Money magazine lists six money dilemmas and what to do about them. This is the last one of the group I've been posting on the last few days. Here goes:
Dilemma #6: Take Social Security early OR late
Money's suggestion: If you're healthy and don't need the cash, wait.
My take: This is a long way off for me, and I'm counting on absolutely nothing from Social Security as I save for retirement.
That said, I think at this point we'd take advantage of the hybrid Social Security strategy for couples. And if it ends up that this won't work, I think we'd wait to take Social Security. We won't need the money, so we'd be willing to bet on the fact that we'd live longer and get more benefits in the long run.
FMF posts related to this topic: An Interesting Strategy for Taking Your Social Security Benefits, When to Take Social Security
What's your take on this issue?
Whether or not you think Social Security needs "saving" or not, I think we could all agree that it at least needs a few fixes. Money magazine has a series on what the leading presidential candidates say they'll do to fix Social Security. Here are the highlights:
Here's my position on each of the four factors:
A few other comments/things I noticed in the info above:
1. I'll be glad when we get through Iowa/New Hampshire and the presidential field gets weeded out a bit. I'm getting tired of listing all these candidates. ;-)
2. Clinton says she won't "cut benefits or raise the retirement age." As you can see, I'm not on the same page with her on this one.
3. Obama and Edwards want to impose Social Security payroll taxes on income over $200,000 a year. Nope, I'm not with them either.
4. Richardson seems to be the only one that thinks all is well.
5. Some ideas that interest me (not sure if they'd work or not, but I'd like to hear more about them):
Money magazine lists six money dilemmas and what to do about them. Over the next few days, I'll list each dilemma, what Money suggests as the best option, my take on the issue, and additional FMF posts on the topic. Here goes:
Dilemma #2: Save in a Roth 401(k) OR a regular 401(k)
Money's suggestion: Unless you are on the verge of retiring and know your income will drop, the Roth wins.
My take: I'd take the Roth if I had the chance (even if just for the tax diversification versus my other retirement savings), but this isn't really a dilemma for most people. Why? Because the Roth 401k isn't widely available. It just isn't offered that many places.
FMF posts related to this topic: Nine Keys to a Great Retirement, Five Reasons You'll Love a 401k
What's your take on the issue? Anyone out there have a Roth 401k?
Money magazine lists six money dilemmas and what to do about them. Over the next few days, I'll list each dilemma, what Money suggests as the best option, my take on the issue, and additional FMF posts on the topic. Here goes:
Dilemma #1: Pay off a credit card OR fund your 401(k)
Money's suggestion: If you have a big credit-card balance, wipe it out before you open a 401(k).
My take: This is a very hard one -- probably the hardest of the group.
I never really had to face this situation since I've always paid off my credit cards in full. So my suggestion would be to never buy anything on a credit card that you can't pay off right away. If you live by that principle, you'll never have to face this issue.
But if I was in the situation where I did have credit card debt, I'd first look to cut my expenses so I could do both (pay off the cards and at least get my 401k match). If I couldn't do both, I'd look at the interest on the credit card and how much I owed on it. If it was above 15% or so and if it was a big balance, I'd pay it off first. If it was below 15% and not such a big balance, I'd go with the 401k first (but still would sell some things, take gifts, etc. and pay off the debt asap).
FMF posts related to this topic: Help a Reader: 401k or Debt, 401k Match Trumps Debt Repayment
What's your take on the issue?
As I wrote in The 10 Most-Hated Money Saving Tips, people don't like to be told to move to a foreign country to save money (see tip #9.) No, they'd rather put up this objection and that objection on why it's a bad idea. Maybe it is a bad idea, but if you haven't saved much for retirement (a situation many Americans will face), it's better than eating dog food and living under someone's porch.
Of all the foreign options, Mexico is particularly a decent place to consider moving to because:
1. It can save you a TON of money (more on that later.)
2. It's not far from the U.S. You can drive there.
3. Nice climate.
4. It's easier to learn Spanish than Chinese. ;-)
So how much can you save by moving to Mexico? Here's what MSN Money came up with:
Suppose you can find a place where the cost of living is about 75% of the cost in the United States -- some beach town north of Puerto Vallarta or south of Manzanillo. What happens to your standard of living when you move to Mexico? It rises to the equivalent of about $42,400 in the U.S.
So let's say you have a $60,000 a year lifestyle but only have enough retirement income (via Social Security and your own savings) to fund $30,000 a year. Move to Mexico, make a few lifestyle changes, and you're not far from your pre-retirement standard of living in the U.S. Not bad at all!
Here's an interesting piece from Yahoo that details how one company (Devon Energy) is offering a "super 401k" -- but it comes with strings. The choice is to stay with the traditional 401k and make your own investment decisions or to get a much higher level of contributions and let the company manage the money for you. The main details:
Rather than rely on employees to take the initiative to save, Devon plans to save for them--by making annual contributions to these accounts in line with what it would have spent to provide a traditional pension benefit. Depending on an employee's tenure, the company will put 8% to 16% of annual compensation into the 401(k)--regardless of whether the employee kicks in a dime. For those who put money into the plan, the company will also match it dollar for dollar up to 6% of salary.
Add it all up, and Devon workers who divert 6% of their pay into the super 401(k) could receive as much as 22% per year from the company. While many companies that freeze pensions increase their 401(k) contributions, Devon "is one of the few coming close" to what's required to compensate employees for the loss of a pension, said EBRI's VanDerhei.
In return for its largesse, Devon plans to impose an unusual degree of control over how its contributions are invested. Under the new plan, employees are required to use "target date" funds. Already available in many 401(k)s, the funds recently got a big boost when the U.S. Labor Dept. approved their use as a default investment for accounts established under automatic enrollment programs. Designed to provide workers with all they need within one portfolio, the funds put investing on autopilot: Employees simply select the fund that most closely matches their expected retirement date and the funds' managers do the rest of the work, by shifting into a more conservative mix of stocks, bonds, and other asset classes as retirement approaches. Devon's target-date funds will consist of low-cost investments in its $614million defined-benefit pension plan, including alternative investments such as real estate investment trusts and inflation-indexed securities.
The article goes on to detail the issues Devon employees are considering. It seems like a no-brainer to me (take the money and run!), but it's a bit more complicated than that.
What would you do? Would you rather take 14% to 22% of your salary in a super 401k managed by your employer or take 6% and control everything yourself?
Bankrate notes that you should take a 401k match before paying off debt (in this case, they're talking credit card debt). As if the reason isn't totally obvious, here's why:
You may be paying 13 percent on your credit card, but you're earning 50 percent on the typical company match.
Let's see -- which is better -- a 50% return or a 13% return? ;-)
For some of us, the issue is even more glaring. Anyone out there get a 100% match? Many do.
Yeah, I'm a big believer in paying off all kinds of debt, but there are better options that have to be exhausted first, and getting the full employer match on a 401k is a major one. Even when I was paying off my mortgage a decade ago, I still put as much as I could into my 401k first. Not only did I get the match, but that money has now been working for me for ten years and it's grown into a sizeable chunk of change. I plan to let it sit for a couple more decades -- it should REALLY be a nice sum by then.
For more thoughts on 401ks, retirement, and debt, see these posts:
When it rains, it pours. Just when I find one article on "retiring early", I find a couple more. But since it's a topic I like, I'm going to run with it for now.
This first piece tells the story of two couples who retired early (one of which I covered in an earlier story. But the key part of this piece is the list of five steps for early retirement. Here is their list:
Can I say how much I love this list? If you've been a reader for any amount of time, you know these are principles I believe in. Here are some posts I've written on each of these topics (in order) that explains my related thoughts:
Really, all of these can be summarized by the following: How to Get Rich in Three Easy Steps.
The second story lists some personal "extreme" early retirement experiences. There are some very interesting stories in this article on how people retired early. Seems like there are lots of ways to do it (and many reasons for doing so too.)
In my net worth post wrap up for the year (I'll post it sometime in mid-January), I'll talk about our plans for retirement. If all goes well, we should be able to retire in several years with a solid income to boot. Stay tuned.
Here's the story of a couple who "retired" at age 38. I have retired in quotes because it seems like they didn't really retire, they simply quit their hectic lifestyles (and jobs), started easier jobs (their own business/website), and spent more time traveling. That said, they do have some good tips in listing their five steps to early retirement. Their list:
1. Track spending
2. Save a lot
3. Invest wisely
4. Put peer pressure into perspective
5. Keep your eye on the prize
It's pretty basic advice, but I've said before that much of personal finance is simply doing the basics. Besides, doing these five things WILL allow you to retire early. However, they won't allow you to retire at 38 -- it will be something more like 55 or 60. Saving 10% to 15% of your income can only go so far unless you're making a boatload every year.
For more thoughts on retirement, see these posts:
The following is provided courtesy of Marotta Asset Management.
