Free Money Finance

Millennials Should Look at Retirement in a New Way

The following is a guest post from Riley at Young and the Invested.

Everywhere you look, Millennials seem to be killing something.  Whether it’s traditional products, definitions of convenience, working demands, or some other societal convention -- we constantly receive a bad rap. 

Despite this, we manage to get by.  Though I’ll admit to seeing some chronic problems among my peers when it comes to establishing good financial habits.  Nobody’s perfect.  I’m certainly not without error.

Things as common as living within our means, saving money, or setting aside enough to fund a traditional retirement fully. We make a lot of mistakes with money it would appear.

But why is that? What is driving this? Allow me to share my perspective as a millennial.

What We Want

I’ll be the first to confess, much like my peers, I don’t enjoy the idea of delaying my gratification and saving consistently to reach some eventual goal 30+ years in the future.  If pressed to place blame, I’d highlight things like long-term unpredictability, social media, and our on-demand culture.  

However, allow me to say this clearly: I don’t pretend to speak for my generation.  These are just some of the drivers I see -- ones I don’t see going away anytime soon.

Regardless of the culprit, it doesn’t look as though we’d do well with a modern marshmallow test.  Instead, we desire a life of convenience and immediate fulfillment because we have a high discount rate on what the future will provide. 

Simply put, we don’t know what tomorrow will hold.  For a generation who’s hooked on binge-watching television shows seasons at a time, we aren’t the most patient bunch.

I don’t say this to shirk responsibility for being patient. Rather, this post intends to demonstrate how we operate the best we can within our expectations for what life can deliver and what we’ve come to expect based on other areas of our lives.

Understandably, our circumstances differ from those who came before us.  What we have come to expect above all else are convenience, low-costs, and choice.

Preferably, we’d want these all wrapped up in an unforgettable experience, because they tend to make us happier. In short, we want a life with fulfilling experiences at a reasonable price when we want them. 

Retirement, What Retirement?

After seeing how the traditional demands of life have changed, why would this not also extend to reshaping our definition of retirement?  What I have come to find is I do not enjoy feeling constrained in my decision-making.  But then again, who does?

I think Millennials feel acutely annoyed by restrictions because we’ve grown up in a world where convenience is king.  We constantly seek methods to automate, scale, and reduce time commitments to time-intensive tasks when more expedient options exist.

From a retirement perspective, this means not wanting to stick to a strict schedule.  Why wait until our golden years to hit travel the world without consequence when we can travel hack with help from Reddit Churning there for less?

What millennials desire is to expedite our financial security thereby allowing us the independence to make decisions irrespective of financial concerns.  This would change our path and free us from a traditional retirement course.

Why do we want this?  The reasons should be self-evident: we want what we want when we want it.  That means cashing in those freedom chips sooner rather than later. 

After all, because we don’t know what tomorrow will hold, we want to live more today.  This makes us more inclined to delay gratification a bit less than our predecessors.  YOLO (you only live once), right?

Reaching Financial Independence Sooner Than Traditional Retirement Age

Millennials must confront unique resistances other generations didn’t have to face. Namely exorbitant student debt, stationary wages, increasingly-expensive homes, and impediments in career advancement.

As a result, I’m not of the mindset traditional financial advice applies to our generation in the way it did to our predecessors.

When people advocate for saving 10% of your earnings in perpetuity and relying on Social Security and Medicare to cover the rest in retirement, I’m not certain this will be enough for us to live comfortably in retirement.

Because we cannot afford to start saving for retirement as early as previous generations (see problems above) and we have less certainty of having entitlement programs existing in their current forms, we need to find another way to reach retirement.

As such, I advocate for pursuing financial independence rather than a traditional retirement.  And in order to do so, we should:

• Develop unique, in-demand skills to take up side hustles. Doing so will provide lucrative opportunities to reach financial independence sooner.
• Make investments in assets which provide passive income to cover our costs of living. This can come from investments like dividend-paying stocks, buying rental real estate like condos or apartments, or finding alternative investments which provide diversification for your investment portfolio.
• Learn to live within our means. By living on a budget, we can begin to improve our financial picture and prioritize the items in our lives which create sustaining happiness.
• Discover how to build wealth through investing in index funds. Building wealth begins with making wise choices, allowing those to play out over time, and remaining invested for the long-term. Compounding returns over extended periods of time are the surest pathway to wealth.

Financial Independence Sooner than Traditional Retirement Later

Using these four actions to guide your route to financial independence will be easier said than done.  Inevitably, all take time to develop but can be accomplished by anyone dedicated to living in a more financially-savvy way.

These should items can easily combine to cover our cost-of-living as well as leave room for financial growth. And because our efforts compound, I suggest seeking financial independence sooner, rather than later.

Looking at retirement in this manner will help millennials reach a state of financial peace of mind.  However, getting there requires steps which greatly differ from conventional retirement advice. 

Learning and adopting these strategies will free millennials to pursue their passions and give them the lives they want.

The Two Best Ways to Insure Income for Life During Retirement

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

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

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

A few thoughts here:

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

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

• My Best Financial Advice: Spend Less than You Earn

• Free Money Finance Guide to Making More Money

• Free Money Finance Guide to Getting Rich

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

The Four-Legged Retirement Stool

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Five 401k Mistakes to Avoid

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

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

Here are my thoughts on each of these:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Best Foreign Country for Retirees

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

The Best Foreign Country for Retirees: Mexico

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

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

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

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

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

• Save Money: Retire in Panama

• Retire in Style South of the Border

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

• The Best Retirement Plan is Simple

• Key to Retirement: Planning Ahead

• How to Have a Successful Retirement Savings Plan

• Retirement Wisdom: Review Your Savings and Plans Annually

• Key to Retirement Saving: Start Early

• How to Double Your Retirement

The Best Place to Manage Your Retirement Income

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

The Best Place to Manage Your Retirement Income: Fidelity

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

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

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

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

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

The Most Tax-Friendly State for Retirees

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

The Most Tax-Friendly State for Retirees: Delaware

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

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

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

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

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

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

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

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

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

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

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

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

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

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

How Much You'll Need to Save for Retirement

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

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

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

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

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

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

• The Best Retirement Plan is Simple

• Key to Retirement: Planning Ahead

• How to Have a Successful Retirement Savings Plan

• Retirement Wisdom: Review Your Savings and Plans Annually

• Key to Retirement Saving: Start Early

• How to Double Your Retirement

The Best Place for IRA Rollovers

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

The Best Place for IRA Rollovers: T. Rowe Price

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

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

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

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

The Best Low-Cost IRA

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

The Best Low-Cost IRA: Scottrade

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

A few thoughts on this:

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

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

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

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

Where to Put Your Retirement Savings

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

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

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

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

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

The Best All-Around Retirement Account

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

The Best All-Around Retirement Account: Roth IRA

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

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

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

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

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

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

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

Should You Contribute to a Non-Deductible IRA?

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

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

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

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

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

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

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

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

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

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

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

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

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

The Best 401k Plan

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

The Best 401k Plan: It could be yours.

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

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

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

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

Roth IRAs Make Great Estate Planning Tools

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Reverse Mortgages Are A Last Resort

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good Tips to Make the Most of Your Retirement Savings

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

Tips for building a strong 401(k):

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

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

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

Tips for every consumer:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

How Much to Withdraw in Retirement

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

Dear Marotta Asset Management,

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

--Ready to Retire

Dear Ready to Retire,

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

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

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

Reproduced in this table are some of the results:

Age: Withdrawal Rate 

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

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

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

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

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

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

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

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

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

Life Insurance is Not for Retirement Savings

Here's a piece from Money magazine that I'm in total agreement with. It's in response to a reader who asks about her insurance agent who wants her husband to forego funding his 401(k) plan and instead invest for retirement through a universal life policy. Here's Money's response:

It may be a good way for the agent to plan for his retirement. He gets a nice commission for selling you the universal life policy - which directs part of your premium toward insurance coverage and the rest into an investment or savings component that can grow in value over the years.

But although I'm all for insurance as a way to protect a family in the event a breadwinner dies - in which case, basic term insurance works just fine - I think it's a lousy way for you and your husband to save for retirement.

The piece then lists the reasons the author feels this way. Good stuff!

And just in case there are some of you out there ready to say "but what if...", there's this added to the article:

Now, I expect some insurance agent and advisers - many, in fact - would say that once you've maxed out on options like a 401(k) and IRA, then life insurance becomes a splendid way to save for retirement. But I don't agree.

Me neither. If you want to see Money's reasons for not agreeing, click through on the article link above.

My take:

• If you want to save for retirement, see Best of Free Money Finance: Retirement Posts.

• If you want/need life insurance, buy term life invest the difference.

Review: Retired with Husband

Here's a very, very interesting book targeted to a unique, large, and growing audience.

Imagine this: a ba-zillion baby boomers will be retiring over the next couple decades. Many (if not most) of them include couples where the husband worked and the wife was at home. Well, all of a sudden, the husband doesn't have to work (translation: he has no where to go every morning.) Think there might be some adjustment issues? You bet your bippy!

And that's just the dynamic that Retired with Husband: Superwoman's New Challenge is written to address. Here's what the book says it's about (regarding the issue of dealing with retirement):

Together, the couple meet specific challenges through specific strategies in order to:

• survive the transition into retirement by taking charge of their time and their home-management activities (laundry, cooking, cleaning...)
• improve communication with their parents, with their children, and with their friends
• reengineer their lifestyle by choosing wellness, agreeing to take risks for the good of others, and finding their giftedness
• find new ways to combine work and retirement while seeking continuous improvement

And this is EXACTLY what the book delivers -- in a fun, often hilarious writing style that many people will find enjoyable.

Not everything was roses and cute bunnies, though. The book had a few negatives for me including:

• It's written more for women than for men. In fact, guys, if you see your wife considering this book, you may want to hide it (or offer to buy her jewelry immediately -- anything to distract her) or else you could find your retirement chained to the dishwasher/washing machine. ;-)

• I'm not big on the combination of personal finances and humor, so after awhile the cuteness got to me.

