/revise it regularly.

6) Term life insurance is all most people ever need.

7) Repeat after me: a broker is a salesman, a broker is a salesman…

CREDIT CARDS
 
AFM – If you can’t afford to pay off the balance each month then you probably shouldn’t buy on credit. If you believe you have the self control to buy on credit, make sure you set specific limits on your credit and don’t exceed them. If you over extend yourself you can end up with credit card balances that you will be paying off for the rest of your life.

JSB – Don’t ever carry credit card debt! This is purely a “math idiot” tax on the stupid and undisciplined.

AFM – Pay them off every month or burn them.

How Does Your Retirement Nest Egg Compare?

Here's an interesting set of facts from US News. It lists how much people at various ages have saved in their 401ks. It includes lots of great information such as the median account balance based on salary range, the average account balance based on job tenure, and the average asset allocation for five sets of people -- those in their 20s, 30s, 40s, 50s, and 60s.

I'm in my 40s, so I looked at those numbers. I have only been at my current job for five years and though I max out my 401k contributions, the account isn't nearly as big as it would be if I had been with the same company for 20 years. Of course I have a sizeable IRA, the recipient of a few 401ks that I've rolled into it through the years. That said, here's where I stand versus the averages:

• Based on my salary range, my current 401k is below the median balance (there's that time issue kicking in), but my total retirement savings (this 401k plus other 401ks I've rolled into IRAs) is well above the median -- even with the recent beating these accounts have taken.

• For job tenure, my current balance is way, way over the average. The 2-5 year average is just over $31k and I've already said I max out my 401k every year, so it's evident that I'm out-pacing the averages here.

• 54% of 401k investments are in equity funds. I have 100% in equities (an index equity fund to be exact.) My total asset allocation is spread out among various types of investments in various accounts, but my 401k is all in equities.

It's interesting to me that the numbers for the 50s and 60s group aren't that much larger than the 40s group. Does this mean that people in their 50s and 60s today have been bad savers? Or maybe something happens in their 50s and 60s that slows down savings? You'd think that simply the growth of the money people had in their 40s would be higher than what is showing in the 50s and 60s group.

The numbers are interesting to me as I love "averages" and "median" numbers dealing with personal finance. If you like the same, you'll want to check out the US News piece. And if you get the chance, stop back and tell us all how you stack up against these numbers! I'm betting most FMF readers are well ahead of the pack. ;-)