Medicare Medical Savings Account (MSA) Plans are one of the newest Medicare Advantage Plan options. Private companies began offering these accounts in 2007. Like Health Savings Accounts, a Medical Savings Account puts you in control of your own health care dollars.
If you are in good health and want to limit the maximum you would need to pay in a medical emergency, you may want to consider a Medicare Medical Savings Account plan during your retirement years.
When you choose a Medicare MSA plan, you are still participating in one of Medicare's plan options. A Medicare MSA plan is a "Medicare Advantage Plan," also known as Medicare Part C.
A Medicare MSA has two parts: a medical insurance plan and a savings account. The medical insurance portion is a high-deductible health care plan which covers your medical expenses only after you have met a high out-of-pocket deductible. But before you receive coverage, you'll have to pay all of your health costs until you reach your deductible. However, to help you pay the out of pocket costs, the Medicare deposits money into your savings account each year. You can use this money to pay your health care costs before you meet your deductible.
To purchase the Medicare MSA coverage, you probably won't have to pay an additional premium. In keeping with the Medicare Advantage Plan system, you'll simply have to pay the Medicare Part B premium. The costs of Part B are dependent upon your yearly income. In 2008, seniors will pay $96.40 per month if they are married filing joint and reported $164,000 or less in income. Monthly premiums climb as high as $238.40 if you are in the highest income bracket.
With a Medicare MSA, you can keep all the money you don't spend on health costs. In fact, you may do better than break even each year. The annual amount you are given will not cover the gap until you meet your deductible. But if you spend less than the amount you are given, your account could grow in size. You may be able to accumulate enough money in your account to cover all of your health care costs up to the amount of your deductible. And like a true savings account, anything you don't spend one year carries over to the next. With an MSA, it's your money.
As an example, the Anthem MSA plan in Virginia has an annual deductible of $3,000 and an annual deposit $1,300. In short, you pay all medical costs up to $3,000. But to help you cover those costs, Medicare will deposit $1,300 at the beginning of the year into your medical savings account.
If you don't need all of your savings for medical expenses, you can spend your account on what you do need. Withdrawals for Medicare covered expenses are tax-free and count toward your deductible. Withdrawals for qualified medical expenses that are not Medicare covered (such as dental, vision and prescription drugs) are tax-free but do not count toward your deductible.
Qualified expenses may also include items which may or may not count toward your deductible. The IRS has approved a long list of qualifying expenses. In addition to doctors visits, hospitalizations, lab tests and the like, the list also includes prescriptions, some over the counter drugs, vision and dental costs.
You can withdraw and use a portion of the money in your Medicare MSA for non-medical reasons (such as groceries and utilities) without penalty. You will still need to pay income tax on non-medical withdrawals, just as you would with a traditional IRA. The limit you can withdrawal without penalties is equal to your account balance on December 31st of the prior year minus 60% of your policy's deductible. Withdrawals above that for non-medical expenses will be taxed as income and slapped with an additional penalty.
A Medicare MSA can also be a good solution if you have very high out-of-pocket costs under your current Medicare program. Unlike the plain vanilla Medicare Part B which could leave you paying 20% of all your medical costs with no limit, a Medicare MSA account caps your liability. Once you've met your annual deductible, your insurance plan will cover 100% of your Medicare-covered health costs.
Consumer-driven health care plans may help shape consumer behavior and keep health care costs from spiraling out of control. Contrast Medicare MSA plans with other Medicare Advantage Plans. Generally HMOs pay for medical services. Doctors dictate which services are given, and patients are the ones who actually benefit from these services. With Medicare MSA plans, consumers pay, dictate and benefit from services. They are empowered to make their own healthcare decisions.
Those covered by a Medicare MSA plan should be more likely to engage in healthy behaviors and to get annual check-ups. They should also be more likely to inquire about costs and less likely to consume health care they don't need. If this sounds like you, you may be a good candidate for a Medicare MSA.
Medical Savings Accounts offer you the opportunity to take more control of your health care spending. The money you save on your medical expenses is really yours and can be used to pay whatever bills you might have in retirement, even if those bills are not Medicare covered expenses.
Enrollment in a Medicare MSA is limited to one percent of Medicare recipients on a first come first serve basis. If you are interested, I suggest you sign up early. Open enrolment for Medicare MSA plans begin November 15th and ends December 31st every year.
For related articles, see the following:
Kiplinger gives us a list of seven ways to boost your retirement which contains the following suggestions:
1. Consider working a little longer.
2. Build tax-free retirement income.
3. Downsize.
4. Keep 50% of your retirement savings invested in the stock market.
5. Delay taking Social Security.
6. Tap your home equity with a reverse mortgage.
7. Buy an annuity.
Here's my take on each of these:
1. Yes, working longer can make a big difference to your retirement savings. But you might not be able to control whether or not you can work longer (due to an accident or illness), so don't bank on this one.
2. Of course. 401ks, IRAs, and Roth IRAs are all retirement savings vehicles everyone should consider. (I know not all of these are tax-free, but they are tax-preferred.)
3. We'll be doing this, I'm sure. Once the kids are gone and we officially retire, we'll probably sell our house and move into a much smaller one.
4. Gone are the days when you put all your retirement savings in an income-producing security. Why? Because people are now living 30 years in retirement, not five years, and it's hard to live off the proceeds of bonds for three decades.
5. We've debated when to take Social Security quite a lot here at Free Money Finance. If you're married, seems like there's a decent strategy you can employ that makes the issue pretty clear. For you singles, it's still murky on what's the best option.
6. I hate this idea. If you do #3 correctly, you shouldn't have to do #6.
7. I'm still sorting out my feelings on this one. When I hear "annuity" I also hear "over-priced, expensive investment." But maybe that's just a bias based on not knowing all the facts.
And a couple points to add:
The following is courtesy of Marotta Asset Management.
Many seniors look forward to saving on medical insurance costs by enrolling in Medicare at age sixty-five. However, navigating the Medicare system is not for the faint of heart. Medicare is an alphabet soup of plan choices. Currently Medicare is organized as parts A through D.
Medicare Part A provides hospital insurance to seniors. For the majority of seniors who have paid into the plan, enrolling in Part A comes at no cost. Part A covers hospital stays, home health care services, and hospice care. However, if you just need a check up, you'll need to resort to Part B or Part C to help with those costs.
Part B helps to cover doctor's services, some outpatient care, and routine preventative services. However, unlike Part A, you'll have to pay a monthly premium to buy the coverage. The costs of Part B are dependent upon your yearly income. In 2008, seniors will pay $96.40 per month if they were married filing joint and reported $164,000 or less in income. Monthly premiums climb as high as $238.40 if you report lots of income in retirement.
However, unlike Part A, Part B may require you to first pay the $135 deductible before Medicare will pick up the tab. For other services, Medicare will cover 80 percent of your medical costs, requiring you to pay the other 20 percent. Still in other cases, you'll wind up paying both the $135 deductible plus 20 percent of the remaining costs.
Don't try and save a few bucks by skipping Part B coverage. If you fail to enroll in Part B at age 65, you'll be slapped with a 10% penalty for each year you delayed enrollment.
Your Part B insurance will provide you with some free services such as a flu shot, diabetes and cancer screenings, and 'Welcome to Medicare' physical exam. If you take advantage of these services you may avoid more costly and more dangerous conditions.
Most seniors sign up for the Original Medicare plan, a combination of Parts A (hospital insurance) and B (medical insurance). However, if Uncle Sam's doesn't provide you with sufficient coverage, you may be better served by a private insurance company offering a Medicare-approved insurance plan.
Part C, also known as Medicare Advantage Plan, includes coverage for parts A and B through private insurance companies. The plans are usually offered in the form of a Health Maintenance Organization (HMO) or a Preferred Provider Organization (PPO). Your premiums, co-payments, coinsurance and deductibles will vary based on your specific plan benefits. And, although offered by private companies, Medicare Advantage Plans are approved by Medicare.
Choosing a Part C plan may mean you already receive prescription drug benefits. If your prescription drug coverage is deemed "creditable" by Medicare, you won't have to pay an additional premium for the Medicare prescription drug plan, also known as Part D.
Part D, the Medicare Prescription Drug Plan, is the newest of all the Medicare programs. However, Medicare does not provide the insurance directly. Instead, each state has contracted with insurance providers to offer the drug coverage. If you are a senior, you must decide if you should sign up, and then which plan you should purchase.
Most states offer at least 40 different drug plans. Premiums average $28 per month, depending on the level of coverage and the types of drugs covered by the plan. If you are enrolling in the Original Medicare or don't already have "creditable coverage", you'll need enroll in Part D, or face a penalty. If you fail to enroll at age 65 but decide to enroll at a later date, you'll pay a 1% penalty for each month you delayed enrollment.