• I don't really need this book now -- it's not written for me.

That said, if you're a woman who has a husband who is soon to retire, this book is perfect for you.

The Free Money Finance rating for Retired with Husband: Superwoman's New Challenge (based on my 0 thru 10 rating system) is: 6 Stars.

How to Double Your Retirement

Here's some advice courtesy of Marotta Asset Management on how to maximize your retirement savings:

Every six years you delay saving and investing you cut in half the lifestyle you will have in retirement. Here are ways to save and to invest that are simple and specific enough to keep.

Tell someone. Goals that are shared are ten times more likely to be acted upon. Don’t wait until you have everything set up to seek out accountability.

Set goals. If your goals aren’t concrete and specific they won’t be achieved. Your savings goals should be a specific annual percentage of your Adjusted Gross Income (AGI). We recommend saving at least 10% of your AGI in tax-free retirement accounts and another 5% toward retirement in taxable investments. If you are behind on your savings (over forty with less than three times your AGI in investments) you may want to save more in order to catch up.

Translate your percentage goals into specific numbers. I receive correspondence from readers on a regular basis who assume this advice somehow doesn’t apply to them because they are rich and my average reader isn’t or because they are lower income and my advice is targeted at the rich or some other nonsense.

If you are accustomed to living on $200,000 a year, you will need to save enough in order to retire with that same standard of living. Once you retire, it will not be any easier to cut back on your standard of living. If you think it will be easy, then do it now and save and invest the difference.

If you have a $20,000 per year standard of living, you will still need to save enough in order to retire with that same standard of living. You are lucky because you won’t need to save as much as the person with a $200,000 a year standard of living. If you think that it is too difficult saving now, imagine trying to live off $10,000 per year from Social Security.

So, put your specific annual savings goals down on paper, one for your retirement accounts and a second for retirement savings which will go into a taxable account.

Now, prioritize the retirement vehicles that you can use for retirement accounts. We recommend investing just enough to get the entire match that your company’s 401(k) plan offers first, then funding your Roth IRA accounts. After these two, make certain you have enough non-retirement savings. Beginning January 1st, you may also have the option of investing in a Roth 401(k) through your employer-sponsored retirement plan.

The purpose of prioritizing your investment vehicles is to deliberately put your money into accounts that have the greatest number of asset allocation choices and the lowest fees. Many company 401(k) accounts have such high fees and poor choices they frustrate investors.

As an example, imagine that your AGI is $60,000 and you decide to save 10% in a retirement account and 5% in taxable savings. That translates to saving $6,000 in retirement accounts and $3,000 in taxable savings. Your company offers a dollar-for- dollar match on the first 2% of your salary, so you decide to save $1,200 in your 401(k) first in order to get a $1,200 match from your employer. After this, you decide to fund your Roth IRA before investing more in your company’s 401(k) or IRA. Since Roth IRA limits are $5,000 per individual, this finishes off the remaining $4,800 for savings in retirement accounts.

The remaining $3,000 earmarked for taxable savings we recommend saving in monthly installments of $250 each month. Since finding the money to fund your Roth IRA at the end of the year is sometimes difficult, we recommend saving toward funding your Roth IRA each month by adding that amount to your taxable savings. In our example, we would save $7,800 a year in $650 monthly installments and transfer $4,800 into our Roth IRA at the end of the year.

Our example assumes that you need to build up your taxable savings. It might be better for you to fully fund your Roth IRA and your Spouse’s Roth IRA instead. Also, depending on your specific needs, you may need to save more than $9,000 a year in order to catch up and meet your retirement needs.

Next, to help you save, automate your savings. Automating your contribution to an employer-defined contribution plan is easy. Automating a taxable savings plan is just as easy. Most brokers offer an automatic money link between your investment account and your checking account. They also offer a monthly automatic transfer between the two accounts.

If your paycheck is deposited on the first day of the month, ask your broker to transfer money (in this case, $650) from your checking account into your investment account on the second day of the month.

From there, automate your investing. If $650 is being deposited into your brokerage account each month, designate an asset allocation that purchases $100 or more of five or six funds. Again, most brokerage firms make this process easy to set up and easy to change.

Once a year rebalance your portfolio. I recommend doing this some time half way through the year after your June 30th statement.

You can get much more sophisticated than this, but set your sights on getting the benefit of saving and investing with a minimal amount of work. After all, the whole point is that you haven’t been saving and investing because it is too much work. New Year’s resolutions, if they are to be kept, should be simple and specific.
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For more of my thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

Save for Retirement before College

Here's an interesting and useful comment left on my post titled More on the Financial Tsunami Waiting for Us All where I offered ideas on how to deal with the intersection of four major financial challenges many people will face in the years to come, namely:

• Saving for retirement
• Caring for aging parents
• Paying for college
• Kids moving back home after graduating college

Here's the comment:

I deal with people concerned about saving money for both retirement and college educations on a regular basis. The advice I give, which I believe many financial planners would give as well, is that saving for retirement should be a priority over paying for expensive educations. The reasons are fairly logical: not only is borrowing money for college fairly easy (and not terribly inexpensive) but your kids have their entire lives to make money and budget out funds for paying back student loans. Plus, federal programs such as Stafford and Perkins will subsidize the interest on loans while you are still a student (grad school included). Or, how about the fact that not everybody needs to go to a private university that costs $35k/year? I went to New York University and to be perfectly honest, I'm not sure I'd value my education at the $140k it cost me and my parents. I think about it every month when $175 is deducted from my checking account for the one year of school I was required to pay. It would be unreasonable for parents to cut their retirement funds short because they are overpaying for an optional private education.

The other two items, kids moving home and caring for aging parents, we see more often lately as the baby boomers really do start retiring. I even read an article about "baby echoes" (i.e. the large population boom we can expect starting after 2010 when the boomer grandchildren start springing up). These items are all related to demographic shifts- along with the whole social security problem.

What I find particularly interesting is the addition of caring for aging parents and kids moving back home into the equation. I'm not sure Suze is right about demanding 25% of take-home pay for kids. Kids moving back home doesn't usually raise living costs that much (except for food/electric and stuff like that). So, to prevent young kids from saving money to teach them a lesson I don't think is such a great idea. Suze knows about the time value of money. How about, rather than requiring a recent grad to pay rent, you demand they contribute $4,000 to a Roth IRA? That... would be teaching a good lesson.

I agree with the "retirement before college" thoughts, though if you concentrate on keeping your spending as low as possible, you should be able to save for retirement and put a bit away for college at the same time. One thing to add: there are tons of ways to save a bundle on college costs, so be sure you/your kids consider them in order to get the best education for the least amount of money.

As far as Suze's guideline to make kids pay 25%, she wasn't suggesting that the parents keep the money, but rather put it into a fund for the child's first house down-payment. (see the paragraph above the 25% note in the original post) That said, I'm fine with the Roth IRA suggestion as well, though it's likely that they'll hit the $4,000 well before the end of one year and will then need to put the savings in another place (maybe then put it into a housing fund.) Personally, I think either strategy is great.

Seven Steps Retirees Can Use to Control Health Care Costs

Rapidly rising health care costs is the wild card in many retirement savings plans. As I noted when I calculated my retirement number, rising health care costs was one of the main reasons I was so conservative in the amount of money I estimated I needed for retirement. If they keep going at current rates, they will be out of this world by the time I retire.

So I was really interested in this piece on MarketWatch that suggested seven steps retirees can take to lower their health care costs. Their suggestions:

• Improve the use of information technology to cut waste and achieve efficiencies.
• Reduce the toll of medical errors.
• Promote health and healthy behavior from infancy through old age.
• Prevent disease; not just cure it.
• Sharpen our focus on the growing problem of chronic diseases.
• Deal with the escalating cost of prescription drugs.
• Make sure that all Americans have access to the health-care system.

Yep, these seem like good ideas to me. In fact, I've already written about many of them. To see the details, click on the links below:

• Save Money by Correcting Medical Bills

• Money Saving Tip: Take Care of Yourself

• Save 50% on Health-Related Expenses

Of course, you'll still need to plan and save for retirement to be sure you have a long and prosperous life after work. For a list of my best tips on the subject of retirement, see Best of Free Money Finance: Retirement Posts.

More on the Financial Tsunami Waiting for Us All

I should have known it. The minute I write about The Bermuda Triangle (Plus One) of Personal Finance, I find a couple more articles on the subject.

For those of you not up-to-speed on what I'm talking about, I'm addressing the intersection of four major financial events that are happening to today's middle-aged adults. These are:

• Saving for retirement
• Caring for aging parents
• Paying for college
• Kids moving back home after graduating college

The first article I want to highlight discussing this issue is one by Suze Orman. She focuses on people who are dealing with both their children moving back home as well as caring for aging parents. Here's her advice for how to handle the first part of this issue:

Regardless of why the kids are back, the absolute worst move you can make is to welcome them without any financial expectations.

Charge rent. Insist that your child set up an automatic payment from their own checking account into a special savings account you set up. That savings account becomes their housing account. You aren't pocketing the money for yourself -- you're helping (OK, forcing) your child to save for a goal: being able to buy their first home, or more likely, at least have enough of a housing fund to cover some of their rental costs.

As for how much to charge, it should be a percentage of their take-home pay -- at least 25 percent.

You should also set a timeline for when they'll move out. Don't wait until you're at the breaking point; you don't want to have this conversation under the cloud of frayed nerves.

I absolutely love this advice. This is what I'll plan to do if our kids ever try to move back into the house. That is if they can get in once we have the locks changed. ;-)

Next, here are some of her thoughts on caring for your parents. Specifically, she suggests you discuss the issue of care with your parents and gives this advice on how to frame the conversation:

"Mom and Dad, I've been working on making sure I have the right documents in place to ensure my family is OK if anything were to happen to me. I'm wondering if you have everything in place, so that when the time comes I can carry out your wishes exactly the way you intend. That's so important to me. I want to make sure I can take care of you, and take care of your estate when the time comes, exactly as you want everything to be handled. And for that to happen, I need to make sure you have the right documents set up in the right way."