The costs of Part D vary, and if you don't think you will need the coverage you should find the lowest cost Part D to avoid the penalties. That way, if you need the coverage later, you won't be stuck with premiums inflated by penalties. You can always change providers at a later time, if you decide different coverage suits your situation better.
If your income and assets are low enough, you may be able to save money on your Medicare costs. This assistance is done through your State Medical Assistance and is often called Medicaid. Call even if you aren't sure if you qualify. The Virginia Medicaid office can be reached at 804-786-7933. Call 1-800-MEDICARE to get the telephone number for other states.
The initial enrollment period begins three months before your sixty-fifth birthday and ends three months after your birthday. Be sure you enroll to avoid unnecessary penalties.
You can get more information by visiting Medicare on the web or by calling 1-800-MEDICARE.
The following is courtesy of Marotta Asset Management.
Health Savings Accounts (HSAs) can provide inexpensive medical coverage if you maintain a healthy lifestyle. With your healthy lifestyle you may not spend anywhere near your high deductible insurance and consequently save on your medical costs. Even if you do not need to, we recommend funding your account with the maximum allowed. If your HSA builds up it may help you cover any extra medical expenses during retirement.
An HSA is a tax free savings account. As long as funds are spent on qualified medical expenses, all contributions, capital gains, and withdrawals remain untaxed. And like any other bank account, HSAs come complete with debit cards and checks.
But to qualify for one of these tax-free savings accounts, you must have a high deductible health plan (HDHP). Now, you may be thinking your insurance plan has a high enough deductible already. However, to qualify as a high deductible health plan, your insurance deductibles must be a minimum of $1,100 for individuals and $2,200 for families in 2007.
The good news is, once you meet your out-of-pocket deductible, most HSA-eligible high-deductible plans cover 100 percent of most medical expenses like emergency room visits, hospitalization, lab tests and prescriptions. Still, these deductibles are nothing to joke about. Paying a couple grand out of pocket before your insurance chips in may seem like financial suicide.
HSA-eligible high-deductible premiums are only a fraction of the cost of a traditional medical insurance plan. As an HSA owner you’ll likely do better than break even each year. With the savings on your insurance premiums, you should be able to accumulate a sizeable nest egg in your HSA.
Unlike your traditional health care plan, your HSA funds are not subject to a "use it or lose it" policy. Anything you don’t spend one year carries over to the next year. After all, it’s your money. While you’re on a roll, why not check out the invest options offered by your HSA bank?
Some people put only enough into their HSA each year to fund their medical expenses. This is shortsighted. We would recommend making the maximum HSA contribution each year, after covering your other financial needs.
In 2007, you can contribute $2,850 for individuals or $5,650 for families. If you are 55 or older you can make an extra $800 catch up contribution. In 2008, you can contribute $2,900 for individuals or $5,800 for families. If you are 55 or older you can make an extra $900 catch up contribution.
One you enroll in Medicare (typically at age 65) you can't make new contributions to your HSA. But any money left in your HSA will continue to accumulate tax free. It is a good idea to over fund your HAS while you are young so that during your retirement you will have some extra tax-sheltered dollars to use for medical expenses. After enrolling in Medicare, you can't contribute to an HSA.
Any HSA withdrawals that are not for qualified medical expenses are counted as taxable income and subject to a 10% tax penalty. The tax penalty does not apply, however, if you are 65 or older, or are permanently disabled. However, the withdrawals are still taxable at ordinary income rates.
In other words, any excess contributions you make to your HSA can be withdrawn after age 65 without penalty. Just like a traditional IRA, when the funds are used for non-qualifying medical expenses you will have to pay tax on the withdrawals, which is no different than other retirement savings option.
The law is currently silent on what happens to your HSA when you reach 70 1/2. We expect that the IRS will treat your HSA like an IRA and therefore require minimum distributions, but this has not been settled.
When you die, your surviving spouse inherits your HSA and it is treated as their HSA if they are named as the beneficiary. Otherwise, your HSA ceases to be an HSA and is included in the federal gross income of your estate or the named beneficiary.
There are three strategies that you can use to grow your HSA large enough to cover your retirement years. First, make the maximum allowable deposit to your HSA each year. Second, if your medical plan includes the option, invest your HSA in mutual funds instead of keeping your account entirely in an FDIC-insured savings account. And third, delay reimbursing yourself from your HSA account as long as possible to profit from its tax sheltered compounding interest.
You can reimburse yourself for qualified medical expenses at any time, but you also have the option of leaving the money in your HSA so that it continues to grow tax free. You can save all your receipts in a shoe box for decades and then decide to withdrawal your reimbursements at any future date when you need the money. This allows the growth on these funds to continue to compound tax-free.
Once you turn 65 and enroll in Medicare you can no longer fund your HSA. Medicare will pay for the majority of your health expenses during retirement. There are some expenses, however, that Medicare will not cover that your HSA can. In retirement, your HSA can cover proactive health screenings, unconventional treatments for terminal illnesses and nursing home expenses. Your HSA can even cover long term care expenses if you decide to self insure, or pay your long-term care insurance if you decide not to. None of these expenses will be paid by Medicare.
Another option during retirement is to enroll in a Medicate Medical Savings Account. This account is similar to an HSA, but funded in retirement by Medicare contributions. If you select a Medicare MSA during retirement, you can use the funds in your HSA until you build sufficient value in your Medicare MSA.
Maximizing your contributions to an HSA may secure your health care spending for life. Even if you end up not needing it, you can pay income tax and withdraw it without penalty after age 65 just like a traditional IRA.
We've had some debates here and been back and forth on when to take Social Security retirement benefits (for an overview of the discussion, see When to Take Social Security). There's not one "right" answer, of course, but we all seemed to agree that the "best" option was much more up for debate than most personal finance-related decisions. That is, until now.
Here's a piece from Forbes that recommends the "best" way for couples to answer the "when do I take Social Security" question. The recommendation:
One spouse (usually the wife) claims at 62 to 66, while the other waits until 69 or 70 to collect. This pays off because of obscure Social Security rules and some facts about life expectancy that aren't obvious if you don't make your living as an actuary.
And the reasons it supposedly works:
For the boomers turning 62 next year (and anyone born from 1943 through 1954) the Social Security "full retirement age" is 66. If they claim benefits at 62, they get just 75% of their full retirement age benefits. For each year they wait past 66, they get 8% more (plus an inflation adjustment), for a maximum benefit at 70 equal to 132% of the full retirement age payout.
These adjustments are supposed to be actuarially neutral--meaning if you live to the average age, you get about the same whether you start collecting smaller checks early or bigger checks later. But they're not. One reason is that married couples get a special deal: When one dies, the survivor can take the dead spouse's benefits (if they're higher) and drop his or her own.
"Whoever the higher earner is should plan to delay taking Social Security, because the higher benefit will always live on," says James Mahaney, vice president of Prudential Retirement and coauthor of one of the papers. "The key message is keep your husband in the workforce as long as you can,'' quips Alicia H. Munnell, director of the Center for Retirement Research at Boston College and coauthor of the other paper. (She notes that a wife might continue to work, too, while collecting Social Security. Although early retirees can lose a portion of their benefits if they earn too much, once you reach 66 you don't incur any penalty for working.)
The piece goes on to list more details and thoughts in support of this recommendation, but these are the highlights. I must say, this plan makes sense to me. Of course it only works for married couples and we still have the "is it better to wait" question for individuals, but this does seem to address the problem for a large segment of the population.
Any thoughts or comments on this strategy?
Here's a piece courtesy of Marotta Asset Management that discusses the advantages of converting to a Roth IRA.
If you don't have retirement savings in Roth IRAs, it's time you considered the benefit of these tax-savings accounts. The long-term tax savings opportunities are driving more Americans to rollover various retirement funds into Roth accounts. These so called "Roth conversions" can be performed on traditional IRAs. And, beginning in 2008, it will be easier to roll money from an employer plan into a Roth IRA.
But first, you may be wondering what's so great about Roth IRAs. Roth IRA contributions are always made with after-tax dollars. That's right; you won't get a tax deduction for contributing. However, the principle grows tax-free and the account holder may make tax-free withdrawals at 59 1/2. Furthermore, there are no required minimum distributions for a Roth, which makes them ideal for funding the latter years of retirement.
Conversely, a traditional IRA allows before-tax contributions to grow tax-deferred, but not tax-free. So, although you can usually deduct your contribution to a traditional IRA, you pay ordinary income tax on the withdrawals. Furthermore, the IRS will require you to take minimum distributions, whether you need the money or not.
However, Roth IRAs may not provide tax savings for everyone. Remember, contributions to Roths are made with after-tax dollars whereas traditional IRAs are made with pre-tax dollars.
Roth IRAs provide tax savings for individuals who expect to be in a higher tax bracket later in life. The tax benefits of a Roth are created by the tax disparity between your tax bracket when you put your money in versus your tax bracket in retirement. The lower your tax rate, 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, after taxes are paid on the traditional IRA. 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.
If you expect to see your tax bracket increase significantly - from say, 15% to 25% - you 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.
Before you rush off to begin your Roth conversions, be sure you have enough money to cover the tax bill. During a conversion, you'll withdraw funds from your 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.
You'll also have to pass an income test. Until 2010, income limits do apply. Only joint and single filers with a modified adjusted gross income of $100,000 or less can qualify. After 2010, the income restrictions on converting funds from a traditional IRA to a Roth IRA will disappear completely.
Traditional IRAs, SEP IRAs and SARSEP IRAs are subject to the same conversion rules. Until 2010, you'll have to pass the income test to qualify.
SIMPLE IRAs can also be converted to Roth IRAs, if you participated in the plan for more than two years. SIMPLE IRA account holders are not subject to this rule if they are over 59 1/2. The income test of $100,000 or less (no requirement after beginning in 2010) still applies.
Keep in mind there are more ways than one way to get funds into a Roth IRA. Although conversions from a traditional IRA to a Roth are common, funds in employer sponsored plans – like 401k, 403b and 457 plans - can also be rolled over to a Roth.
In 2007, rollovers from an employer plan cannot go straight to a Roth IRA. Instead, you'll first have to rollover funds into a traditional IRA. Once in the IRA you can immediately do a Roth conversion. But thanks to the Pension Protection Act of 2006, it will soon be easier to convert your retirement savings to a Roth IRA. Beginning in 2008, funds from your employer sponsored plan can be directly rolled over into a Roth IRA.
However, don't Roth conversions with the other Roth plans sponsored by your employer. Currently, you cannot convert a traditional 401k or 403b to its employer-sponsored Roth counterpart such –a Roth 401k, Roth 403b.
Remember, no matter when you do your conversion, it must be done before Dec. 31st of the tax year. Later, if you find you weren't eligible for the Roth conversion, you can undo the damage with a Roth recharacterization before your file your taxes.
Here's a piece courtesy of Marotta Asset Management dealing with giving from your IRA.
For a few more days this year, the tax law will allow you to give to charity directly from your IRA and count that gift toward your required minimum distribution. Giving to charity from your IRA will also provide you with additional tax savings. But, to qualify, you must make your donations before 2008.
Unlike the typical deduction you may be taking to offset your charitable giving, the Pension Protection Act of 2006 offers you tax savings opportunities which a charitable contribution deduction will not.
The Pension Protection Act provisions allow you to make so called "qualified charitable distributions" from your IRA and to exclude the gift from your gross income. Furthermore, such gifts can be used to fulfill required minimum distributions. But you must give before 2008, when the provision sunsets.
If you are an IRA account owner over 70½, you are required to take withdrawals, known as "required minimum distributions" (RMDs), from your IRA account. You must take your RMD each year, regardless of whether you need the money or not. What's more, IRA withdrawals must be reported as income and are taxed at ordinary income rates. After all, Uncle Sam won't let your money go tax-free forever.
The Pension Protection Act offers a unique tax benefit with these so called, "qualified charitable distributions." Here's how: Gifts you make to charity from your IRA bypass your taxes altogether. Since your gift is not counted as income, it does not increase your adjusted gross income (AGI).
Your adjusted gross income determines your tax bracket and your eligibility for a number of other tax benefits. By reducing this number, you may avoid the phase-out rules which may limit your itemized deductions or personal exemption amounts. You may even be able to drop to a lower income tax bracket.
If your IRA contains both before-tax and after-tax dollars, you can save even more by giving. Qualified charitable distributions made from an IRA containing both before-tax and after-tax dollars are taken from the portion of untaxed dollars. This is a radical departure from the typical IRA model which requires you to withdraw the pre-tax and after-tax dollars proportionately. Under the Act, you'll be able to give away the dollars which carry the highest tax liability. At the end of the day, you'll have a higher percentage of after-tax dollars left in your IRA.
To be considered a "qualified charitable distribution," your donations must meet a few criteria. First, only IRA account holders age 70½ or older are eligible to participate.
Next, your donation must be made directly from your IRA to the charity. Contact your IRA trustee for more instructions on how to initiate the transfer. Any distribution made payable to you won't qualify.
Finally, be sure the receiving organization is a qualified public charity or private foundation which can receive donations. Contributions to donor advised funds aren't considered qualified charitable distributions. And, as with any gift to charity, don't forget to obtain a receipt acknowledging your gift.
Qualified charitable distributions will help to fulfill your annual required minimum distributions. But, your donation can be greater than your required minimum distribution amount. You can exclude up to $100,000 in qualified charitable gifts each year. A gift amount over $100,000 must be recognized as income and deducted according to the standard charitable deduction rules.
Above all, keep in mind that you cannot double-dip and take a deduction for your IRA qualified charitable contribution. No deduction is permitted for charitable distributions which are not recognized as income.
Finally, be sure you act soon. Only contributions made to charity before January 1, 2008 can be characterized as qualified charitable distributions.
Qualified charitable distributions are just one tax planning tool which may save you money. We advise our clients to meet with their tax professional in November or December to review their tax plan before year's end. Tax planning is complex and time consuming. So, make an appointment with your tax professional before the real tax season hits.
Here's a piece courtesy of Marotta Asset Management with some additional retirement thoughts.
Most employees have all their retirement eggs in one basket --their employer's retirement plan. The plans usually offer less than two dozen fund choices to cover all your hopes of maintaining your lifestyle, independence, and dignity in your later years. As discussed in the previous article, the more baskets (and eggs) you have, the better. If most of your retirement assets are with your employer, here's how to make the most of what you've got.
First, there are some mistakes to avoid. Probably the most common mistake made by employees is to allocate an equal amount of money to each of the fund choices. Studies have shown that given ten choices, employees tend to put 10% in each choice. Given five choices they put 20% in each choice. If four of the choices represent one type of asset and the fifth is unique the asset allocation is split 80/20. If the funds happen to be the other way round then the asset allocation is 20/80.
The equal proportions methodology builds very poor portfolios. You can't afford to make these types of mistakes with your future livelihood. The only thing worse than the equal proportions strategy is allocating all of your money to just one fund. You need an investment philosophy that integrates all of your asset holdings. Only then can you evaluate which of your company's fund options are right and determine what percentage to allocate to each.
Many employer sponsored retirement plans are just mediocre. Neither the fund company nor plan provider has much incentive to fill your selections with stellar choices. Plan sponsors have a fiduciary responsibility, but few take that responsibility seriously. Procedures may or may not be in place even to meet minimum guidelines. Still, you should be able to find a few funds worth selecting in order to gain your employer's match.
Your own company or plan provider usually isn't the best place to turn for advice. After all, they are the ones that picked the options in the first place. You should get the outside opinion of a professional financial planner on where to invest.
Another common mistake is to invest in whatever funds have done the best over the past 1, 3, or 5-year period. None of these measures is long enough to produce a balanced asset allocation. Every financial disclaimer states that "past performance is no indication of future returns," and yet, past performance remains the primary selection criteria for many investors. Too many employees pick the asset category that has done the best over the past three years. However, these higher-than-average returns often represent a peak. Going forward, they are the fund choices most likely to under-perform for the next three years.
While three year average returns is a poor way to select a fund, thirty year average returns is a good way to select an asset category for including in your asset allocation. If small cap value is a good asset category to include for the long term, see if your plan includes any small value funds. Then judge them against other outside funds within their asset class and not against other funds within your plan.
You should be looking for funds which are the best funds within their asset class regardless of how well the asset class has done over the short term of just the last few years. Funds that are the best in their category can often be found through index funds that have very low expense ratios.
Remember also that you are looking for a team of funds and not just a few hot shots. Your retirement portfolio consists of more than just your employer's plan. Even if your employer's plan only has a couple of good choices, you can use your other investments to create a balanced asset allocation. While the choices in your employer's plan may be limited, investments in your IRA or taxable account will have an unlimited number of choices from which to craft a balanced allocation.
It is important to start with an over all asset allocation plan and then see what asset classes your employer's plan offers that would integrate well with your investment philosophy. Since your employer's plan usually has the most limited number of choices, pick the best it has to offer that fits with in your over all plan.
Here's something that I've always understood, but never seen an article on before -- the fact that we all face extra risks in retirement. This piece from Yahoo details the two added risks of retirement -- longevity risk and spending risk. Let's start with longevity risk:
One of the common concerns I hear from people approaching or in retirement is the fear of running out of money too soon. It's tough (okay, impossible) to know just how long a life expectancy you should plan for. When I run retirement projections for people, I'm now using age 97 as the default life expectancy. If I know that long lives run in a client's family, I may shift this even further out.
When you're planning for your retirement years, you'll want to err on the conservative side of life expectancy, meaning that you should plan as though you're going to live to a ripe old age. When you look at tables showing average life expectancies based on your current age, remember they are just averages.