Suze then details what these "right documents" are -- so click through on the link above if you'd like more details.

The second article deals with the even more daunting (at least financially) issue of saving for retirement and college at the same time. Every piece I've ever read on this subject has the same advice -- and this one is no different:

I recommend that people avoid trying to do too much and, instead, adopt a realistic saving plan that focuses on the most important goals first and then moving on to secondary ones.

So which goals are most important and which are secondary? Well, ultimately that's a personal decision. But if you look at this issue in terms of what strategy has the best overall chances of securing your family's current and future financial security, I think the following three-step approach makes sense for most people.

• Have an emergency fund.
• Put as much as possible in retirement accounts.
• Once you know you're on track for retirement, you can start to think about other goals, such as saving for a child's education.

Basically, the thought is that only you can provide for your retirement. On the other hand, your kids can get scholarships and other financial aid to go to college, they can borrow money to do so, other family members may help pay for schooling, etc. If you don't save for your retirement, no one else is there to help you out.

I'm in general agreement with this thinking, but I'd add a couple comments:

• My preference is that people would control their spending enough to be able to save for retirement and save a good amount for college. This may mean they need to either control spending or earn more income. (or both!)

• There are tons of ways to save on college costs that can make it much more affordable. You can get financial aid or scholarships, take steps to save 50% on college, save money by studying abroad, or take any number of steps to save on college.

The Bermuda Triangle (Plus One) of Personal Finance

The October issue of Money magazine has an article on what I'm calling the Bermuda Triangle of Personal Finance -- trying to save for/fund three major financial milestones at once. The three all require massive amounts of money and are made all the worse by the fact that, for many people, they occur at about the same time in life. They are:

• Saving for retirement
• Caring for aging parents
• Paying for college

To these, you can add another financial hardship that many people have to deal with -- an increase in spending when kids graduate from college, then move back home (versus moving out on their own). Ouch! This is the last nail in the coffin. It makes an already bad situation worse!

More and more people are dealing with these issues. According to Money, only 7% of people in their sixties had at least one living parent in 1900. Now, in 2006, that number is 49%. And in 1990, only 25% of young adults between 18 and 24 lived with their parents. In 2000, it was 52%.

For us, I've already set our retirement number and feel pretty good that we're on the right track there. I still need to set our college savings number but my gut is that we're "ok" there. "Caring for aging parents" is a wildcard for us -- how do you even plan for it? And as far as the kids moving back, we're a decade away from even starting college, so we'll worry about that later.

But can you imagine what others are going through? People are trying to save $1 million for retirement, pay for college that can easily be $100,000, and care for parents at $50,000 a year or so. Yikes!

Money magazine says that most people are tempted to pay for their parents' care and the kids' college first, then save for retirement with what's left over (which isn't much). Money says this is a mistake and gives some advice on what to do instead:

Borrow money for college if you have to. Exhaust your parents' own assets to fund their care later in life. But remember that no one can contribute to your own retirement savings except you. Do that part right and your kids won't need to worry about becoming a part of the senior sandwich someday.

Ha! Maybe that's the strategy -- spend it all and count on your kids to take care of you! ;-)

Anyone out there dealing with/considering this issue? I'd certainly like to hear your thoughts on it.

How High Income Individuals can Fund a Roth IRA

One of the issues many higher income individuals face when planning for retirement is that they can't fund a Roth IRA because of income limitations. Well, now there's a way around the limits posed by the law (actually the law has changed a bit to allow the new actions). Here are the details courtesy of Marotta Asset Management:

Since its inception in 1998, the Roth IRA has been off limits to those with high incomes. Thanks to the Tax Increase Prevention and Reconciliation Act (TIPRA) signed by President Bush in May 2006, wealthy Americans will be allowed to convert their traditional IRAs to Roth IRAs beginning in 2010.

There are years and situations when a Roth conversion is not appropriate, but they are often surrounded by years when it should be considered.

Roth IRA contributions are always made with after-tax dollars. The principle grows tax-free and the account holder may make tax-free withdrawals once they hit age 59 ½. There are also no required minimum distributions for a Roth, which makes them helpful for funding the latter years of retirement.

Conversely, a traditional IRA allows before-tax contributions to grow tax-deferred, but not tax-free. During retirement, the IRS requires minimum distributions, all of which are taxed at ordinary income rates. So, you can either pay now or pay more later.

Getting your money into the Roth tax shelter is currently impossible for those with higher incomes. If your modified adjusted gross income exceeds $150,000 ($95,000 for individuals) you cannot make a full annual contribution to a Roth. The benefit is phased out for couples with a modified AGI between $150,000-$160,000 and for individuals between $95,000-$110,000. Currently, wage earners who exceeded these income limits may not fund a Roth.

But all that changes in 2010. Although TIPRA does not lift the income limits for funding a Roth account—we’ll call this the front door option—it does away with the income restrictions on converting funds from a traditional IRA to a Roth IRA—the back door option. Even though the front door will remain closed to higher wage earners, the back door option will be open to everyone.

To be more precise, the new law lifts a $100,000 modified AGI limit on both joint and individual filers wishing to do a Roth conversion. By creating the back door conversion option, big wage earners will be able to fund a Roth by funneling money through a traditional IRA and then performing a Roth conversion. Until 2010, only those with incomes below the $100,000 mark can convert their traditional IRAs to Roth IRAs.

During a conversion, account owners withdraw funds from their traditional IRA, report the funds as income, and roll them over to a Roth IRA account. The tax implications from the conversion will vary based on whether you took a deduction on the principal. If you deducted your IRA contributions, you’ll have to pay taxes on both the principal and the earnings. If you didn’t, you’ll just pay taxes on the earnings. I say ‘just,’ but either way, this could be a big bill. The good news is you can withdraw funds from your traditional IRA and convert them to a Roth without incurring the 10% early withdrawal penalty.

If you don’t have enough to cover the taxes on a full conversion, you can cherry-pick the securities you convert and do a partial conversion each year. To lighten the tax bill for conversions in 2010 (only), TIPRA will allow you to split the tax bill and pay half in 2010 and half in 2011. In anticipation of the new provisions, some are stashing away money in traditional IRAs with the hopes of converting to a Roth come 2010. But, the conversion doesn’t always come out on top.

Should you consider a Roth conversion? Probably. The lower your tax bracket and the longer you have until retirement, the more likely a Roth conversion will play in your favor.

Imagine John, age 60, owns two traditional IRA accounts. Each is funded with $5,000. Let’s assume he keeps the $5,000 in one IRA. But with the other, he uses some of the funds to pay the taxes due and then converts it to a Roth. Assuming John remains in the same tax bracket and the accounts deliver the same return on investment, each account will generate the same spending money in retirement. If John drops into a lower tax bracket after his retirement, the traditional IRA would have been the better bet. But if John’s taxes rise, the Roth IRA proves to be the better option.

Guessing your future tax rates is nearly impossible. Traditionally, it was thought your tax rate in retirement would be less than when you were working, but this is increasingly not the case. Tax rates are not adjusted for inflation, so many retired couples continue to creep into higher tax brackets. Also, tax rates are at a historic low and likely to rise if the political winds change. There are, however, two cases where the outlook is clearly in favor of doing a Roth conversion.

Clients who expect to see their tax bracket increase significantly—from say, 15% to 25%—will likely benefit from a Roth conversion. This is true for younger workers and also for new retirees. In the early retirement years, many couples dip into a lower tax bracket just after retirement but before Social Security checks start arriving. The taxes due on the conversion are more than made up once they are back in a higher tax bracket and able to take tax-free withdrawals.

Second, we encourage clients to consider a Roth conversion if they experience wild fluctuations in their pay from year to year. Again, converting while you are in a lower tax bracket will mean you keep more of your hard earned dollars in the long run.

Remember, no matter when you do your conversion, it must be done before Dec. 31st of the current tax year. One other important rule: you must be age 59 ½ or older and have held the account for at least five years before you can take a tax-free disbursement from your Roth.

Before you convert your traditional IRA, you’ll need to do some careful tax planning with your tax professional. You should consider your current and future tax brackets, your current and expected income, your time horizon until you begin withdrawals, and your estate plans. Taken together, these factors will tip the balance in favor of either the traditional plain vanilla IRA or the Roth. A professional can help you determine which path will yield the most value. To find a fee-only financial planner in your area, visit www.napfa.org.

Key to Retirement Saving: Start Early

We all can retire as fairly wealthy individuals. The key to doing this? Start saving and investing early. Check these posts out for more information on this topic:

• How to Retire Rich: Use the Power of Compounding

• Save Now, Retire Rich

• Start on Your First $1 Million at Age 16

• Getting Rich is Simpler than You Think

We're adding to this list of posts today with a piece courtesy of Marotta Asset Management. Their thoughts:

There is an urgency to planning for your retirement. Some choices can be postponed, while others will severely impact your financial freedom later in life.

I love math, especially story problems. One of my favorite goes like this: Tom is driving to a city that is 120 miles away. For the first 60 miles Tom averages 30 miles per hour. How fast must Tom drive the last 60 miles in order to average 60 miles per hour for the entire trip?

The answer is not 90 miles an hour. The answer is that it is impossible for Tom to average 60 miles per hour. Tom has used up two hours driving the first 60 miles and in order to average 60 miles an hour Tom must complete the remaining 60 miles instantly.

There are situations when you have fallen behind that it is too late to make up for lost time. Meeting your retirement goal is all about setting the right pace and taking the right road.

Retirement does not seem urgent. It is not a goal that will be solved today, this week, or even this month. But there is an urgency to long term planning.

Every six years you delay funding your retirement you cut in half your standard of living during retirement. Money makes money, and most of the assets you use to fund your retirement will come from compounded growth - not contributions.