Yep. I'd be really, really, really conservative on this one. It would be very bad to run out of money before you run out of life. In a bit, I'll detail how I'm handling this risk as well as the other one. My solution for each one goes hand-in-hand with the other.
As far as how to deal with longevity risk, the piece gives a suggestion:
There are protections you can put in place to guard against longevity risk. One is purchasing or electing an immediate annuity.
They then detail what sort of annuity, special circumstance you need to consider, what provisions you'll want as part of the annuity you buy, and so on.
The article then switches to spending risk:
People are living longer in general and spending more money in retirement than previous generations. In particular, people are spending more on gasoline, entertainment, travel, and health care. Most of my clients expect to spend about the same, or perhaps even more, in retirement than they do now. That's because they want to travel, play more golf, or spend more time on hobbies.
In particular, here's a big cost to watch out for:
No discussion of the spending risks in retirement would be complete without touching on the cost of long-term care. According to the MetLife 2006 Survey of Nursing Home and Home Health-Care Costs, the average rate for a private room in a nursing home is about $200 a day or about $75,000 a year.
So, how do we deal with these two risks? Here's what the article suggests:
This is basically what I'm doing. I'm estimating that I'll live a long life and that my living costs will be higher than I expect. If I then save according to these goals, I should be fine. But, boy, that sure makes for a very big retirement number! Yikes!
The following article is courtesy of Marotta Asset Management.
Putting all of your retirement eggs in one basket is easy to carry, but risky. Most workers are putting all their retirement assets in the basket of their employer's retirement plan. They are depending on one employer and two dozen eggs (funds) to hatch and maintain their lifestyle, independence and dignity in their later years. Don't trip.
Just one generation ago employers provided their employees with defined benefit plans for retirement. The employee could plan on a benefit that the employer had contractually promised. The employer was responsible to insure that a defined amount would be payable to each employee when they retired. Such security today is obsolete.
The new model moves the outcome responsibility from the employer to the employee through what are called defined contribution plans. The employer is helping with the input (the contribution), but no longer guaranteeing the output (the benefit).
An employee's retirement income is now contingent on four variables: how much the employee puts in, how much the employer matches, the performance of the underlying funds and of course, time.
In a typical defined contribution plan the employer will match dollar for dollar the first 3% of your salary, and fifty cents per dollar on the next 2% of your salary. That means if you contribute 5% of your salary, your employer will give you an additional 4% of your salary in retirement contributions.
Getting the maximum amount possible of this free money should be your first priority in saving for retirement. Even if your 401k or 403b defined contribution choices are not stellar, you still get an automatic 80% return on your money the very day you contribute. Strangely, many employees neglect to pick up this free money. The 80% automatic return is an offer you should not refuse.
After saving enough to get the full match from your employer, don't necessarily continue to use your employer's plan as your only retirement basket. After getting the full match, we recommend funding your Roth IRA, your spouse's Roth IRA and your taxable account. Only after adequately funding these individual account choices should you consider putting more money into your employer's plan than is necessary to get the full match.
Retirement plans through work are laden with fees and expenses that are not on individual investment accounts. The difference in fees is often 1% or more. The longer you leave your money in a defined contribution plan, the more the excessive fees will erode its value. There are plans so laden with fees that they are not even worth the match. Where the fee differential is 2%, after 30 years the fees will have eaten up the entire 80% match.
In other words, if you had the same amount of money in a traditional IRA account earning 2% more because of lower fees after 30 years you would have 81% more money in your account. For this reason alone, make sure that you don't leave money in an employer's retirement plan any longer than you have to. After terminating employment with one employer you should always roll that money into an individual IRA Rollover account where you can invest with lower fees and better choices.
It is a mistake to move money from a pervious employer's plan into your current employer's plan. This mistake, however, can often be undone. Money that has its source from another employer is usually allowed to be rolled out of an employer's plan and into an IRA Rollover account. If you are in this situation you should see if you can rescue some of your investments from the higher fees and limited choices of your current employer's plan.
There's another important tax reason not to put all of your retirement assets in your employer's plan. If you take a deduction while you are in a low tax bracket and in retirement when you are taking withdrawals you are in a higher tax bracket then your contributions work against you. You would have done better to have put your extra non-match retirement savings into a Roth or taxable account. Your tax rates are likely to be higher during your retirement. Currently, top marginal tax rates are only 35%. Before the Bush tax cuts the top marginal rate was 39.6%. Before the Regan tax cuts the top marginal rate was 70%. Before the Kennedy tax cuts the top marginal rate was 90%. Tax rates are at historic lows.
When you take the money out of an employer's plan or a traditional IRA account you will have to pay taxes at whatever tax rate is currently in effect. And after age 70 ½ you will have to start taking required minimum distributions in order for the government to ensure that they will get their tax. Historically speaking, the odds are your withdrawals during your retirement will be charged at a higher income tax rate than the deduction you received when you put the money in.
If may be better for you to pay your current tax rate and get your money into a Roth IRA where it won't be taxed again or a taxable investment account where the growth is only taxed at capital gains rates.
If you are just starting out in your career you are probably in the lowest tax bracket you will ever be in. Therefore it is more important to carry your retirement savings in more than one basket. Fund your employer's plan with no more than is necessary to get the match and then fund your Roth IRA and build your taxable savings.
Ok, here's a piece that really has me steamed. It's about what Forbes calls "middle-class millionaires" (they use the word "mMillionaire" to refer to them) and how they have to dramatically cut their standard of living if they retire with only a few million dollars. Yep, you read that right. The article is about how tough it is for these people with only a few million dollars when they retire. They have to do unheard of, horrible things like "live in three- and four-bedroom homes and drive mid-priced four-door sedans and mini-vans." Oh no! Not that!
Here's a quick summary of what this piece is about:
Just a generation ago, a person with $2 million or more in liquid assets would have had enough for a secure retirement. But not today. Combine longer life expectancies and the rising costs of health care, food, transportation and property, and you have financial challenges ahead for the mMillionaire.
The piece does have its facts straight. If someone is used to living off $400,000 a year, then $5,000,000 in retirement either isn't going to last long or they'll need to adjust their spending. But the point here is that these people have simply under-saved during their careers. Yeah, they made a bundle of money and saved a good chunk of it, but they didn't save enough. If they wanted to retire at the same level of income, they needed to spend less and save more while working.
And then the article simply goes overboard when it talks about how they'll now need to give up "mansions and yachts" and somehow try and get by with "three- and four-bedroom homes." Is anyone feeling sorry for these people? Not me.
If there's any value in this piece at all, it's in what's implied but not stated outright: funding retirement takes a load of money -- much more than what most people (even rich, smart people) estimate or imagine. That's why you need to calculate your retirement number now and take steps to start saving for it. Otherwise, you might have to cut your standard of living substantially in retirement as well.
Here's a piece from Money Central that details how several couples have retired by age 50 and what it takes to do so. It boils down to three success factors. The people who can retire at 50 are:
Hmmm. Those sound familiar. :-)
My take on how to get rich is fairly similar to these, and I often talk about the three items listed above. Here's what I'm doing with each of the suggestions above:
1. Yep, I hate debt too. That's why I have none. Paid off my mortgage over 10 years ago. Of course I do still charge on credit cards, but I pay them off each month. And I bought a new car a few years ago where I had a "two years same as cash" deal (I tried to get them to give me a discount instead and let me pay cash, but they wouldn't) that was torture because I again had payments. All that to say -- I am certainly allergic to debt.
2. Yep. The power of time/compounding is part of my formula for getting rich.
3. Again, it's a yes for me. I don't really care what the neighbors think of what I drive, what I wear, the "toys" I own, etc. I'd rather be wealthy and look middle class than be middle class trying to look wealthy. Heck, I'm not even interested in being wealthy and looking wealthy. Middle class is much more comfortable, laid back, and "warm" to me anyway. :-)
I think if I really, really pushed it, I could retire by 50, but I'm not sure I want to push it. The biggest category that would need to be cut back in order for me to make it is my giving, and I'm not prepared to give up on that in order to call work quits a few years early. In reality though, I do see myself down-scaling when I get to 55 or so. I should have enough saved up and the kids will be out of college, so at a minimum I should be able to take a job that generates less income as well as requires less of my time.
Consider this a "basic" personal finance post. I know many of you reading it will be far beyond this topic, but I also know that many people who read Free Money Finance are new to personal finance and haven't read the other 4,500 posts I've written to date. With that said, let's explore a recent piece touting the great benefits of 401ks.
This article is from Kiplinger's and lists five reasons you'll love a 401k:
1. It could make you a millionaire.
2. Your employer may give you free money.
3. It's a low-maintenance relationship.
4. You don't have to remember to make deposits.
5. You'll have fewer taxes taken from your paycheck each month.
My (even shorter) summary:
1. It makes you money (both in employer matches and long-term earnings).
2. It saves you money (on taxes).
3. It's easy to participate.
What isn't there to love? I especially like the free money of the employer match -- where else can you earn 50% to 100% return on your money?
I've maxed out my 401k for years now and the amounts I have saved from them (I have a 401k as well as an IRA rolled over from previous jobs' 401ks) is amazing. In addition, I'm adding more to this amount each pay period and all these funds still have 25 years or so to compound. If I can earn 10% on them, they'll double every seven years or so, so I'll be looking at many, many times with I currently have now even if I don't put in another penny (which I will.)
As I'm sure you can tell, I LOVE 401ks and recommend them to everyone who will listen!
For more on this issue, see these posts:
Here's an interesting contest. The basics for those of you who like a topline summary:
1. SmartMoney magazine is holding a contest to replace the term "retirement."
2. To enter, you go to the SmartMoney site and submit a text or video entry.
3. If you are selected as the winner, you get a $100,000 annuity.
Now the details from the SmartMoney press release:
SmartMoney magazine, the Wall Street Journal magazine, and Genworth Financial, a leading financial security company, have partnered to create an innovative multi-platform campaign to retire the term "retirement." From now until mid-November, visitors to SmartMoney's Web site have the chance to submit to SmartMoney.com, the online home of SmartMoney magazine, either a text or video entry of their replacement term for "retirement."
According to Bill Shaw, publisher, SmartMoney: "Today's retirees are more active than ever. 'Retirement' suggests retreat and withdrawal, and we believe that the word no longer does that life-stage justice. Retirement is the number-one topic of interest for our readers, so I know they'll redefine the term for us."
The winner of the contest, selected by the editors of SmartMoney, will be announced in February. The winner will receive a $100,000 annuity from a Genworth company and be featured in the February 2008 issue of SmartMoney magazine.
Personally, I kinda like the term "retirement," but then again, I'm sort of "old school" on many issues. I certainly like the $100,000, though!!! :-)
AARP recently listed several money traps people fall into. The one that stood out to me was the free money people let slip through their hands simply by not taking the full employer 401k match. The details:
Here’s a $30 billion mistake: that’s how much matching funds Americans miss out on each year because they aren’t saving for retirement through their company’s 401(k) plan.
If your employer matches any part of contributions to a 401(k) —and four out of five plans do—sign up and take full advantage. It’s free money on top of a tax break, since what you set aside isn’t subject to income tax.
The boost the match gives your retirement can be astounding. Say your company offers the most common match of 50 cents on the dollar on anything up to 6 percent of your salary. If you make $68,000 a year and earmark 6 percent for your 401(k), you’ll get $2,040 in matching funds. Over a 20-year span at an 8 percent average return, you’ll have about $300,000—and more than $100,000 of it because of the match. Who can afford to leave that kind of money on the table?
Indeed. Free money for the taking. I certainly hope no one reading this is in the $30 billion group, but if you are, you need to make plans immediately to get yourself as much free money as you can by saving in your 401k to get the full employer match.
Money magazine lists three 401k mistakes to avoid as follows:
My thoughts on these:
1. This one can be hard to avoid. Many company's do their match in company stock (or at least they used to -- I had one that did years ago), so it's hard to keep a balanced portfolio. I used to regularly sell my stock and reinvest it in something else once the grace period was over.
2. It's hard to believe that so many people simply let most of their retirement money sit in money market accounts or in bond funds, but it's true. The 401k is still a good deal for these people because they earn a great return simply by having their contributions matched, but they forego a TON of extra earnings by being so conservative. If anything, my problem is the opposite -- being too aggressive.
3. I was never really a "spread out investments with a little in each option" sort of guy. Maybe it was because when I started I just didn't have that much to spread around, so I picked the three or fours stock funds I liked and then stuck with those.
Money goes on to compare wimpy (too many bonds), unbalanced (too much company stock), and just right (mostly stock funds) 401k investment strategies over a 35-year period. They assume that you start at age 30 with a $50,000 balance and contribute 10% of a $50,000 salary that grows at 1.5% above inflation each year. They don't mention if a match is taken into account or not, so we're left in the dark on that one (nor do they mention the rates of return), but here's what they say each sort of investment strategy will yield after 35 years:
Big difference, huh? Just look how much money those "invest in bonds and money market accounts" people are leaving on the table -- half a million dollars!!!!
Here are four questions from Money magazine that will help you determine whether or not you have the right investments for retirement:
1. Do you have the right stock and bond mix?
2. Are you holding the line on fees?
3. Do you ignore hot investing trends?
4. Do you rebalance once a year?
Here's how I do on these:
1. Right now, I have 20-25 years before retirement (unless I retire early), so I'm almost totally in stocks. I think that's right for me based on the time I have left as well as my tolerance for risk (which is moderate to high.)
2. I certainly am holding fees down. That's one reason I love index funds -- low costs.
3. Index funds are the opposite of hot investing trends. ;-)
4. With my allocation so heavily weighted in stocks, there's not much rebalancing to do. But I am trying to consolidate all my investments into a handful of accounts and a handful of funds. It's taking some time as I'd accumulated several funds over the years before I got into index investing. So now I'm moving them around slowly, trying to minimize capital gains taxes. here's one way I'm going this.
For more of my thoughts on investing, see these posts:
Money magazine's August issue has some great pieces on retirement. One asks if you are doing the right things to prepare for retirement. Money says you are if you can say "yes" to these four questions:
1. Are you maxing out your 401(k)?
2. Are you keeping tabs on your progress?
3. Are you grabbing every tax break you can?
4. Have you created a safety net?
Here's how I stand on each of these:
1. Yep, I've been maxing mine out for years now.
2. Yes. Every year I review my retirement goal and progress towards it, making any needed adjustments.
3. I'm desperately grabbing every tax break I can. I wish there were more!
4. I do have extra savings as well as life and disability insurance.
The thing that amazes me is that though I'm doing all these things, it still takes a TON of time and discipline to save up what's needed to retire. It's simply such a big number to swallow!!!!
For more on retirement, see these posts:
Here's a question I recently received from a reader:
I was wondering what your take on a pension is. Here's my question. Would you suggest taking a pension as a lump sum if you believe the company you work for is not doing well?
Before I did anything, I'd talk to my CPA or someone else knowledgeable on pensions (which I am not that versed on.) But without that information, here's the direction I'd lean towards:
1. If the pension is administered by the company and the money is in their possession, I would certainly take the lump sum if I thought there's a potential they could default on the amount.
2. If the pension is guaranteed in some way (held by a third party that's stable, in a holding company separate from your company, etc.), then you need to go through the process of determining what the best option is for you -- lump sum or payments.
Anything I missed here, readers? I'm sure there is. Please fill in what I've missed below in the comments.
I often get asked how much they should save for retirement and I usually point people to the process I used to set my retirement number. But now I have some additional options to suggest -- some good retirement calculators I found at CareerJournal They highlight the following and have these comments:
I tried the Fidelity calculator and REALLY liked it. It was easy, fun, and gave me a very good take on where I stand financially. And it gave me almost the same number I got doing my own calculations, so it must be good. ;-)
So check some of these out and let me know what you think.
And if you want some more thoughts on saving for retirement, see these posts:
And while we're talking about moving to a job you like versus one you don't, what about the issue of hanging it up altogether -- quitting work for good? Who hasn't dreamed of doing that?
MSN Money has some thoughts on how to do this in their five minute guide to quitting the rat race. Here are a few of their thoughts that I thought were especially good:
I would really, really, really like to echo tip #1. As I said earlier today, the pain of not having a job is usually much worse than the pain of staying in your current position (even if you hate it now.)
I also like the other two ideas. It's good to try out what you think you want before you take the plunge because you may find that the grass isn't greener on the other side. And as far as moving to a new location, I've told you before that you can save millions doing this. :-)
For more thoughts on your career, see these posts:
One of the on-going debates in personal finances is whether to pay off your mortgage or keep your mortgage and invest extra money in stocks (or some other investment.) The two sides of the story were recently highlighted in a couple different pieces -- both suggesting a different outcome. First, here's David Bach making a case for paying off your mortgage early:
Like some of my fellow Yahoo! Finance columnists, I'm often asked if it makes more sense to prepay a mortgage or invest the money in stocks and bonds. Rather than ponder which asset will get you a higher return, I think the better question is which investment decision will free you financially and allow you to retire earlier.
In my 9 years of experience as a financial advisor for Morgan Stanley, the clients who paid their debts off early -- specifically their mortgages -- retired 5 to 10 years before those who didn't.
He goes on to tell how to pay off your mortgage early -- make bi-weekly payments (don't pay for the service), automating your extra payments, etc.
This is what I've done and have now been without a mortgage for about 10 years. We did it by keeping our expenses very low, well below my income, then using as much possible to pay off our mortgage. We also applied gifts, bonus money and extra income from a side business to the mortgage. And we did this while fully funding my 401k.