If you fail to put your investments in the best investment vehicles, you could cut in half your standard of living during retirement. Select investments that are publicly traded with no hooks or penalties for selling. Avoid paying commissions and high expense ratios. They could ruin an otherwise adequate investment plan. Old 401(k)s from previous employers should be transferred into an IRA Rollover for more investment choices with fewer expenses. A, B, or C share mutual funds should be avoided.

Your current standard of living should be kept under control in order to provide automatic savings for your retirement fund. You should follow conservative assumptions in order to have a gradually rising standard of living during retirement. You should not keep too much money in cash, but invest for growth. You should invest much of your raises and most of any windfalls.

You should be smart about insurance and insure against catastrophic losses that you cannot plan for. You should be aware of the tax implications of financial decisions. You should understand the difference between "good" debt and "bad" debt. Therefore, you should use a mortgage appropriately.

You should guard your assets against inflation or the dropping value of the dollar. You should include stocks of the "value" and "small-cap" variety. You should limit your exposure to technology stocks. Be sure to include the healthcare sector. You should also invest in the world outside the US. You should balance bonds with hard asset inflation hedge stocks. And don’t tie up all your assets in real estate.

There will always be bubbles that are rippling through our economy such as technology stocks, fixed income securities, real estate, the US dollar and credit. While one category may do well this year, you should use all six-asset categories (short term money, US bonds, foreign bonds, US stocks, foreign stocks, and hard asset stocks). You will always need some growth, but you should reduce your risk gradually with age. You should avoid short-term timing of the markets in favor of diversifying for safety, and rebalancing your portfolio annually.

These prescriptions are urgent only because they should be accomplished in the next six months. Make sure that you take the time to get your family’s finances in order before it is too late or your retirement standard of living will suffer.

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Good stuff! Key quotes that warrant repeating:

• "Every six years you delay funding your retirement you cut in half your standard of living during retirement. Money makes money, and most of the assets you use to fund your retirement will come from compounded growth - not contributions."

• "Your current standard of living should be kept under control in order to provide automatic savings for your retirement fund."

• "Make sure that you take the time to get your family’s finances in order before it is too late or your retirement standard of living will suffer."

Retirement Wisdom: Review Your Savings and Plans Annually

As a normal course of managing my retirement, I look at my savings at least once a year (I have to if for no other reason than to up my 401k to make the maximum contribution allowed) and I recommend that everyone do so at least annually. This piece, courtesy of Marotta Asset Management, explains why an annual review is a good idea as well as offers suggestions on how to manage special situations that may pop up and impact your retirement plans. Their thoughts:

It is important to know how much you should be saving. Every year you delay adequately funding your retirement cuts in half your retirement standard of living.

Imagine Fred and Wilma, now in their forties, with savings of $250,000 and an income of $55,000. They project that putting $1,036 a month into savings this year will meet their goal of retiring at 65. But that projection is only good for the coming year.

Projections are like blinking your eyes open as you are walking quickly. They give you a quick snapshot of where you are and what direction you are heading. They allow you to adjust your next few steps, but as soon as your situation changes you need to blink another snapshot of where you are to keep from tripping up, or something worse.

I used to play that game when I was young. On an open field I could last several seconds with my eyes closed, but on a tight sidewalk or where there were people around I needed to blink open constantly. Sometimes no correction was necessary. Other times the correction was small. The goal was zero mistakes. When I felt unsure, I would blink open.

Market conditions change significantly every six to eighteen months. An annual blink open allows you make critical adjustments in the steps necessary to meet your retirement goals. Sometimes the change can be in a direction you did not expect. Consider the following changes:

Getting a $10,000 raise

If Fred, earning $55,000 a year, receives a $10,000 raise from Bedrock Quarries, can he and Wilma continue their same savings plan? No. They have suddenly dropped 11% behind on their retirement savings.

When Fred and Wilma were earning $55,000 a year and saving $12,430 their standard of living was $42,570 and they had 5.87 times their standard of living saved (250,000/42,570). With the increased earnings of $65,000 a year and the same savings of $12,430 their standard of living increases to $52,570. Based on the increase though their saving pace would reduce to 4.76 times their standard of living (250,000/52,570). Initially their $250,000 nest egg had completed 54% of their retirement savings, but after adding the $10,000 raise to their standard of living they slipped to only achieving 43% of their retirement savings need.

If Fred and Wilma’s standard of living goes up more than inflation, they drop behind on what they have saved. In order to keep their retirement goals on track, Fred and Wilma need to save $3,863 of their $10,000 raise.

Inheriting $100,000

Now imagine instead of getting a $10,000 a year raise Fred and Wilma inherit $100,000. If Fred and Wilma spend a significant portion of this windfall they will increase their standard of living without an annual income stream to support that lifestyle in the future. Every dollar of inheritance that is immediately spent has the effect of increasing their standard of living and therefore diminishing that multiple of their standard of living they have saved for retirement.

A better way to appropriate a sudden influx of cash would be to apply the entire amount toward retirement savings and then lower your savings to enjoy a higher standard of living. If Fred and Wilma chose to add their inheritance to their existing $250,000 of investments they could lower their annual savings from $12,430 to $8,906 – allowing them to spend $3,524 of their $100,000 inheritance every year and still stay on track to retire at age 65. Living off 3.5% of their inheritance (3,524/100,000) would allow Fred and Wilma to take a Brontosaurus Tour to Mt. Crustaceous every year and still be on track for retirement. Yabba-dabba-doo!

Most people though don’t choose to live off 3.5% of their inheritance and save the rest. It is a well-established fact that the tendency of human nature is to spend windfalls frivolously. Studies have shown that those who receive large sums of money immediately begin spending large percentages of it and become accustomed to a higher standard of living. They mistakenly believe that so long as they spend less than their windfall they will come out ahead. But the fatter the dinosaur, the more it insists on being fed. Once we begin spending found money, the $70 “gift” often primes the pump for a reoccurring increase of lifestyle!

Investment Returns

If the markets perform poorly, you need to increase your savings. But if the markets perform well, you can reduce your savings. Like driving in reverse, most people turn the wheel the wrong way and make these adjustments exactly opposite from what they should. It is difficult to put more into the markets when they are going down. Such a contrarian approach requires tenacious discipline.

In our example, if Fred and Wilma’s savings grow from $250,000 to $300,000, they can reduce their monthly savings by $147. (When the market goes up their savings can be reduced.) But if their savings drop from $300,000 to $250,000 they would need to contribute an additional $147 per month. (When the market goes down their savings should be increased to absorb the shortfall.)

Tax changes

Most of these numbers are computed in after tax dollars. More is required when saving pretax dollars due to the forced shrinkage from taxes. Also, if your tax rate changes, the amounts you should save pre and post tax change. Changes in tax rates are especially important for those who are small business owners, doctors and dentists as their income can fluctuate widely.

And if your income drops one year, that is when you should consider a Roth conversion. Most people would not consider a Roth conversion because it increases their taxes in a year when their income is low, but the long-term income gains outweigh the short-term tax within a few years.

So whatever financial changes come your way, an annual reviews guarantees that the changes in your lifestyle are minimized and the chances of meeting your retirement goal are maximized. Study an annual snapshot of your progress with an advisor you can trust. And keep blinking open along the way.

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

How to Have a Successful Retirement Savings Plan

Here's another good article on retirement planning courtesy of Marotta Asset Management. Today, they discuss the principles behind a successful retirement savings plan. Here goes:

The most successful way to save it is to automate your saving plan. Saved money makes money. And saved money making more money can make the difference between upper middle class and struggling middle class. Automate your savings, and you will automate growing richer.

A rich person is nothing but a poor person who has saved a lot of money. Save and invest as little as $100 a month for forty-eight years earning 9% and you can retire with a million dollars. Save and invest $1,000 a month for twenty-four years and you will have a million dollars. For $4,000 a month you can be a millionaire in twelve years. And for $10,000 a month you are there in six years.

The sooner you get started the less expensive it is to be a millionaire! The wisest financial decision you can make is to start – now! The key to getting started is simply getting started. Any amount is better than nothing.

A successful savings program must have the following five characteristics:

1. Savings must be regular. Every pay period, pay yourself first. Applying this one commitment will have a life changing cumulative effect.

2. Savings must be automatic. You won’t miss what you don’t see. Savings should be by default. We help our clients set up an automatic electronic funds transfer from their checking account into their investment account. The transfer is set up to take place shortly after their paycheck is deposited.

3. Savings must be adequate. While any amount is good to start with, your savings should ultimately increase to the level appropriate to meet your retirement goals. This amount should be reviewed and adjusted annually as your situation changes.

Whenever you get a raise, consider putting the greatest portion directly into increased savings. Increasing your savings when you get a raise is a lot easier than reducing your standard of living later.

If you don’t know what level of savings is adequate to meet your retirement goal, we are offering a Retirement Planning Seminar for those in the Charlottesville area on November 10th at our offices at the Boar’s Head. David John Marotta, AAMS will be the speaker. There is no charge, and a personal retirement projection will be computed for each attendee. Please call Bob Arms at (434) 973-0988 for date & time.

4. Savings must be diversified and balanced. Meeting your retirement goal is dependent on the safety and growth of your investments over long periods of time. Your investments should be diversified for safety while being invested for growth.

5. Savings must work for you. Your choice of investments should exclude those with high commissions and expense ratios. It may seem counter intuitive to pay for objective and unbiased financial advice, but fee-only financial planners have a fiduciary responsibility to act in your best interest. They are free of many of the conflicts of interest of those who sell commissioned based financial products.

By law, the SEC requires those involved in securities to disclose if their compensation is fee-only or commission based. This is often the fine print in financial documents. Ask specifically how someone is compensated before you accept his or her financial advice. And beware of the term "fee-based" which means that they charge a fee and are compensated from commissioned based sales.

If you are interested in finding a fee-only financial planner in your area, visit the National Association of Personal Financial Advisors at www.napfa.org.