But if you do prepay, be sure to fund your retirement first or else it could cost you:
A recent study suggests these households blow more than $1.5 billion a year, or $400 per household, by accelerating their mortgage payments instead of contributing more to their retirement accounts.
The research found that at least 38% of those who were making extra payments on their mortgage were "making the wrong choice." Instead, these households would get back 11 to 17 cents more on the dollar by putting the money into a workplace retirement plan like a 401(k).
Then there's the other side of the argument -- the one that says to keep the mortgage and invest instead (FYI -- there's a more recent piece than this one, but I just can't find it. But this one will do):
My take is that as a purely financial matter, you're probably better off investing the extra $500 a month given your low mortgage rate.
If you repay your home loan ahead of schedule, you're basically earning a 5.25% return, which represents the amount of interest you avoided paying by making the extra payments.
I think you should be able to do better than that over the long term by investing in a diversified portfolio of stocks and bonds.
I've said before that there's a big difference between planning to do something and actually doing. And one thing I've seen over and over again is people who plan to keep their mortgage and invest what they would have put as extra against the debt. But what most end up actually doing is keeping the mortgage and SPENDING the extra amount. So they end up with a long-term mortgage and no additional investments (or at least not much.)
What's your take on the issue?
Here's a question I recently received from a reader:
My wife and I both work and contribute the maximum to our 401k accounts. We are good savers, don't use credit, etc. However, we do have a large student loan from my wife's medical school education that we are paying the minimum on. The loan balance is currently ~$45K with 8.25% interest.
We would really like to accelerate the paydown of this loan and are considering stopping contributions into one of our 401k accounts for a period of 2 years and applying the money to the loan, in addition to increasing our regular monthly payment.
Mathematically, I know those 2 years of contributions will be worth a lot in 30 years when we retire, but psychologically, it would be great to be free from this debt and the $2-3K of interest it generates each year.
I told him what I recommended, but now it's your turn. What would you suggest this couple do?
Here's a press release I received a few days ago that I wanted to pass on to all of you interested in some free retirement advice:
During two special days this month, consumers can get free, personalized answers to their retirement savings questions by just picking up the phone or logging on to their computer. For the sixth time, Kiplinger’s Personal Finance magazine and the National Association of Personal Financial Advisors (NAPFA) are partnering to sponsor Jump-Start Your Retirement Plan Days. Whether you’re just starting your career or plotting your exit strategy, it helps to know if your retirement plans are on track.
On Friday, August 17th and Thursday, August 30th from 9 a.m. to 6 p.m. Eastern Time, NAPFA advisors across the country will be standing by to answer your questions. And it won’t cost you a cent—just dial toll-free 888-919-2345. Or, for the first time, consumers can e-mail their questions to jumpstart@kiplinger.com and a NAPFA-Registered Financial Advisor will reply on one of the two Jump-Start dates. To learn more about the Jump-Start project and for tips on making the most of your retirement savings, see the cover story in the September 2007 issue of Kiplinger’s Personal Finance or visit www.kiplinger.com/links/jumpstart/ or www.NAPFA.org.
We've talked a lot about when to take Social Security payments -- either early or on time -- including the following posts:
So I thought it was appropriate to let the people from Vanguard weigh in with their thoughts on when to take Social Security. As with most articles on this subject, Vanguard's thoughts start with whether or not you need it right away:
"If you have sufficient assets so that you have no immediate need for Social Security income, then it may be best to delay taking the benefit," he said.
However, if you don't have enough money to meet your current spending needs, you should feel free to take Social Security as soon as possible, Mr. Ameriks added.
And, of course, how long you live has a BIG impact on which is the better choice:
If you expect to live a long time past age 80—or if you're just concerned about the risk of outliving your assets—you might consider delaying benefits until age 70, to boost your future monthly payments. If not, you may want to start collecting benefits at age 62. Although your monthly payments will be reduced, the lifetime amount you receive may be higher because you started taking benefits sooner.
But since no one knows how long they'll live, this is a bit of a guess.
Here's what I am doing/plan to do:
1. I'm saving for retirement assuming I won't get a penny from Social Security. Who knows, maybe I will, maybe I won't. If I do get anything, it will be a windfall since I'm counting on nothing.
2. I'll wait as late as possible to take Social Security. If anything, I'll use it as a last-chance safety net in case my retirement savings get low.
What about you? What do you plan to do?
Business Week recently ran a spread on how to retire. Within the section, it listed what to do at various life stages if you want to retire well/early. I thought I'd share some of these thoughts with you and give my comments on them. Today, we'll be covering what they recommend you do in your 50's:
My thoughts on these:
1. Yep, now's probably the time to decide what to do with your house. Will you be retiring here or somewhere else?
2. Personally, I'll stick with index funds.
3. This is probably one of the biggest issue limiting early retirement -- what do you do about health care costs/coverage?
4. Time to jettison the kids -- if they haven't already become self-sufficient.
5. Call in the CPAs!!!!!!!
Business Week recently ran a spread on how to retire. Within the section, it listed what to do at various life stages if you want to retire well/early. I thought I'd share some of these thoughts with you and give my comments on them. Today, we'll be covering what they recommend you do in your 40's:
My thoughts on these:
1. Start feeding it before you get to 40!
2. Of course. This isn't good advice just for your 40s -- you should be watching your investments at every age.
3. If you haven't yet, now's a good time to set your retirement number.
4. I don't know about this one. They want you to by a retirement home in your 40's? Doesn't seem like a good financial move to me.
5. Man, they've got you fully into retirement -- suggesting you set up a home office and start getting used to using it. A bit too early for that too, isn't it?
Business Week recently ran a spread on how to retire. Within the section, it listed what to do at various life stages if you want to retire well/early. I thought I'd share some of these thoughts with you and give my comments on them. Today, we'll be covering what they recommend you do in your 30's:
My thoughts on these:
1. Said a different way, "concentrate on your most valuable financial asset."
2. We had kids in our 30's and if I was to do it again, I'd have them in our 20's (late 20's).
3. I look at my net worth every month. It's my main financial measurement -- though I have others, of course.
4. Keep saving!!! That's a big retirement number you have!!!!
5. Insurance is often the forgotten step-child of personal finance but it's a vital part of any solid financial plan. It's so important that I made it one of my five principles.
If you'd like to learn more about how to grow your net worth, you can subscribe to Free Money Finance's RSS feed for free by clicking this link.
Business Week recently ran a spread on how to retire. Within the section, it listed what to do at various life stages if you want to retire well/early. I thought I'd share some of these thoughts with you and give my comments on them. Today, we'll be covering what they recommend you do in your 20's:
My thoughts on these:
1. The key to this -- having a budget and sticking to it.
2. I didn't put my savings on autopilot until I was in my 30's. Wish I'd done it earlier.
3. Spending less than you earn is the best financial advice I could give.
4. I started a "retire early" fund in my late 30s. But it will take a TON of money to get me to where I'm ready to pull the plug on work life.
5. Yes, the Roth is a great way to save. Just remember to save for retirement in the right order.
6. Costs matter if you want to maximize your investment returns.
7. The best advice for people in your 20's: start saving/investing now and let compounding work for you for a few decades.
Here's an interesting comment left on my post titled When Should You Take Your Social Security Retirement?:
I downloaded a calculator from the SS administration website and calculated my benefits at every year from 62-70. Assuming 8% return, the break even point where all had the same value was age 85. With 10%, there was no break even point. I have 35 years to make that decision. If the market still returns 10.5% through then, I'll probably take it early.
Also, if you are in your 30s, you may end up hitting 62 just a couple years before SS is supposed to run out. If so, take the early option.
Interesting thought -- if you think you can do better than what they have in their projections, then taking your benefits early may make sense.
Ahhhh, the debate goes on. ;-)
Since I wrote When Should You Take Your Social Security Retirement? I found an interesting article from Financial Planning that gives some thoughts on how financial planners should help their clients make a decision on Social Security. The bottom line is that it's a confusing process -- and the Social Security help line is no help. They claim that different people give different answers to the same question. Ha! Sounds like the same people running the IRS help line are now manning the phones for the Social Security Administration.
But there were a few "rules" to follow as well as nuggets of information in the piece that I thought were worth posting on it. These include the following:
Ok, so maybe it's as clear as mud still. But what is certain is the fact that the system will change (probably becoming more complex) -- maybe even several times -- before I need to make this decision in 20-25 years.
For some reason, people hate it when I rant about Social Security (see Why Social Security is a Rip-Off -- Especially for Higher Income Workers and Social Security is Robbing Me of $1 Million; You Too?), so I figured I'd let Yahoo do the ranting for me this time. They detail the fact that Social Security will pay out less (as a percentage) in the future. Here's the bottom line:
A new study says Social Security will replace much less of your pre-retirement income than it has for retirees in the past.