Saving growth happens best when you aren’t paying attention. Set up your own savings program and put your plan for wealth accumulation on autopilot. Regular systematic savings is one of the seven principles to reaching your retirement goals.

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This is an excellent article -- I couldn't have said it better myself (which is why I ran this piece -- why re-create the wheel?). A few key quotes that I'd like to highlight one more time:

• "Every pay period, pay yourself first. You won’t miss what you don’t see."

• "The sooner you get started the less expensive it is to be a millionaire! The wisest financial decision you can make is to start – now! The key to getting started is simply getting started. Any amount is better than nothing."

• "Savings must be automatic. You won’t miss what you don’t see. Savings should be by default."

These are simple, basic, proven principles that, if applied, will make a tremendous, positive difference in your retirement savings. (And given the amount we all need to save for retirement, we need all the help we can get!)

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

Key to Retirement: Planning Ahead

Since retirement has been on my mind recently (not retiring itself, but planning for retirement -- I still have 20-30 years of work left), I've been writing a lot about the subject. Now that I've set my retirement number (and detailed how I did it), my main focus is on saving for retirement. But I know there are many of you out there who haven't even started putting together a plan. Yet if you want to be successful during retirement (i.e. you want to keep eating), one of the most important things you can do is to develop a retirement plan now and follow it to ensure your financial health after retirement.

That's the heart of this message shared today courtesy of Marotta Asset Management. Their thoughts:

Most families have not planned for their retirement. They may save toward their retirement, but without a plan their saving is random and haphazard. Retirement decisions today can only be made in the context of accurate math projections that span decades. Saving what you can and hoping for the best is an expensive and dangerous approach.

Every seven years you delay can cut your retirement assets in half. That means that if you under fund your retirement for the next seven years you will have to save double what you should have saved in the following 7 years in order to catch up. The price of procrastination is expensive.

Retirement projections are not simple. Assumptions are everything.

Consider the following algebra story problem: Imagine you knew for certain that you would earn $60,000 after taxes for the next two years but then would be unemployed the third year. How much would you spend the first year?

a) $38,065 b) $38,632 c) $40,000 d) $48,000 e) $56,400 f) $60,000

Even simple algebra can make financial planning intimidating. Those who enjoy math see the answer: $40,000. The equation is: 2 * $60,000 / 3 = $40,000.

But as inflation keeps pushing expenses up the buying power of a constant income goes down. At 5% inflation, $40,000 will only have the buying power of $38,095 in the third year. In our three year example, if we spend $40,000 each year, our buying power and therefore our standard of living will drop by the amount of inflation each year.

Adjusting for inflation, to keep our buying power constant, the three year spending amounts should go up by 5% each year: $38,065, $39,968, and $41,967. When we add compounded inflation the math grows more complex: first year spending = $120,000 / (1 + 1.05 + 1.1025) = $38,065. Using 5% inflation, you might assume that $38,065 is the right amount to spend the first year.

But when we save over a third of our salary the first year, we should invest that amount and earn interest. Investments that will be spent within the next two years should be invested in secure non-volatile investments. For example, we could invest the first year’s savings in a 2-year CD and the second year’s savings in a 1-year CD.

Assuming that a 2-year CD earns 3% and a 1-year CD earns 2.5% we should be able to spend a little more of our income the first year and allow what we have saved to grow the second and third year. Long-term investments usually make more than inflation, but short-term investments often do not. Also, our inflation estimate of 5%, though it is the historical average, is higher than the actual inflation of the past few years. We are being conservative in order to maximize the chances that we will achieve our goal of funding our third year.

Adjusting for what our investment will gain, the equation grows even more complex: What our first year savings will grow to plus what our second year savings will grow to equals what we can spend in the third year. In algebra the equation is: ((60,000 – x) * (1.03) * (1.03)) + ((60,000 – 1.05x) * 1.025) = 1.1025x where x is equal to the first year spending. Solving for x we have the first year spending at $38,632.

That’s a very complex formula for a very simple three-year plan. Without a plan some people would save 6% and spend the remaining $56,400. Others would save $1,000 a month and hope it will be enough because $1,000 a month sounds like a large amount. Those most blind to their coming unemployment would spend the entire $60,000 and run up their credit card debt when they are laid off.

Many retirement decisions are also blindly made without a plan.

In addition to inflation and interest, retirement planning needs to take into account taxes, capital gains, and the different savings vehicles: taxable and tax sheltered. Retirement planning also involves projections of accumulating assets for 40 years and spending during retirement nearly as long. The math may get complex, but the answers that you should know are simple.

First, you should know what percentage of your retirement goal your current assets can grow and cover. Second you need to know how much to save this year toward your retirement. Finally, you should know what rate of return will assure that you reach your retirement goal.

These projection need to be updated annually. A plan older than two-years old is hopelessly out of date. As your savings change they cover a different percent of your retirement goal. While market returns fluctuate and your standard of living increases, your monthly savings may need to be adjusted. And your investments should grow gradually more conservative as you get closer to retirement.

Retirement planning isn’t simply a matter of putting some money in a retirement account. It requires periodically working through the mathematical assumptions and projections required to ensure you will meet your retirement goals. Annual financial physicals ensure that your portfolio remains strong and healthy as long as you do.

Failure to plan for retirement is the primary reason why retirement plans fail.

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The key to retirement planning to me is time. As he says above, "The price of procrastination is expensive." If you start sooner rather than later, you can use the power of time and the power of compounding to your advantage to exponentially grow the value of your retirement savings.

If you want some specifics on how to set your retirement number, see my post on how I determined my retirement number and use one of the methods there to set your own goal.

Roth IRA vs. the Traditional IRA

Here's an interesting article courtesy of Marotta Asset Management dealing with the Roth IRA and the traditional IRA -- and which one's better for you. Here goes:

Albert Einstein referred to compound interest as “the greatest mathematical discovery of all time.”  However, earning compounding interest in a tax free environment is even better. Individual Retirement Accounts were created to give Americans an incentive to save for retirement by combining the benefits of compounding interest with a favorable tax status.

While both traditional and Roth IRAs allow investments to grow tax-free, they differ in their tax treatment. Your particular circumstances will determine which IRA is most tax-efficient for you. But in many cases, a Roth IRA offers some of the biggest tax advantages. So, how do you know which IRA to choose?

The Traditional IRA

As long as you (or your spouse) receive a paycheck, you are eligible to open a traditional IRA. And, depending on the size of your paycheck, your contributions may even be tax deductible. All contributions to an IRA grow tax-free, allowing you to take full advantage of compounding interest year after year. However, when it comes time to take a withdrawal, you’ll pay taxes on the money withdrawn - the vast majority of which may be earnings.

For example, T.J. opens an IRA and makes a tax-deductible contribution of $1,000. After ten years he retires and decides to drain the entire account. His initial investment has grown to $10,000. Because T.J. owns a traditional IRA, he must pay taxes on the full withdrawal amount of $10,000.

If you are tempted to postpone withdrawals from your IRA to avoid paying the taxes, think again. Soon after your 70½ birthday, all IRA owners must begin their Required Minimum Distributions. A traditional IRA will not let you enjoy the tax-free earnings forever.

Whether you are hoping to fund a traditional IRA or Roth IRA, caps on yearly contributions are the same. Account owners may contribute $4,000 per year in 2006 and 2007. Contributions limits rise to $5,000 in 2008. Thereafter, contribution limits will increase in $500 increments, indexed to inflation. All account owners 50 and over are permitted an additional “catch up” contribution of $1,000 per year.

In order to get money back out of your IRA without incurring a penalty, you must be 59½ or older. A handful of special circumstances will permit you to take early withdrawals. However, all non-qualified distributions will be subject to a 10% penalty in addition to any federal and state income tax.

The Roth IRA

The Roth IRA bears some similarities to its counterpart. Like the traditional IRA, contributions grow tax-free. But the defining difference of the beloved Roth IRA is in the way funds are taxed, or - better said - not taxed. While all contributions to a Roth IRA are made with after-tax dollars, the growth on the account is not subject to taxation.  When funds are withdrawn, neither the contribution nor the earnings are taxed. That’s right. All the growth in the account is tax-exempt, not just tax-deferred as with the traditional IRA.

Let’s assume that, this time, T.J. decides to opens a Roth IRA. He funds his Roth with an after-tax payment of $1,000. Ten years later, he decides to drain the entire account. Again, T.J.’s initial investment has grown to $10,000. But this time, with a Roth, he can withdraw all the funds, tax-free.

And if that wasn’t enough, Roth IRAs do not force you to begin required minimum distributions at age 70½. This difference is an effective planning strategy. Because there are no required distributions from a Roth, it should always be the last tax qualified dollars to be used in retirement. You are best to leave your Roth investments untouched and happily compounding.

While the face value of two IRAs may be the same, the taxes owed on traditional IRAs may dramatically reduce the actual amount you bring home. Sometimes it is clearer to plan ahead by looking behind. Remember back in the ‘50s and ‘60s when the top marginal tax brackets were close to 90 percent?  In comparison, today’s top tax bracket of 35 percent is a deal. Historically, income taxes have not been this low since 1931. Now is good time to move money into a Roth. Tax rates are probably going to increase, not decrease.

Making the right choice between a traditional IRA and Roth IRA is not always clear. Changing tax laws, your current tax bracket, your current and expected income, and how long you have until retirement are important factors in the formula. The foresight of an experienced professional can help you plan ahead. To find a fee-only financial planner in your area, visit www.napfa.org.

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I'm a big fan of the Roth IRA and highly recommend you use one as part of your overall retirement plan (I do!).

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

Fund a Teenager’s Retirement as a Multi-millionaire for Only $18,000!

As I've said before, there are only three simple steps you need to take to be rich. This article talks about them all -- suggesting that if you get your kids to save early enough they can retire wealthy. The article has been provided to Free Money Finance courtesy of Marotta Asset Management. Here goes:

We teach teenagers ten times more about sexuality than money. Many get the wrong message about what we expect them to be engaged in. Give this article to a teenager and encourage them to start a Roth IRA.

For an $18,000 gift over the next six years plus a little work on the teenager’s part you can completely fund a teenage child or grandchild's retirement in the multi-millions. Here’s how it’s done:

They can contribute to a Roth IRA to the extent they have earned income. Getting earned income requires some work on their part. They need to keep track of everything they earn. The work has to be real work and the income needs to be reported on their tax form. Contributions to a Roth IRA are after taxes, so a good time to start a Roth is after age 14 when they are no longer taxed at their parents’ rate.

The maximum contribution for a Roth IRA is $3,000 for 2003. Teenagers who have earned that much money often have other ideas for its use than funding their retirement. That’s where a parent or grandparent can offer the right incentives. You can offer to give to them any amount that they earn and use to fund a Roth IRA between 14 and 19 years old. They will work hard to fund their IRA and still have the money to spend. If they work very hard and earn $3,000 each year it will cost you $18,000 over the next six years. It will be worth the effort on both your parts.

Contributing $18,000 in the first six years and earning 11% will result in investments worth over a million dollars at the end of 39 years. If the process is started at age 14, the value of the Roth IRA will pass a million dollars at age 56, and be worth nearly 9 million at age 72!

Starting early makes a big difference. At the end of the first six years of $3,000 investments, the portfolio should be earning and reinvesting over $3,000 per year. That means that funding a Roth IRA for 6 years and then stopping results in more money than waiting until the seventh year, and funding it for the rest of your life! And if you start at age 14 and continue to contribute $3,000 each year, you will own results in a 18 million dollar portfolio at age 72 earning nearly two million dollars a year.

Teenagers don’t need to earn and contribute the maximum each year to benefit. Even funding a Roth IRA with $700 over six years starting at age 14 will result in a portfolio of over two million dollars at age 72. This incentive would only cost $4,200. Offering to match their funding with a gift is generous and provides an incentive for them to plan and save for their future, but families with less income can mentor their children through the process without matching their contribution. A financial planner can help set up the accounts, manage the investments, and explain the principles to the teens involved.

Everything that is true for a teenager is true for adults as well, so don’t forget to fund your own! Roth IRAs can be funded until April 15 using income earned in the previous year. The highest wage earners are not eligible to fund Roth IRAs, but their children, who file separately, are eligible. Because of their benefits, funding your Roth IRA should be one of your highest priorities.

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1. Spend less than you earn.
2. Invest the savings.
3. Do it for a long time.

Those are the simple keys to becoming wealthy. Helping you kids do the first two early in life will set them up for a financially secure future.

How Much Income Will You Need in Retirement?

Here's a piece from Yahoo that gives the three questions to ask about retirement savings. I'm going to discuss these in three separate posts so I can adequately cover the issues associated with each.

The first question is "How much income will I need in retirement to maintain my standard of living?" The key points:

Middle-income households tend to need a [income] replacement rate of 70% to 75% instead of 100% mostly because only part of Social Security is taxed and because saving for retirement usually ends once a person enters retirement.

According to the study, this wealth-to-income ratio indicates that people aren't saving enough of their income to finance their retirements. Indeed, the study concludes that 43% of households are currently at risk of not replacing enough of their preretirement income with adequate retirement income.

Wait a minute. You mean people aren't saving enough for retirement? Shocking!

Yeah, right.

Ok, these are interesting and useful points (though they aren't really "new" news), but the question doesn't really get answered. If you would like to see how much income you'll need in retirement, see my post titled How I Set My Retirement Number. It lists the five methods I used to set my number and should give you some pretty good guidance in coming up with your own as well.

And if you want more thoughts on retirement, see Best of Free Money Finance: Retirement Posts.

Five Money Mistakes to Avoid

Here are five money mistakes we should all avoid according to personal finance author Suze Orman. She claims that these are moves that men are more inclined to make than women, so pay attention, guys (and don't turn away, ladies). Here goes:

1. Funding early retirement with a home equity line of credit.

2. Not paying off the mortgage early.

3. Neglecting to make a will.

4. Refusing to take the investing long view.

5. Assuming the role of the family's sole money manager.

Ha! Boy, has she got us pegged! ;-)

Here are my thoughts on each of these:

1. Does anyone really do this? What a crazy idea! How about the strange concept of funding early retirement with something like, say, savings? What a novel concept, huh?

2. Oh, yeah, she's talking my language now! If you buy the right house, you should be able to pay your mortgage off in 10 years at the most. So what's the issue?

3. Yep. No one wants to make a will (including me). But we have to. Just read Do Yourself (and Your Family) a Favor: Read This, then Do Something About It and see if you don't agree.

4. Many people want to get rich quick with a "hot" stock tip. Me? I'd rather get rich slowly -- investing in index funds and letting the power of time and the power of compounding work for me.

5. I do most of the money management in our family, though my wife and I have regular money meetings to make sure we're on the same financial page.

The Best Retirement Plan is Simple

Since I've been working on my retirement number recently, the subject of retirement seems to be on my mind a lot more. Yeah, I still have over 20 years of work left -- even if I retire at 65, which I hope not to -- but it's still on my mind. Good thing too, since it takes a bundle of money to retire properly.

Here's a piece from Money magazine that suggests that the best retirement investment plan is a simple one. We'll start by laying out the scene -- and talking about how investment companies are finding all sorts of ways to "help" you out with retirement:

With the market struggling to eke out even meager gains this year, you may be tempted to look beyond traditional investments for something, anything, to fatten up your retirement account. Financial services firms, of course, are only too eager to oblige with a growing smorgasbord of "alternative" investments - oil-well partnerships, direct investments in privately held companies, foreign currency ETFs - that seem to offer an inside track to superior gains.

But just because it's easier to get into more "sophisticated" investments, does that mean you should? I say no. While exotic investments may seem like an ideal way to revive a flagging retirement account, they often come with risks and onerous fees that could derail your retirement rather than enhance it.

As many of you know, I'm pretty suspicious of financial services firms and financial advisors. Many of them are simply looking for ways to make your money become their money. Yes, there are good ones out there (I like Vanguard, for instance) but you need to be on guard. The bad seem to far out-weigh the good.

The article goes on to tell why these investments aren't a great deal for investors (for instance, many cost a fortune, thus severely reducing your total return) before getting to the bottom line:

My advice: Ignore the siren song of sophisticated investments. Either you'll end up paying huge fees for a magic investing touch that may or may not be there or you'll need incredible timing to come out ahead in the long run.

At the end of the day, what really creates the wealth you need to retire is the long-term growth potential of companies large and small. And you don't need fancy strategies to tap into that. You can do so by simply investing in a mix of low-cost stock and bond funds. The strategy does have three big advantages: It's cheap, it's unlikely to blow up in your face and, even though there may be occasional setbacks, it works.

Yep, I'm with them here. I'll be a bit more specific: index funds. I won't re-hash all the reasons I like them so much (see Why I Like Index Funds or Best of Free Money Finance: Investment Posts) but there are plenty of good reasons. And, no, they're not glamorous or exciting investments, but they certainly get the job -- which is what you want most when you're facing the menacing retirement monster.

For more on retirement, see these posts from Free Money Finance:

• Don't Take Early Social Security Retirement If You Don't Have To

• A Better Way to Set Your Retirement Number

• How Much Is Enough for Retirement Savings? (How to Set Your Personal Retirement Number)

How I Set My Retirement Number

Last week I posted I Set My Retirement Number and Boy It's a Doozy! and I had this comment from a reader:

If you don't mind sharing, I'd like a little more information as to the five methods that you used in calculating the retirement number. I'm particularly interested in the two methods of calculation that you devised yourself.

So here we go -- I'm going to detail how I set my number.

First of all, I googled around a bit and found three retirement calculators that were to my liking. Each of them asked different questions (and thus made different assumptions), so the answers varied more than a bit. However, I recorded the answers provided by Monroe Bank, Money Central and Dollar Times as three data points in setting my number. Then I set off on developing my own estimations in two different ways.

The first estimation was the simple "4% method." It's developed on the premise that you will be able to take out 4% of your nest egg in year one of retirement -- and if you can do this (and live on it) -- you'll be set throughout retirement. So here's what I did:

• I took the annual salary I would need today to retire. (Note: This was not figured as a percentage of my current salary or our living expenses. I simply determined what we would need to live on today based on actual expenses. I did not adjust downward -- as many people recommend -- since I like to be conservative and I assume any decrease in living costs at retirement will be eaten up by increased health care costs.)

• I adjusted for inflation (assuming 3.5% inflation per year) to get the amount I'd need to withdraw the first year I'm retired. In other words, I increased the number I got in step #1 by 3.5% per year for 23 years.

• I then divided this number by .04 (4% -- you can also multiply by 25 -- it gives the same result) and that was my retirement number estimate #4.

For further details on this method, see Will My Savings Run Out in Retirement? where they comment:

If you withdraw 4% of your personal savings during your first year in retirement and adjust subsequent withdrawals to compensate for inflation, you're virtually assured of never outliving your money over a 30-year retirement.

Remember, in my original post, I said I wasn't counting on anything from Social Security, so I have to save this entire amount myself. If I wanted, I could subtract what I already have saved (plus growth of that amount) to see how much MORE I need to save before retirement. 

By the way, this method gave me the highest estimate of all the methods I used.

As an example, here's what this method would look like for a person planning retirement:

• Let's say the person decides he needs $50,000 a year in today's dollars to retire.
• In 23 years at 3.5%, that number balloons to $110,306 per year.
• Divided by 4%, $110,306 means the person needs $2.8 million at retirement.

From this amount, the person could subtract what he expects to get from Social Security as well as what he thinks his current savings will be worth at retirement to get how much he needs to save in the next 23 years. For instance, someone counting on nothing from Social Security but who thinks his current portfolio will be worth $1 million at retirement only needs to save an additional $1.8 million (principal and growth) in the next 23 years.

My last method took all of the same steps I employed in the example above, but I just laid it out year-by-year. For every year (from now until I'm 92), I listed the following:

• My income needs (increased by 3.5% annually).
• The value of my current savings. I estimated annual appreciation at 6% to be conservative, but my spreadsheet allows me to change this rate to do "what-if" analysis.
• The value of additional savings -- the amounts I contribute annually to my retirement savings for the next 23 years. These numbers include both the amounts I save as well as 6% annual appreciation.
• A running balance for my retirement funds (the value of my current savings plus the value of additional savings less my income needs)

I then took all five methods, and averaged them to get "my" retirement number. This number was a bit higher than the one I got in method #5, so I felt that it was one that would allow me to reach the savings goals I needed.

I end up with lots more money when I die at 92 than I had at 65 when I retire -- my needs are just not as great as the growth of the amount I'll save. This could be looked at two ways:

1. I'm saving too much and thus don't need to put as much away.

2. This protects me against potential snags in my assumptions (what if it costs more to live than I estimate, what if I can't get the annual returns I have estimated, etc.?).

Finally, this number is not set in stone. I will re-visit it in 3-5 years, see how I'm doing and make any needed adjustments. I hope to put in more than planned in the next few years to really boost my savings, so hopefully that review down the road will show I've made good progress towards my goal.

The Five Costliest Mistakes Retirees Make about Social Security

As I've written previously, I'm not counting on any payout from Social Security when I retire. By the time I'm ready to retire, I think it either won't be around, won't pay much, or will raise the retirement age well past the time I'd get anything from it. However, if you're retiring anytime in the next handful of years, you will be getting something and should plan accordingly to make the most of your Social Security payout. I've suggested before that there's a best age to start Social Security (the later the better), but there's so much more than that to be considered.

Author James Mahaney recently emailed me a piece he co-wrote titled Innovative Strategies to Help Maximize Social Security Benefits. Part of this document lists the five costliest mistakes retirees make about Social Security. Here's the list and my comments on each point:

1. Underestimating the real value of Social Security. Key quote: "Some never take charge of this benefit [Social Security] because the discount the viability of the system in general. But whatever your personal beliefs are about the Social Security reform debate or a 'pay-as-you-go system', most new retirees have been paying into the Social Security system for many more years than they have contributed to their Defined Contribution plan. They can count on both as critical sources of retirement income."

Hey, is he talkin' to me? ;-)

I'm not going to ignore Social Security when I get to the age to "manage" it, I just have a hard time believing that it will be worth much in 25 years. I guess we'll see.

2. Rushing to collect, then regretting the reduced benefits for the rest of your life. Key quote: "And most [retirees] certainly didn't stop to think that they could potentially double their initial payments if they only waited until age 70."

I'm planning to wait as long as possible before drawing whatever Social Security has for me -- that's one advantage of not counting on it for anything (and saving myself accordingly).

3. Not understanding how one spouse's decisions affect the other one's benefits. Key quote: "In essence, the value of delaying Social Security 'lives on' as the higher benefit is passed on at death to a spouse. This is a wonderful way to protect a spouse from running out of money."

Good information here -- I never knew this. If you're close to retirement, you HAVE to read this piece.

4. Getting blind-sided by the "Tax Torpedo". Key quote: "The tax situation for the retiree is often worse than expected. Once a very low income threshold is met, every dollar received from an IRA causes up to 85% of a Social Security dollar to become taxed too."

Yikes! I had (mistakenly) thought that taxes would be much more of a non-issue in retirement. Guess again, huh?

5. Assuming that more control equates to more income. Key quote: "The inability to delay 'ownership' of their Social Security benefits may cost many retirees dearly."

Another great point -- and one that shouldn't be missed.

As you can probably tell by now, I highly recommend Innovative Strategies to Help Maximize Social Security Benefits for anyone that's close to retirement or even if you're simply interested in knowing more about Social Security and "best practices" for managing it for yourself or for someone you love.

Don't Take Early Social Security Retirement If You Don't Have To

A few months ago I wrote The Best Age to Start Social Security. The bottom line of the piece was that the longer you wait to take Social Security benefits, the better off financially you'll be. Most people do the opposite and take early retirement through Social Security. Here's some information from Kiplinger's on why you shouldn't take early Social Security retirement if you don't need to:

Working longer may be the key to financial security for many future retirees who haven't saved enough during their working lives. Early retirees accept a permanent reduction in benefits of 20% or more for the rest of their lives.

Every year you work past age 62 boosts your financial well-being in retirement. Not only do you avoid a reduction in social security benefits and increase your annual income, but you also avoid having to touch your retirement accounts, so they can grow tax-deferred for another year. In addition, you shrink the period during which you have to draw down your savings, trimming the size of the nest egg you need in retirement.

As we've discussed before, you may not be able to work as long as you'd like to before retirement, but if you can, you certainly should. Here's the difference it can make for a person currently making $77,000 a year and needing 80% of that at retirement:

• Retire at 62: Potential Income Gap to Be Funded by Assets after Social Security -- $26,760
• Retire at 66: Potential Income Gap to Be Funded by Assets after Social Security -- $19,200
• Retire at 70: Potential Income Gap to Be Funded by Assets after Social Security -- $8,712

Wow! I never knew it made this much difference!

That said, I'm not planning on getting anything from Social Security. When I retire in 25 years, either it will be paying a minimum amount or nothing at all. I'm assuming the worst (also known as taking the conservative approach) and anything I get will simply be gravy.

A Better Way to Set Your Retirement Number

Yesterday, I gave a simple method for setting your retirement number. Today, we're going to take the sophistication level up a notch with a suggestion from Kiplinger's on a more advanced way to set your personal retirement number. Here's an example they provide:

• Age: 45
• Current Gross Income: $75,000
• Projected Gross Income Before Retirement (Assuming current salary increases of 1.5% each year until age 65): $99,521
• 85% Retirement Spending Need Estimated: $84,593
• Social Security & Pension Income (Social security income of $19,380 based on Social Security Administration data plus a hypothetical pension income of $25,213.): $44,593
• Potential Income Gap to Be Funded by Assets: $40,000
• Multiply Income Gap by 25 to Arrive at the Number: $1 million

Not a bad method for getting a "rough" estimate of your retirement number, but here's what I would do differently:

1. I'd estimate more than a 1.5% annual salary increase. If this is all you get for the next 20 years, then: 1) you're doing something wrong in managing your career and 2) you're losing big ground to inflation in those 20 years. I'd at least use 3.0%.

2. I use 100% instead of 85% as the amount of income I'll need at retirement as a percent of my current salary. Why? Because of the wildcard of health costs -- there seems to be no end to them increasing. Besides, I prefer to be conservative, so if this change gives me more money than I'll need, that's fine.

3. I'm counting on zippo from Social Security. If I get $1, that will be $1 more than I expect.

Put all these together, and here are the new numbers:

• Age: 45
• Current Gross Income: $75,000
• Projected Gross Income Before Retirement (Assuming current salary increases of 3.0% each year until age 65): $135,458
• 100% Retirement Spending Need Estimated: $135,458
• Social Security & Pension Income: $0
• Potential Income Gap to Be Funded by Assets: $135,458
• Multiply Income Gap by 25 to Arrive at the Number: $3.4 million

Yes, my assumptions make a big difference and could be viewed as fairly conservative (especially on the Social Security issue), but you don't get a second chance to save for retirement. It's better to have more saved than you need than it is to get to retirement and realize that your standard of living needs to drop significantly for you to survive.

For tips on saving for retirement, see these posts:

• The Real Retirement Secret (How to Maximize Your Retirement Savings)

• Three Ways to Make Sure Your Retirement Savings Outlasts You

• Tips for a Great 401k

• 10 Tips to a Prosperous Retirement

How Much Is Enough for Retirement Savings? (How to Set Your Personal Retirement Number)

Here are some thoughts from Kiplinger's on various ways to set your personal retirement savings number:

A conservative rule of thumb suggests that if you withdraw only 4% -- or one twenty-fifth -- of your retirement nest egg during the first year and adjust subsequent annual withdrawals to compensate for inflation, you'll never outlive your money. Another approach is to estimate how much you'll need to withdraw from savings during your first year of retirement and multiply that amount by 25 to determine your target number. For a bare-bones budget, you'd need only half as much, or 12.5 times your initial withdrawal. Your personal number is probably somewhere in between.

It's a basic way of setting a number, but it does give you a range to consider (and believe me, it is a range -- there's a big difference between the "25" number and the "12.5" number.)

Also be sure that when you set the amount you'll need in year one that you adjust for inflation. For instance, if you need $50,000 in today's dollars, you'll need a heck of a lot more in 25 years.

Finally, you'll need to subtract (if you want to) any amounts you expect to get from Social Security. Personally, I'm estimating getting nothing from Social Security so any amount I do get will be a bonus.

For those of you who would like an example, here goes:

• Let's say you think you'll need $50,000 a year in income in today's dollars when you retire in 20 years.
• If you assume inflation of 3.5%, that means you'll need annual income of $99,489 when you retire.
• Multiply $99,489 by 25 to get the high-end of your retirement savings need: $2,487,225.
• Multiply $99,489 by 12.5 to get the low-end of your retirement savings need: $1,243,613.

As I said, this is a very simplistic way of setting your retirement number, and I'll be reviewing a few more-advanced methods in the next few days.

I Set My Retirement Number and Boy It's a Doozy!

Well, I finally took the time to set my retirement number as I've been planning to all year. And let me tell you -- it's big. REAL BIG!

Luckily, I have a good headstart since I've been maxing out my 401k for years and I have lots of time left to save (over 20 years). I have time to let the power of time and the power of compounding work for me.  Still, I have a long way to go. It's unbelievable how much you have to save to fund retirement these days.

When I set the number, I made some very conservative assumptions that made my retirement number higher including:

• I assumed no retirement support from Social Security.
• I retired at 65 (though I'd like to work longer).
• I set the return on my savings at only 6% -- an amount I think I can beat.

From there, I used five different methods to set my retirement number -- two I created myself and three I found on the web. Then I took an average of these five (and they did vary by a decent amount) and set that as my retirement number.

I suggest you do the same -- come up with a concrete number that you need for retirement -- and then start saving for it. Otherwise, how will you know what you need and what you should save to get there?

If you want some thoughts on retirement, check out these posts from Free Money Finance:

• How to Retire Rich: Use the Power of Compounding

• Save Now, Retire Rich

• 10 Tips to a Prosperous Retirement

• Free Money Finance Guide to Saving for Retirement

• Tips for a Great 401k

Now -- I need to set a college number for my kids!!!!!!!

Best of Free Money Finance: Retirement Posts

Here's a list of what I consider to be some of the best retirement related posts here at Free Money Finance (sorry this is long, but there's lots of good stuff here. I'll try to update this more frequently so it's not so big a list next time):

General Retirement

• How to Retire Rich: Use the Power of Compounding

• Save Now, Retire Rich

• 10 Tips to a Prosperous Retirement

• The Best Age to Start Social Security

• Three Ways to Make Sure Your Retirement Savings Outlasts You

• Why You Need a Roth IRA

• Ten Ways to Pay for Retirement

• Free Money Finance Guide to Saving for Retirement

• Save Money by Retiring in Dirt-Cheap Buenos Aires

• The Keys to a Great and Prosperous Retirement

• Top 10 Things to Know About Retirement Planning

Planning for Retirement

• How Much Do You Need to Save for Retirement?

• The Real Retirement Secret (How to Maximize Your Retirement Savings)

• Setting Your Retirement Number

401ks

• Tips for a Great 401k

• Advantages of a 401k

• Making the Most of Your 401k

• Why Contributing to Your 401k is Vital to Your Financial Health

• Retirement Dynamic Duo: 401k and Roth IRA

• Figuring Out Your 401k

• The Money Move You Must Get Right: Rollover Your 401k the Right Way

• What to Do with Your 401k Money: Roll It Over into an IRA

• Company Stock in Your 401k (How Much You Should Invest)

Working Longer (Postponing Retirement)

• An Easier Way to Fund Your Retirement

• Funding Retirement: "Keep Working" May Make Sense, but Isn't Always Practical or Realistic

• Alternatives to Retiring that Will Make Your Money Last Longer

• Don't Retire, Keep Working

• 7 Reasons Not to Retire

Retiring Early

• A Simple Guide to Retiring Early

• How to Retire Early

You Probably Will Have to Retire before You Want To (And You Need to Plan for It)

We've discussed the "working past retirement age" issue from both sides quite a bit. On one hand, if you can work later in life (past 65), you can stretch your retirement savings a lot farther (and it's even good for you to keep working.) That said, "keep working" may make sense, but isn't always practical or realistic. Many people have brought up this issue in comments, and today we'll add a piece from Yahoo to that list. Their key thoughts:

Rocco's story could serve as a cautionary tale for boomers who think they'll be able to fill the gaps in their retirement savings by working longer in their current jobs. It also illustrates the challenges for those who assume they alone will determine exactly when they'll retire.

The stark reality is that most of today's middle-age workers who want to continue working after 60 or even 65 will need to find a new source of income. While nearly half of baby boomers expect to work past 65, only 13% of current retirees surveyed this year by consulting firm McKinsey & Co. actually worked past that age. Forty percent of current retirees were forced to stop working earlier than they had planned, the survey found. The average age when current retirees left the workforce: 59.

As of 2005, just 60% of 60-year-olds, 32% of 65-year-olds and 19% of 70-year-olds were employed, according to the Bureau of Labor Statistics. Current retirees cited two primary reasons for quitting sooner than planned: illness and unemployment (job loss or downsizing).

Let's digest this for a minute. Here's what I'm getting out of this:

• In most cases, people will not be able to determine whether or not they'll be able to continue working -- especially at their current salary.

• Many of these people will have several years left even before Social Security kicks in.

So, this leads me to believe that we should all be setting our retirement ages at 59 and saving for retirement as if that's the age we'll need to go it on our own. And if we're able to keep working at that age, then that's great, our finances will be much better off when we do eventually retire. If we're not able to keep working (for whatever reason), then we'll be set based on our own savings.

The article goes on to share several other worthwhile pieces of information. For instance, it presents the two sides of the "is it harder for older workers to find employment or not?" debate. Here's the support for the suggestion that it is harder for older workers to find work:

To test whether age bias is real or imagined, researcher Joanna Lahey sent out about 4,000 résumés to firms in Boston and St. Petersburg, Fla., and measured response rates from employers. The results: A younger worker is more than 40% more likely to be called for an interview than a worker 50 or older, according to the 2005 study done through the Center for Retirement Research at Boston College.

Another sobering statistic: The average period of unemployment in 2005 was 24.1 weeks for job seekers 55 and older, compared with just 17.8 weeks for those under 55, a report by AARP found.

"It's a huge issue, and it really comes down to, 'How do I, the established job seeker who is 50-plus, how do I establish my differential advantage so it distinguishes me from my younger counterpart?' " says Damian Birkel, a career counselor and founder of Professionals in Transition, a support group for the jobless in Greensboro and Winston-Salem, N.C.

There is a great solution to this issue. Here's the one I thought of immediately:

Frustrated by the dearth of good jobs, older workers are increasingly becoming independent contractors or starting their own businesses.

Among workers 50 and older, 16% are self-employed vs. 10% for the overall workforce, according to a 2004 AARP study. About one-third of older self-employed workers started their businesses after 50, AARP said.

Self-employment allows older workers to put their years of experience to use. It usually also offers more flexibility than a traditional job. Fifteen percent of self-employed workers 51 and older reported having a health condition that limited the type of work they could do, compared with 8% of salaried workers in that age group.

And just to complete the debate, there's reason to believe that it may eventually be easier for older workers to find employment:

Employers are expected to face a skills shortage in coming years, and baby boomers provide a varied and experienced labor pool. Over the 2004-14 decade, total employment is projected to rise by 18.9 million jobs, or 13%. Over the previous decade (1994-2004), total employment grew at the same annual rate and rose by 16.4 million jobs, according to the Labor Department.

Here's my advice: plan and act as if it all depends on you and assume the worst-case scenario. Assume you'll need to retire at 59 (which really isn't the worst case, but it's a good estimate) and that you need to fund your retirement 100% yourself. Then start saving accordingly. At the same time, start developing hobbies and/or other business interests that could turn into a full-time job when you retire. Finally, get active! Studies show that exercising your mind and body are great ways to make sure you live a longer, healthier, and happier life. Doing this, you'll help to take at least one of the late-life employment challenges (illness) out of the equation.

A 401k is a Great Deal Even Without a Company Match

As you may know, I'm a big fan of 401ks (because of all their great advantages) and I've noted a few times that I max mine out each year (and have been doing so for years). Along the way, I pick up a good amount of free money because my employer does give a company match to employee contributions. But what if an employer didn't match? Would a 401k still be a great deal?

That's exactly the question a reader asked Money magazine. The reader's employer didn't match contributions and he didn't expect to be in a lower tax bracket when he retired, so he was questioning whether or not a 401k was worth it. Money runs the numbers and says that a 401k is a great deal even without a company match. Here are some of their comments:

Granted, a company match makes a 401(k) a better deal. But I wouldn't be so quick to dismiss a 401(k) without the match. The long-term tax-deferred compounding of gains you get in a 401(k) alone may be enough to make it a better bet than the alternative you're suggesting. It really comes down to how big a jump in tax brackets you're likely to make and how tax efficiently you can invest outside the 401(k).

When you consider that the 401(k) is such a simple way to save - I mean, all you've got to do is sign up and the money is deducted from your paycheck before you get your greedy little lunch hooks on it - I think it would be a mistake to forego the 401(k) just because you might end up in a higher tax bracket.

Good advice and I would agree.

Then Money goes a step beyond the question and recommends a Roth IRA for the questioner. Their thoughts:

I think it would also be wise for you to contribute to a Roth IRA. Why? Well, with a Roth you pay tax on your contribution, but you get to withdraw the money from your account tax-free later on (assuming you meet certain conditions). That's a big advantage if you end up in a higher tax bracket because you're effectively arbitraging the tax system in your favor - that is, paying taxes today when you're at a lower rate and avoiding them in the future when you would be in a higher tax bracket.

Actually, if you invest the max in a Roth it's a better deal if you stay in the same tax bracket and possibly even if you fall into a slightly lower one because doing the max in a Roth effectively allows you to earn a tax-free return on more dollars.

There are a couple of other benefits to doing the Roth. You'll have a pot of money in retirement that isn't subject to income tax, giving you a benefit I call "tax diversification," which is a fancy way of saying your entire retirement stash isn't at the mercy of wherever income tax rates happen to be after you retire. And you can also leave your money in the Roth the rest of your life if you wish. With a 401(k) or traditional IRA, you've eventually got to start making required withdrawals, which means some of your money is no longer sheltered from taxes.

Good stuff. I often recommend the 401k/Roth IRA combination (more on that later). It's a powerful duo that can really super-charge your retirement planning.

Finally, Money makes the bottom line recommendation for this reader:

So max out on the Roth, then put as much as you can in your 401(k) and if you still have savings left over, then go ahead with your tax-efficient investing plan. This three-pronged approach would really make you a model of tax diversification.

This is a bit of a different order than for someone who does have a company match (In that case, the order would be: put money in the 401k to get the entire match, invest in a Roth IRA, put any remaining amount into the 401k until you reach the maximum contribution), but since this reader doesn't have a company match, this seems like good advice to me.

For more information on 401ks, Roth IRAs, and retirement, see these links from Free Money Finance:

• A Simple Guide to Retiring Early

• Figuring Out Your 401k

• The Real Retirement Secret (How to Maximize Your Retirement Savings)

• How to Retire Rich: Use the Power of Compounding

• 401k Tips

• 10 Tips to a Prosperous Retirement