There's a shocker.
Then, it gets worse for some people:
And the more you earn, the greater the difference would be. [between how much you used to get and what you'll get in the future.]
Personally, I'm not counting on Social Security for a dime as I save for retirement, so I'm not really worried about what happens to Social Security personally. I am hopeful that it gets worked out for those who are less fortunate and need retirement support, but I'm not too excited about paying a chunk of my current income to support many people who should be saving on their own to fund their retirement. And the fact that I'm putting in more and more and expecting to get back less and less doesn't sit well either.
But there I go again -- ranting. We'll move on to the next thought from Yahoo on what the future of Social Security holds:
For those in their 20's, 30's and 40's, you can bank on this: whatever changes are decided, you'll either end up paying more for the benefits promised or you'll receive less of them, or, possibly, both.
Just another reason to count on it for nothing. Set your retirement number and save for it yourself -- act as if you won't receive a penny from Social Security. Then, if you do get anything, it will be a pleasant surprise.
Of course, it could be worse:
Or you could just move to Luxembourg. According to data in NASI's report from the Organization for Economic Cooperation and Development (OECD), retirees in the tiny European nation get Social Security-like benefits that equal 100 percent or more of their pre-retirement income, ranking it No. 1 among all 30 member countries of the OECD, many of which fund government retirement benefits with contributions from workers, employers and general taxes, with typically higher tax rates than in the United States.
More taxes. Great idea. Maybe we could all just send our paychecks into the government and they could send us each back whatever they didn't need. Sounds like what they do in Luxembourg.
There I go again...
Here's an interesting piece from USA Today that gives advice on how to withdraw retirement funds. Their suggestion:
Diversify your investments among stocks, bonds and money market securities, or cash. That way, if your stocks tumble, gains in bonds or cash could soften the blow.
The next tip: Withdraw money from your investments in a sensible order. Guyton recommends setting a basic asset allocation, and rebalancing it every year. Suppose, for example, you decided to keep 65% in stocks, 25% in bonds and 10% in cash. You should take withdrawals from your portfolio in this order:
1. The portion of your stock holdings that exceed your target allocation for stocks. For example, if you're 67% in stocks, clip 2 percentage points' worth from your stock funds. Most of the time, if a portfolio position is overweighted, it's because you've made gains. There's nothing wrong with selling higher than you bought.
2. The portion of your bond funds that exceed your allocation target.
3. Cash.
4. Remaining bond funds.
5. Remaining stock funds.
When possible, don't take withdrawals from stock funds if they absorbed a loss the previous year.
Two other rules can help make your portfolio last: First, cap your inflation adjustments at 6%. Even if inflation soared 10%, you would limit your increase to 6%. Also, don't give yourself an increase if your overall portfolio shows a loss for the previous year.
I am a long, long, long way from needing this advice and it's likely that the best method of withdrawal will change by the time I do. That said, I thought some of you who are closer to retirement might be interested in it. Also, the article itself has several additional insights, so if you want more information, click on the link above and read the whole thing.
For more on retirement, see these links:
Here's a retirement question recently submitted to MSNBC:
I recently turned 60. I have a small retirement fund with the company for which I work, roughly 27 to 28K at this point. I DO NOT want to work past 65 or 66. Is there any way to turn my financial mess around? I have never seriously thought of retirement and the need for money until recently. My philosophy was spend it if you've got, because you can't take it with you. Not sound financial thinking. Is there any hope?
My answer: Maybe. Do you like dog food?
Ok, so that was harsh. But remember, we're not talking about a poor person who tried to do his best and just couldn't make it. This is a guy who wasted forty income-producing years (and probably had a decent time doing so) and now wants a quick fix so he can retire on time. he didn't even think about retiring or planning for it until recently. What planet is this guy from?
Unfortunately, this guy isn't alone. In fact, he's not far from average when it comes to retirement savings -- many people simply aren't saving enough. What are these people thinking? I tell you, I'm simply in wonder at the lack of planning from most people when it comes to retirement.
I bring this subject up over and over again just to remind each of you reading this (not to mention reminding myself) how important it is to save for retirement -- to set a retirement number now and save for it so you can retire when you want to and how you want to.
For more thoughts on retirement, see these posts:
There's a lot of debate (I'm had some of it myself) on what's the best age to take Social Security retirement. There's no doubt that most people take it early (at age 62) and thus get a reduced benefit -- but should they? Yahoo ran the numbers and came up with a general guideline on when someone should take Social Security benefits. Their thoughts:
Taking a smaller benefit early can pay off if you don't live past what's called your "break-even" age - the point at which the cumulative value of your early retirement benefits is trumped by the money you would have been paid had you waited until full retirement age.
Say you want to retire at 62 and would draw a Social Security benefit of $1,125 a month. That's 25 percent less than the $1,500 you would collect if you waited until age 66.
By age 77 and 11 months (let's call it 78) you'd have collected roughly $216,000 in total benefits, whether you opted for early benefits ($1,125 x 192 months from ages 62 until 78) or full retirement age benefits ($1,500 x 144 months from ages 66 until 78).
But your break-even age is actually later when you factor in the investment value of your early benefits. Even if you don't invest those early benefits directly, taking them might mean you can leave other savings to keep growing. That could add three to five years to your break-even point, Gebhardtsbauer estimated.
So in the example above, if you think you'll live past 81, it may pay to wait until full retirement age to start collecting.
They then go on to list a whole host of additional factors that also might influence your decision, so that's why I'd call this a general guideline.
So, what's the likelihood you'll live to 81 if you're already 62? Well, these numbers I found in a Money Central article aren't exactly what we're looking for, but they're close:
Based on actuarial tables of how long Americans actually live, if you retire at age 55, you can expect to live to age 83. If you retire at 65, you get another year's reprieve to age 84. And if you keep working until age 70, you're expected to live to age 86.
So there appears to be no clear choice one way or the other. The break-even age is fairly close to the expected age you'll live to. In this case, I'd go with the "do you really need it" scenario. If you do need the money at 62, then why not take it? The chances are almost as good that you'll do better with it than by waiting. Plus, you'll get to enjoy it while you're younger. On the other hand, if you don't need the money to live now, why not let it ride and retire a few years down the road. Odds are in your favor that you'll squeak out an extra year or two of earnings.
Anyone else have any thoughts on this?
Here's an interesting stat from the folks at Money Central -- people who calculate a specific retirement savings number are actually happier in retirement. The details:
Studies indicate that people who have set retirement goals and saved for their retirements say life in retirement is actually better than they had expected.
The piece then goes on to give five steps to arrive at your retirement number.
Almost a year ago, I set my retirement number. I calculated it by using various methods and then selected a number within the ranges I came up with. All I can say about it are:
1. WOW! It's a BIG number!!!
2. I like having a specific goal to shoot for.
3. I think I'll feel better in retirement as a result. ;-)
Here's a position I never want to be in -- having to work later in life rather than retiring because I've made bad financial decisions for the past 65 years. Yeah, maybe I'll work because I WANT to. But I don't want to HAVE to work.
But that's just the situation many Baby Boomers are finding themselves in -- having to work later in life because they can't afford not to. MSNBC covered this issue recently and I'd like to share their findings with you and give some of my comments along the way. We'll start here:
Two new reports portray aging boomers as better educated, with higher incomes and longer life expectancies than the generations that preceded them. They also have fewer children and are less likely to be married, leaving them with fewer options if they need help in their old age.
So these people have had higher incomes than past generations and yet they need to work longer. Granted, living longer is part of the reason for this, but shouldn't they have factored this into their savings plans? It sounds to me like they weren't very good savers throughout life and they now need to work to stay afloat.
Frey is releasing a report Tuesday that says higher rates of divorce and separation could result in greater financial hardship for aging baby boomers. In 1980, about two-thirds of Americans age 55 to 64 lived in married-couple households. That percentage fell to less than 58 percent in 2005.
This fact has certainly impacted their finances. We've talked in the past how married couples, on average, do better financially than non-married people. For reference, check out these pieces:
Some will continue working by choice — a government survey shows that most U.S. workers nearing retirement age want to gradually reduce their workload rather than abruptly stop.
This is what I'd like to do. I want to shift from a "regular" job to one that allows me to serve reduced hours and focuses more on helping people in some form or fashion. However, I'd like to do this at age 60 (or 55), not at 70 or older.
Others will have to stay on the job as fewer companies offer health insurance to retirees and an alarming number of private pensions fail.
We'll be seeing more and more of this sort of thing in the future as healthcare becomes a bigger and bigger factor impacting people's retirement. This is one reason I think medical tourism will take off like gang-busters.
Don't let this happen to you. If you want to work into "retirement", that's one thing, but don't be forced to work because you didn't save enough now to be able to retire. For some tips on how to think about and save for retirement, see these posts: