Getting Personal
Retirement savings Archives
Naming a beneficiary
Question: I listened with interest about your story of the military man who is investing in the Thrift Savings Plan and was happy to hear your high review of the plan. My husband is a rural letter carrier and has been investing in TSP since he became eligible. When it became available he transferred all funds to the life cycle fund and is very pleased with the performance so far. Every quarter we download and print the statement; we noticed that he has NO BENEFICIARY DESIGNATED. Would that lack of specific designation cause problems for me (as his wife of 34 years) and/or our adult children in the event of his death? Or should that designation be changed as soon as possible? Thank you if you are able to respond to this question. Gail, Springville, Pennsylvania
Answer: As his spouse, the lack of a beneficiary designation shouldn't cause you any trouble. Federal law says that the spouse is automatically the beneficiary of a pension plan, including a thrift savings plan.
However, in general you should still fill it out, especially if you want to include your children as beneficiaries. It's simply a good habit to fill out the beneficiary form which, by the way, overrides what's in your will. (And if you don't have a will, please get one.).
The insurance company USAA recently listed in its newslatter three mistakes to avoid when it come to naming a beneficiary. They are worth keeping in mind.
1) Name an individual rather than an estate as beneficiary. The tax code provides named beneficiaries with more tax-friendly choices than when they receive an IRA through probate.
2) Failing to keep your designation current. It pays to review and update your beneficiaries whenever there is a major life event, from divorce to the birth of a child to retirement.
3) Don't name minor children as beneficiaries without appointing a custodian. Minors can't own investments outright, so they need an adult to act as custodian until they reach the age of majority.
12/17/07 by Chris FarrellSavings for a Stay-At-Home Mom
Question: I'm currently not in the paying workforce while I take care of my infant son. Besides the obvious large loss of income, I'm concerned about my curtailed ability to contribute to my retirement funds. Are there avenues to move money into retirement funds beyond a $4000 IRA contribution?
Answer: This is a pet peeve of mine, and I don't understand why Congress and the White House don't combine forces to dramatically simplify the pension system and make it more equitable. The current private retirement savings system is capricious. It includes 401(k)s, 403(b)s, 457s, SIMPLEs, SEP-IRAs, IRAs, and Roth IRAs to name only the best-known plans. The rules, income limits, and restrictions vary significantly among most of these tax-advantaged savings programs.
For instance, if you were working at a company with a 401(k) you could set aside $15,500 in pre-tax dollars in 2007. An employee at a small company with a SIMPLE plan has $10,500 limit. A stay-at-home spouse running the family household can save at most $4,000 in an IRA. If you are over 50, the plan limits are somewhat higher in each case. But the overall disparity remains.
Why not attach the retirement-savings plan to the individual and have just one rule for everyone--say, 15% of income, or $30,000? The figure could be less or more. The key point is that the rules should be uniform. And the retirement plan system should include parity for working and "nonworking" spouses (an oxymoron if there ever was one).
All right, I'll clamber off my soap box. But unless you bring in an income through freelance projects or a consulting business or some other income generating sideline that you run out of the house, you're out of luck when it comes to the pension system.
But all is not lost. Here are a couple of suggestions. First, you could buy I-bonds from the Treasury. You buy them with after-tax dollars. You pay no commission costs. Your money compounds free of taxes until you cash them in (you'll then pay your ordinary income tax rate on the gain). These bonds are specifically designed to protect your portfolio from the ravages of inflation. The dollar you put in to today will be worth a dollar plus interest 10 years, 20 years, or 30 years from now.
Another strategy is to set up an automatic payment account with a major mutual fund company and buy a broad-based equity index fund. You'll outperform most professional money managers year-in and year-out by matching the underlying index, you'll pay very little in fees, and your tax bite is limited compared to an actively managed mutual fund since there isn't a portfolio manager constantly buying and selling stocks.
An alternative to an index fund is a tax'managed mutual fund--one that is run by the a pro with an eye toward minimizing Uncle Sam's tax take. An added benefit to investing regularly in an index fund or a tax managed fund is that if you need the money before age 59 1/2 you can cash it in without paying the 10% surcharge attached to defined contribution savings plans like 401(k)s and 403(b)s.
In other words, you can make some long-term savings on your own that offer their own advantages even though the money isn't in a pension plan.
IRA or Vacation?
Question: Ten years ago, I left my previous employer with a 401K worth $2,500 and invested the money in an IRA. Its value at the time of this e-mail is around $3,100. In my opinion, that's a very low return. In your view, should I just take the money, pay the penalty and take a vacation? Or should I leave it alone? Mr. Angel, Milford, NH
Answer: I'd rather you leave it alone. Sure, it hasn't grown much. But thanks to the power of compound interest it will add up if you leave it alone. For instance, $3,100 earning a return of 5% annually over 20 years is worth $8,225. The same figures compounded over 30 years equal almost $13,400. Those aren't huge sums, but a little bit here and a little bit there eventually add up.
Still, the main reason it doesn't pay to withdraw the money to pay for a vacation is that you'll owe Uncle Sam income taxes, plus a 10% penalty. Ouch.
01/10/08 by Chris Farrell
Market turmoil and 403(B) Contributions
Question: I am thinking of increasing my 403(b) contributions to lessen my tax obligations. However, I am concerned about increasing my contributions while the market is heading downward. I am 29, so I am not planning to retire anytime soon. My employer offers a flat rate towards my retirement fund regardless of my contributions so that wouldn't be a factor. Should I wait till the market heads up before increasing my contributions? Thanks, David
Answer: At your age, you have little to nothing to fear from a down stock market in your retirement savings plan. Indeed, there is even reason for cheer since you have three decades before you tap into the money. You're buying good companies on the cheap.
Look at it this way. Every time you put money into the stock market out of your retirement savings plan you are "dollar cost averaging" your portfolio. Technically, dollar cost averaging means putting the same amount of money into an investment on a regular basis. So you purchased fewer shares when the market was up, say a year ago, and more equity now that when stocks values. So, let's say you're putting $1000 a month into your 403(b) stock mutual fund choice. When the market is strong, maybe you could buy only 100 shares. But now that the market is taking a nosedive, perhaps you can pick up 150 or 200 shares. Since stock prices rise over time, this technique allows you to build up a stock portfolio worth more than the price you paid for it.
Another benefit of dollar cost averaging is psychological. The time-tested stock buying method takes emotion--fear, greed, and panic--out of investing. You are regularly socking money away in all markets, bull and bear alike.
If it were me, I would hike my 403(b) contributions.
The Market Fall-Out
Question: Help! I retired a couple years ago and the market was going up. Now it's going down, down, and more down. How do I stabilize my savings and IRA money that I'm living on? I'm not on Social Security just yet (I'm 61). Do I need to go back to work for awhile? Ickkkk, I hope not! Kojis
Answer: You're far from alone in your concerns. It's frightening right now with the stock market wildly plunging one day, recovering the next, only to lose even more ground in following days. The housing market continues to tank. The consumer credit default wave is spreading from subprime mortgages to home equity loans, credit cards, auto loans, and other types of consumer credit. A recession is likely.
Truth is, while we're in the midst of turmoil, it's usually a mistake to make any dramatic moves. That doesn't mean you shouldn't go more conservative. But I would use this as a wake-up call to reassess your whole portfolio. You should always pay attention to the downside--what could go wrong. And if you lock in the essentials by investing safely you can sleep at night.
So, as you know, one way to protect yourself is to diversify. Right now, while the stock market is down about 16% from its October 2007 high, the U.S. government bond market has strongly rallied.
It can also mean putting money into cash (by cash I mean U.S. Treasury bills, conservative money market mutual funds, and other creditworthy short-term securities). To be sure, the investment price you pay for credit quality is a lower yield. But cash will hold its value.
My next thought has to do with this question: What is the biggest risk confronting savers? Recessions? Bubbles? Bear market? Yes, all these traumatic events batter savings and undermine confidence. But inflation, a sustained rise in the overall price level, tops the list. The purchasing power of a dollar declines year after year when inflation drives up the costs of goods and services. One hundred dollars loses half its value in 20 years with a 3.5% average annual rate of inflation. The same sum falls by about a third over two decades even at a modest 2% inflation rate.
That's why I'd put money into Treasury inflation protected securities, or Tips. For practical purposes, it's a completely safe asset that adjusts to changes in the consumer price index. The CPI might not exactly match your basket of spending, but its pretty close. Tips can protect your money from inflation for 20 years.
Now, a well-known drawback to TIPS for individual investors is that taxes are paid on the unrealized annual inflation-adjusted gains. Yet there are plenty of ways to avoid the tax on phantom income, such as owning TIPS in a tax-sheltered account like an IRA. Another alternative is the inflation-protected U.S. savings bond, the so-called I-bond. The investment compounds tax deferred until the bonds are cashed in.
Certified financial planners (CFPs) are expensive. There's no way around it. But one of the best investments someone can make in your circumstances is to spend the time finding a fee-only certified financial planer that can go over your portfolio, assets, goals, dreams, and give you a true sense of the trade-offs you face.
And, yes, going back to work may be one of those options.
01/24/08 by Chris FarrellFellowships and IRAs
Question: My husband and I are currently on National Research Council fellowships, working at a government lab. The nature of the fellowship is such that we are neither employed by NRC, nor by the lab we work in, yet we are not required to pay self-employment taxes. Someone told me that in that case, we cannot contribute to our Roth IRA accounts either. Is this true? I'm concerned because it's the only retirement saving vehicle we have right now, since we don't qualify for a 401(k). If we can't contribute to our Roth IRAs, do you think getting Treasury I-saving bonds are our best alternatives? Thanks! Nandita
Answer: As I understand it, IRS rules prevent scholars on fellowships like yours from technically counting the money as "earned" income. So, you can't contribute to your Roth if the fellowships are your only source of income. However, if you have any part-time work (I realize that's probably unlikely given your schedules) then you can use that money to fund the Roth-IRAs.
If that's not the case, I do like the idea of investing money in I-bonds, the inflation protected savings bond. You don't pay any commissions buying and selling them. Your money compounds tax free until you cash them in. And the dollar you put in today is worth a dolla--plus interest 10, 20 or 30 years from now. The other thing you can do is also direct some money into a broad-based equity index fund, like the S&P 500, the Russell 3000, or the Wilshire 5000. That will give you an exposure to the equity market in an investment that keeps fees razor thin and your annual tax liability low.
One advantage of this home-brewed retirement savings approach--bonds plus equity index fund--is that it's easier to pull money out early. Yes, you'll have to fork over capital gains tax and income taxes, but you won't have to pay Uncle Sam the 10% penalty imposed on early withdrawals from retirement savings plans like IRAs or 401(k)s.
01/30/08 by Chris Farrell
Have Fun
Question: My husband and I are in our mid 30's, no kids, both have good incomes and we're putting money away towards our retirement through our employers (so pretax) as well as other sources (Roth). My husband has about maxed the amount he can contribute. I have not, but my employer puts in a substantial amount as long as I put in the minimum required. My husband thinks I should try and max mine out as well, but I want us to put some in shorter term investments so we can enjoy some of the money now to travel, etc. We have a decent amount in savings for emergencies. First, as long as both of us are putting away at least 15% of our income, is it fine to stockpile our savings so we can enjoy some of it now? And second, is there something else besides savings/CD that have a better return rate, but that we can access (within a few months to a year like CD). Thanks. Heather
Answer: My standard advice is to max out your retirement savings plans, and you clearly can afford to do it. However, you and your husband are saving a good chunk of your income every year. You're money smart with a good financial safety net. In this case, I'm on your side. Take that trip (or trips). Go out to dinner. Have fun.
Where to put this money? I would take two very different approaches with the money. First, I'd put the bulk of it into a conservative money market mutual fund with brandname national or international financial institution. (These big companies have a reputation to protect, so the odds are good they'll do whatever it takes to preserve the value of the fund, even if it faces financial difficulties).
I would also consider putting a sliver of the money into a broadbased equity index fund or a tax-managed fund. Your annual tax burden on the savings is low with either product. The money should compound over the years. When you do tap into it, you'll pay low capital gains taxes on the gain.
Savings and Health
Question: I just finished graduate school and started my first real, full time job. I want to begin contributing towards retirement. My situation isn't as simple as many people my age, as I'm a 30-year old with several chronic health conditions. I'm currently able to work, but a downturn in any of my conditions could change that ability. I have two main concerns:
1) Contributing to a retirement account and then needing the money due to a reduced income due to my disability and having to pay an early withdrawal penalty.
2) I have no idea how much to contribute for retirement health insurance costs, or such costs if I have to retire prior to 65 (before I qualify for Medicare). I'm currently in such a high risk insurance category that it would be several thousand dollars per month IF any insurance company would insure me.
I'm unable to find any information on the web and doubt many retirement advisors deal with this type of concern. Thank you! Dawn
Answer: A lot depends on the income you're earning, of course. But let's start with retirement savings. Take full advantage of a 401(k), 403(b), or similar retirement savings plan at work if it offers a company match. When you look at the performance of a retirement savings plan at work, much of the gain comes from the company match. (And you can draw on that money after age 59 ½ without penalty if you need to pay for medical expenses before Medicare kicks in at age 65.)
You could use the rest of your savings money to open a Roth-IRA. Roth contributions are paid with after-tax dollars, so there's an upfront tax hit, but any gain from your investments is tax free. Contributions to a Roth can be a maximum of $4,000 a year; $5,000 if you're over 50.
But the real advantage for someone with your circumstances is that the Roth is both a retirement savings plan and a store of emergency savings. In an emergency, you can take out money from your Roth contributions without paying or taxes on it. You leave the investment gain in the portfolio alone.
Here's a hypothetical example: Let's say in 2005 you put $2,000 into a Roth, and in 2008 you need $1,000 to pay medical bills--and there is no other pot of savings. You could take out $1,000 from your Roth and not pay a 10% penalty or taxes to Uncle Sam on the withdrawal. Of course, the main drawback to this strategy is that you will earn less on your Roth savings. But sometimes that's a price worth paying.
Two quick thoughts on the healthcare front. If I were you, I would focus my job search and employment goals on employers who offer a good healthcare plan. In most cases, that means finding a government job, or working for a large national or multinational corporation. I don't how much you'll need to set aside for healthcare when you get older. By then, we could have universal health insurance--or not. My main message is that you have to save more than the average person to build up a financial cushion. And A Roth is one way to accomplish that goal.
02/12/08 by Chris FarrellSaving for Retirement
Question: I'm a 30 year old who works at a public university. I think I'm eligible to deposit $15,500 at my 403b and another $15,500 at 457b. I plan to deposit $31,000 every year for 30 years and start to withdraw when I get 60. My job is very stable. Our current tax rate is about 28%. Should I do that? Thanks, Qin
Answer: Yes, you can do that. It isn't well known, but through a quirk in the law anyone with a 401(k) or a 403(b) can double the amount they put into their retirement savings if their employer also offers a 457 (which is just another retirement plan). I applaud your discipline and aggressiveness when it comes to savings.
Because you want to retire at 60, I'd like to toss out an alternative idea: Put some of your planned savings into a taxable account. Don't put it all into a pension plan. The reason is that then you'll have a pool of long-term money that you can tap until you're 59 1/2 without paying the 10% penalty imposed by the government on early withdrawals from a pension.
You'll still want to keep your annual tax burden low, say, by investing the money in tax-managed account, broad-based equity index funds, inflation protected savings bonds (the I-bond), and the like. Good savers should always consider a balance of tax-sheltered and taxable accounts.
A Cautious Investor
Question: I'm 44, working at a university. My position is not secure nor stable. I have $40,000 in CD. How do I make my money grow? I would like to have a short term investment. Where should I put my money? I hate to think about retirement... saw many people try to save money for their retirement but it turns out they die before they can use their money. Sorry if my idea is strange. Thanks. Lekas
Answer: Your idea isn't strange. You've focused on a risk all of us take when we set aside money for the long-haul. However, your question also highlights how limited your choices are when you want to stick to short-term investments. There is a trade-off between risk and return. And by limiting the risk you're willing to take in the market, you're also limiting your potential return.
That said, the way for your money to grow is to add to savings. You can then preserve the value of your savings by investing in certificates of deposit (as you're doing), Treasury bills, money market mutual funds, and the like. And, of course, this money is available to you if you lose your job.
Still, how about putting a small slice of money into your university's retirement savings plan? Most universities offer their employees a good pension plan made up of low cost mutual funds.
Market Turmoil and a Retirement Portfolio
Question: My husband and I both put the maximum into our 401ks, which we now see dwindling (9% loss this year already). Money is tight; our daughter is making the decision about what college to attend; and we do not have a lot in savings ($200k in our 401ks; $50k in stocks). Should we continue to put the max into our 401ks or decrease the contribution during this economic downturn? We both turn 50 this year. Thank you so much for your help. Kary.
Answer: With the drop in the market, I'm getting many variations of your question. The feeling about retreating from the market is understandable. But here's my cautionary note: You're both still young. Taking into account your average life expectancy, you're still investing for another 30-plus years. That's why the main lesson I would take from this volatility and turmoil in the market is to review your portfolio. Are you comfortable with how much you have in stocks, bonds, and other securities? Do you need to get more conservative?
That said, you have a big expense coming up: Your daughter's college education. It's a big deal, and if you want to slightly cut your contributions to your retirement savings in order to help pay for college expenses, that's fine (with me, that is).
Nevertheless, I do believe you should take care of your retirement needs first and your daughter's college expenses second. She can always borrow. The reason for establishing this priority is that you and your husband are nearing the end of your earnings years to save for retirement, and she has a lifetime ahead of her.
Market Turmoil
Question: I have some money in 401K but it's all vanishing because of the stock market drop. Is it a good idea to ride it out,or transfer the money out of stocks (investment optons) and put it in a safe stable fund? Frank, Satellite Beach, FL
Answer: A bear is mauling the stock market, and the worst may be yet to come. The S&P 500 is down some 17% from its October high, still in so-called correction territory but not all that distant from the 20% decline that traditionally defines a bear market. The desire to get away from the carnage is understandable. (My answer to your question assumes that you're still in the "accumulation" stage of life, working and adding to your retirement portfolio.)
Still, for many investors the first rule of managing money in a downturn seems to be "do no harm." When people try to time the market, the result is usually disastrous. The average saver who sits tight with their retirement money during a bear market typically does much better than the person that gets in and out of the market.
That said, my mantra is to take advantage of this time by figuring out whether you're comfortable with your portfolio. Are you too much in stocks? Bonds? International? How do you wish your portfolio was constructed? Once you've figured that out, then I would create that portfolio over time.
03/14/08 by Chris FarrellThe Social Security Do-over
Question: I began receiving Social Security payments at age 62. Now I'm 66, and I've read that I can pay this money back to the government and get significantly larger checks. Bad idea? Peter, Ashland, OR
Answer: It all depends on how the numbers work out. But in many cases it can be a savvy financial move. I recently did a brief story for Business Week on the basics of taking the Social Security two-step.
How to Retire Early, Then Change Your Mind
Call it the Social Security do-over. If you retire early and take a reduced monthly benefit, you can change your mind, reapply, and get the bigger payments that go to those who wait to collect benefits.
The catch? After filling out Form 521, you must send the government a check covering the benefits you've been paid (without interest or adjusting for inflation). "Everyone is free to do this," says Laurence J. Kotlikoff, economics professor at Boston University and head of financial-planning software company ESPlanner.
He ran numbers for a couple who retire at 62, have $300,000 in savings, and an additional $100,000 each in retirement assets. They want their money to last until they're 100. If they apply for benefits at 62, each gets $17,921 a year.
Fast-forward eight years. Had they waited until age 70 to file, they would get $31,005 each, for a total of $62,010 a year. To get those higher payouts at this point, the formula requires them to pay $118,957 each. Yes, that's a big check. But to get that same payout by buying the cheapest commercial annuity would cost 40% more. When you include earnings from the couple's other assets and factor in their 30-year time horizon, Kotlikoff calculates that their annual aftertax spending can go from $58,765 to $70,420.
Professor Kotlikoff has written a more detailed explanation of the financial maneuver. You can find it at www.esplanner.com/illustrations.php, and click on "Double Dip on Social Security."
04/01/08 by Chris FarrellA Rollover IRA
Question: I was recently hired for a job in the public sector, working for the state of New York. My previous job was in the private sector. My 401(k) from my previous job is still being administered by my former employer, and it's now worth about $108,000.
The benefits administrator of my present employer has told me that I am not allowed to roll my 401(k) into any pension or savings plans that my employer offers. What are my options for doing something productive with my 401(k), instead of just letting it sit there? Tim, NY, NY
Answer: A rollover IRA (Individual retirement Account) is designed for circumstances just like yours. It's a routine transaction. First, figure out what financial institution offers the mutual fund options and services you'd like. They'll have the forms online for making a rollover IRA, but I always recommend calling the 1-800 number and ask for a human being to walk you through the process. The reason is that you want to make sure that your retirement savings are transferred institution to institution. In other words, you don't touch the money. It goes from your 401(k) to the financial institution you've picked for your IRA. This way you preserve the pension's tax shelter.
Spousal IRA
Question: I am a 30 yr old man with a 9 month old son and a stay at home mom to take care of. I have started contributing to a Roth IRA this year. I maxed out for 2007 and have contributed $3000 towards 2008. I plan to invest in low fee index funds and have invested in the Vanguard Emerging Market Index Fund and the Vanguard Balanced Index Fund. This should cover the whole world!
I have played it safe with my Roth IRA even though I consider myself more aggressive than others. I would like to trade stocks, hopefully keep them for more than a yr to escape the high taxes but in the current market situation there are times I feel like selling stocks that are not doing too well.
My question is: Can I open a Roth IRA for my wife even if she doesn't work. If I can, can I actively trade stocks in that account but opening a Roth-IRA with TDAmeritrade or any other discount broker. Will it all be tax free? Wouldn't it be a good strategy to avoid taxes if you want to actively trade? Pradeep, Chicago, IL.
Answer: Yes, assuming you file a joint tax return, your wife can open up a Roth-IRA in her name. She funds it with after-tax dollars for up to $5,000 in 2008 (the limit is $6,000 for those age 50 and above). The so-called "spousal" Roth IRA and traditional IRA is the one exception to the rule that you need earned income to contribute to an Individual Retirement Account. (Technically, there is no such thing as a spousal IRA, but the phrase is used as descriptive shorthand in the financial services business.) By the way, all the other Roth rules still apply, such as the compensation phase-outs. It doesn't read as if that's a problem for you and your wife this year. But for any couple that doesn't qualify for a Roth, a traditional IRA funded with pre-tax dollars is always an option. There are no restrictions except the amount that can be contributed with a traditional spousal IRA. It's a smart move for your wife to open a retirement account..
But we are going to part ways on trading stocks in the Roth IRA (or any IRA). To be sure, trading in the retirement account won't trigger any tax consequences. But when saving for retirement the savvy strategy is to invest in a well-diversified portfolio with minimal trading and razor-thin fees. This approach substantially increases the odds of doing well over time. That's why I like the portfolio you have in your Roth.
Now, if you want to test your stock-picking wits in the market by trading stocks, I'd do it in a taxable account not a retirement account. Yes, you'll end up paying taxes on gains, but you'll also minimize any tax hit with your losses since Uncle Sam underwrites your bets that go bad.
I would also strongly encourage your wife to manage her retirement account on her own. It's a good idea for everyone to understand how to invest money in the markets.
Retirement Savings vs. Life Insurance
Question: I'm 56 and my wife and I together make around $80k and both contribute to our company matched 401Ks. I plan to retire at age 70. My insurance agent is suggesting I stop contributing to my 401K and instead buy a "Permanent Life" policy of $250k which he says will pay out better than if I stayed in the 401K (the company matches 50 cents on the dollar up to 6%)by spending down what I already have and spending down the dividends in the insurance policy. Is this possible? Is buying Permanent Life Insurance considered a good investment? Dennis, Silverthorne, CO.
Answer: I have a very simple point of view toward questions like this: When a company matches half of your contribution into a retirement savings plan you are outperforming over the long-haul Warren Buffett, George Soros, William Gross, and any other legendary investor of the past half-century. Why would you give up such a superior investment track record?
Financial planners disagree on many things, such as the cost and benefits of actively managed investment funds versus passively managed index funds. But most if not all would agree with me that everyone should take full advantage of their retirement savings plan at work--as well as IRA, Roth-IRA, SEP-IRA, or comparable products if you qualify--before even considering putting money into a cash-value life insurance product. Cash value life insurance, such as whole life, universal life, and variable life is not a retirement plan.
I'd stick with your 401(k).
That said, you should evaluate your need for permanent life insurance as a distinct financial planning question. For instance, at your age do you still need life insurance? If so, how much? Does your company offer a group policy? Is it enough, and if it isn't, how much more insurance do you need? Compared to permament life insurance, would it be better for you to invest the potential life insurance premiums in a low-cost tax-efficient taxable account, such as in the S&P 500--or not? These are the kinds of questions I'd pursue before buying a policy.
Move Retirement Money?
Question: I just changed jobs so am trying to figure out what to do with the 403b account that was left behind. It is with an Insurance company (New York Life) so the account fees are higher (generally 2 times as high) than my Vanguard accounts where I would prefer to move it. There is a 7% surrender charge which falls to 6% year 4, and so on. Not until it's hit year 9 (7 years from now) will it be zero% penalty. They charge $30 a year in general fees, plus 1.3% for various annual fees. The account balance is approx $7800 so there is an added fee for being below $10,000. I think it would be worth it to simplify my life for the $500 or so they will charge me vs. letting the account sit there for the next 7 years where they nickel and dime me with fees that would approach that same $500. What do you think?
Thanks for your help. I love the podcasts and enjoy learning so much from you guys there at Marketplace and Marketplace Money. Keep up the good work. Regards, Kevin, San Clemente, CA
Answer: I don't understand why management locks their employees into high cost retirement accounts like this. Worse yet, a major reason behind a defined contribution savings account--like a 401(k) or a 403(B)--is that you take more risk but in return the pension is portable--it can go with you. Pension plans like this don't violate the letter of the law but I do believe they go against the spirit of the law. .
If it were me, I would pay the price and put my money where I want it. Over the long haul, I believe you'd come out ahead.
06/04/08 by Chris Farrell
How Much Is Enough?
Question: I've yet to find a book or article that can answer this question: How do you know if you're financially okay?
I'm 38. I make $80k a year. I have $250k divided between a Roth IRA, 401k, and a single account. I put 20% down on a condo and the mortgage is the only debt I have. I also have long-term care insurance. Can I stop worrying? C. Houston, TX
Answer: Why is it that dire jeremiads about getting old resonate with so many of us? Why is it that conversations about retirement at work and the neighborhood barbeque so often turn into a litany of woe and dark humor?
Certainly, some segments of society are extremely vulnerable in their old age, such as poorly educated, low skill workers. But for many others, from the worker on the factory floor to the professional with an office--to someone like you--the apprehension largely stems from the realization that there is no way of knowing how much is enough to fund a lifestyle--let alone medical bills.
Yet most people will find themselves in decent financial circumstances with room for maneuver late in life by following some basic savings strategies and taking a broad perspective on investment. And that includes you from what you've told us. Keep doing what you are doing.
As important, take the time to carefully thinking through "What really matters to me?" That way you'll continue to come up with devise sensible answers to the question "How much is enough?"
One book that I like for thinking about a question like yours is Ralph Warner's Get A Life: You Don't Need a Million to Retire Well. Another one is The Number by Lee Eisenberg.
06/10/08 by Chris FarrellQuestions answered on air for June 7-8
In this edition of Getting Personal, Chris and Tess talk about private mortgage insurance, 457s vs. 403(b)s, removing a co-signer and borrowing from a 401(k).
Continue reading "Questions answered on air for June 7-8" »
06/07/08 by Richard CoreTerminal Illness and Retirement Savings
Question: This is in regards to a questioner on a recent program (last weekend, I think). She was terminally ill and wanted to know the requirements for early withdrawal from her 401k. My sister is in a similar but slightly different situation, and I wanted to pose the same question for her. Her circumstances are as follows: She is over 59 and a half (just). She has cancer that is expected to be terminal in less than two years, although she is undergoing chemotherapy. She... continues to work at a limited level. She has had to quit her primary income source.... Her income is about 1/5th what it was, and her other financial resources are now all but gone. She has something like $5,000 or so scattered among a few retirement-type accounts -- 401k mostly, but I believe a SEP-IRA as well. Can she withdraw this money without penalty in a lump sum? It would sure help matters. Anonymous. Alexandria, VA.
Answer: I'm sorry that your sister is so sick. On the financial front, since she is over 59 ½ she can withdraw the retirement money at any time without penalty. She'll pay ordinary income taxes on the sums she takes out of the retirement plans, but since her earnings are down the tax hit should be relatively small.
Here's the link to the question and answer on terminal illness from an earlier show: marketplace.publicradio.org/display/web/2008/06/27/getting_personal/
07/03/08 by Chris FarrellBorrowing Against 403(b)
Question: Most of my 403B money (Thrift Savings Plan) is in the government securities (G) fund. I have a mortgage on a commercial real estate investment property that has a 3 year variable interest rate currently 4% above the rate I can borrow from the TSP. Should I borrow against the TSP, moving the limit of $50,000 to a general loan against the TSP, saving on interest by applying the amount to the mortgage? No prepayment penalty, the property has a positive cash flow, and I can make both payments (TSP loan & the ongoing mortgage payment) Mark. Billings, MT
Answer: I wouldn't do it. I think there is too much risk and not enough reward to this maneuver. You have a solid retirement savings plan. You have a commercial real estate investment property with a positive cash flow. I'd leave them be.
Borrowing against a retirement savings plan is more expensive than it appears. For one thing, you repay the loan with after-tax dollars. You're also losing the benefit of compounding. If you do lose your job you have to repay the loan quickly or it's treated as an early distribution. That means you'll pay a 10% penalty (assuming your under 59 ½) plus ordinary income taxes on the money you've taken out. You're also leveraging up your investments, putting a portion of your retirement money at risk to the property.
Old Retirement Savings Plan
Question: I recently changed jobs and am wondering if I should move funds from my old 401k over to my new one. For your information my previous 401k plan does have more than $5000 in it currently. Is it much more beneficial to have one large 401k or a couple of small ones? Thanks. Tam, Van Nuys, CA
Answer: There are a couple of issues to consider. First, can you transfer the money from your previous retirement plan into your new one? Some pension plans will accept the transfer and others don't. Second, assuming you can move the money into your new plan, do you like the investment options? Third, you can always make a rollover IRA into a financial institution of your choice. I would either move the money into your new plan--if you like it--or set up a rollover IRA. Either way you'll keep better control over the long-term investment.
Save for Retirement?
Question: Chris - How much should someone save for retirement if they do not plan on retiring? I love my job and I plan on working well into my 70s as long as I have no health issues. I'm 50 now and have a modest retirement portfolio. Dave, St. Paul, MN
Answer: Don't think "retirement." Think a "margin of safety" and "flexibility." What you're trying to do by saving is maintain your current standard of living throughout your lifetime. Savings gives you a margin of safety if your job vaporizes when your older and harder to employ or if your health deteriorates.
Maybe you don't want to retire, but perhaps you'd like to change careers, try something else. A financial cushion allows you to do that easily. Perhaps you'll decide when your older that what you really desire is travel the world for three years. Well, with savings you can.
What's the right number? Realistically, most people can set aside 10% to 15% of their income with good habits and by taking advantage of savings vehicles like 401(k)s. Depending on your wealth, health, and dreams you could be more or less aggressive than that. But it's a good benchmark to start with.
Roth-IRAs
Question: I'm not quite sure I understand Roth IRAs. I know there's a limit to what you can contribute each year, but is there a limit on how many Roth IRA accounts you can have? Bridget. Sioux Falls, SD
Answer: There is no limit on the number of Roth-IRA accounts can own. But it could turn into a nightmare to manage multiple accounts, plus you'd end up paying more and more in fees. I would open up a Roth-IRA with a financial institution or mutual fund company with offerings you like, and then make new contributions into that fund every year instead of creating many accounts.
Most finance companies offer good information about the Roth on their websites. But if you want to go into more depth you could look at "Go Roth! Your guide to Roth IRA, Roth 401k and Roth 403b," by Kaye Thomas.
Catching Up on Retirement Savings
Question: I have a unique "problem" when it comes to planning for my retirement. In my early 20s, I struggled to overcome a life threatening illness. In my 30s, I was only able to work part time. I also went through a financially debilitating divorce. Now, I am in my late 40s, healthy and 10 years into good career. However, because of my health I had no chance to save any money. Though I'm thrilled to be alive, I realize that I may face a bleak retirement. Where do I start? Marianna. Liberty. NY.
Answer: I'm glad that you're now healthy and enjoying a good career. While the particulars of your situation are unique to you, you'd be surprised how many people in their late 40s are in similar financial circumstances when it comes to retirement savings.
There's no reason why your retirement should be bleak. Yes, you're starting late with your savings. That means you'll have to try and salt aside more going forward. There's no getting around it.
Even more important is the demand on you to plan ahead. Specifically, you'll need to work longer than someone who has been savings the maximum every year since she was 20. The real financial kick comes from working during those years when a number of your peers are retiring. That's not necessarily a bad thing, either. For many of us, work isn't just a paycheck. It's also a social environment with colleagues and friends. Work keeps our minds active and our outlook young.
A couple of "investment" implications follow from this: First, invest in your health. Eat right and exercise. Second, invest in your network--colleagues, friends, and acquaintances. This way, if you lose your job other opportunities will open up to you. And if you want to make a career shift your network will help make it happen. Third, invest in your job and career. Is this something you'll want to do in your 60s. If not, start investigating other options now while you're still young. Finally, invest the time to understand your Social Security benefits.
I've recommended this book before, Get A Life by Ralph Warner. It's for anyone without a lot of savings and plenty of zest. Warner gets you thinking about creative solutions for your later years. The book's sub-title says it all: You don't need a million dollars to retire well. Amen to that, no?
08/07/08 by Chris FarrellDiversify Financial Companies?
Question: We have just finished our annual retirement portfolio re-balancing. All of our accounts are with Vanguard. Should we consider having some accounts at a different company to spread the broker risk around? Howard, Bozeman, MT.
Answer: This question is coming up a lot recently, and with good reason: The collapse of the investment bank Bear Stearns, the handful of bank failures, the frozen auction rate preferred market, and the ongoing turmoil from the credit crunch.
What do I think? For many of us, it's easier to manage our retirement portfolio if the money is at one institution that offers good service, low fees and investment choice. But does convenience increase your risk? It does a bit, but not by much in most cases. I've gone back and forth on this issue several times over the past couple of years. In essence, my answer is "no", but...
First of all, the biggest protection you have is that your money is invested in securities. So, even if Vanguard, Fidelity, or some other major financial institution got into trouble you still own the securities. (Of course, ownership doesn't prevent the value of your portfolio from going down.) There is also Securities Industry Protection Corp. backing that provides an additional layer of security in case of fraud and malfeasance. (You can learn more about it at www.sipc.org.)
What's more, most of us end up with a kind of natural financial institution diversification. You have your retirement portfolios with Vanguard. I bet you have savings at a bank or credit union, a life insurance policy with a life insurance company, and so on. If you look at your household as a single entity you're probably reasonably diversified overall--even if your retirement portfolios are managed by one firm.
Now for the proverbial "but." In an era of financial supermarkets and one-stop-shopping it's possible to concentrate amost all your financial assets with one firm. At that point say "stop," and diversify. The lack of diversification is one reason why I have never been enamored with the financial supermarket idea. The other is that experience shows a firm good at managing mutual funds isn't necessarily the best at creating other competitive financial products. It always pays to shop around.
Is my Roth safe? How about my SEP?
Question: I have my Roth IRA with Merrill Lynch, in what they call an MFA account. Also have my SEP there. Since the Bear Stearns debacle, I've been wondering what happens to individual investor's accounts, but have been afraid to ask. What I don't understand is what happens to people with accounts in a firm that goes under? I know Merrill Lynch is being taken over, but I don't know what happens to individual small fry accounts like mine. B., Ancram, NY
Answer: Your account is safe. You may be a "small fry" like most of us, but you're still a valuable customer with assets.
Like any merger, there will be a (difficult) knitting of back offices, maybe a name change, perhaps a different logo, and some new employees. These are the kinds of shifts in business that typically accompany a merger.
But you still own the mutual funds, stocks, bonds, or whatever securities you have in the MFA that makes up your Roth. The same holds with your SEP.
I would keep a close eye on several things. First, watch to make sure the information about your account stays accurate. Problems can emerge in the aftermath of a merger, and it's always easier to get the information fixed if the mistake is caught early. Pay attention to any fee changes or investment charges. Monitor customer service. All of these could improve or get worse in the coming months or year.
Fund 401(k)?
Question: I am in my 30's and committed to a long term investment in my retirement. I have decided not to look at my 401k during this terrible financial time, since I am in it for the long haul. I have heard some commentators on the show mention that they are doing the same.
My question is - should I significantly decrease my contributions or stop contributing to my 401k all together until this crisis has passed?
I understand that could be awhile. My plan would be to put the money that I would have contributed to the 401k into a regular savings account. I know it won't grow but it probably won't disappear. Thanks for your help! I love the show. Nicole, Brooklyn, NY
Answer: You're far from alone in your confusion and nervousness. We're all feeling the financial strain of the past few weeks. My advice is to continue to put money into your 401(k). Last week, here's what Michael Mauboussin, chief investment strategist at Legg Mason's said to me last week: "With a longer time horizon, say 10 to 20 years, even the crash of 1987 looks like a blip."
However, you can always change where the money goes. The best strategy for most people your age, say, 20 to mid-40s, is to stick with the existing asset allocation. Assuming you have a well-diversified portfolio you'll do better staying put than selling in a panic. But you might have learned the hard way that your portfolio choices are too risky. You don't like this volatility. If that's the case, I would figure out how you'd like to adjust your portfolio to a more conservative position, and then do it over time. For instance, I would look at putting some money into a safe harbor like Treasury Inflation Protected Securities. Many 401(k) plans now offer a mutual fund option that invests in TIPS. If that isn't available, another conservative option is a fund made up of short-term Treasury bills.
The exception to this overall approach is if you're holding a risky, highly undiversified portfolio. In that case, I would bite the bullet and make major changes fast.
A final thought: While I would keep funding the retirement savings plan no matter what--especially up to the company match--it can make sense to reduce your contribution if you don't have emergency savings or if you can sense you're at risk of getting laid off.
Are IRAs safe?
Question: "Is our IRA account in UBS Financial Services Inc. safe during this wall street crisis?"..." If not, would you recommend taking the money out and putting it into treasury bonds or treasury money markets with an FDIC approved bank?" Thank you for your assistance Lynette, Chico, CA
Answer: There are two answers to this question. First, your IRA account is safe. Even if UBS got into trouble, another financial services firm would take over the account. Second, the value of the account depends on what assets you're invested in. To take an extreme example (just for the sake of illustration) lets say all the money had been invested in Bear Stearns and Lehman Brothers. You'd be wiped out. In sharp contrast, if all the money were in T-bills, you'd be sitting (relatively) pretty.
Retirement savings and debt
Question: I have a SEP plan. I make quarterly contributions. I commit a % for the year. At the end of the year if I have extra I contribute more. My question is would I be better off putting the extra into paying off my car? Or just putting it in savings? I am sticking to my quarterly contributions but it is hard when by the next quarter it has "vanished". I am looking at retiring in 15 years. My spouse has a 401K, company pension and separate investments. Would it be better for him to not contribute at this time to the separate investments and work towards paying off the house? He is looking at retiring in about 11 years. Elizabeth, Indianapolis, IN
Answer: I'm glad that that you aren't just looking at your retirement portfolio. It's really easy to get caught up in the downward gyrations of the bear market in stocks and the abrupt shifts in market interest rates. (Imagine, the yield on the 3 month T-bill went briefly negative last wee. That's right, less than 0%.) It's good to keep funding it too.
When it comes to managing household finances, the main message of the past year has been get household finances in good shape by spending less and paying down debt. That's why I like your thought of taking that extra cash in this tumultuous environment and putting it toward eliminating the car loan.
However, I'd recommend that your spouse continue to save for retirement, too, as well as build up household savings rather than take dramatic steps to pay off the mortgage early.
Of course, in the heart of most (all?) homeowners burns an intense desire to say goodbye to the bank for the last time and own a home free and clear. There are advantages to accelerating mortgage payments. You can get a good return on your money, especially in this market. Let's say your mortgage rate is 6%. In that case, by paying down your mortgage early you'll earn the equivalent of a simple 6% rate of return on your money. If your rate is 5%, the return is 5%. (This simple example doesn't take into account taxes and other factors.) You'll save thousands and thousands of dollars in interest payments. And it's important for most people to be debt free when they enter their elder years--and that's what you want.
That said, here's why I'm cautious about getting too aggressive with mortgage payments. My basic problem is that most people end up putting too much of their financial eggs in one basket -- a home. That's another way of saying that your financial health is now increasingly dependent on how one asset performs and, as we are witnessing right now, home prices can go down as well as up. Diversification pays.
For me, the key is building up a well-diversified portfolio of cash, stocks, bonds, commercial real estate, commodities, and international equities--even in a market like this one. I especially like investing in Treasury Inflation Protected Securities (TIPS) and I-bonds. Both of these default-free securities sold by the federal government will protect you against the ravages of inflation. The value of your home shrinks as a percent of your net worth over time. Once you've built up a well diversified portfolio, then pay off the mortgage by all means.
A sensible way to shorten the life of your mortgage without taking drastic action is to make an extra monthly payment a year. By writing 13 monthly mortgage checks instead of 12 you'll pay off that loan faster. Just be sure to tell the bank in writing to put that extra payment toward principal.
A SEP-IRA in troubled times
Question: This is the first year I have actually made a profit, after five years of self-employment in New York City. And I'd like to keep as much of it as possible, seeing as the future is rather uncertain! My accountant has been advising me to get a $10,000 SEP IRA in order to not give all my money away to the IRS. She insists that "the market is on sale" and that I am under no risk by investing my money this way.
She has suggested that I look up a few different companies that do SEP IRA's, so I know she isn't advising me to do this out of self-interest. Still, I can't help wondering, is it safe to invest in a SEP IRA at this moment in time when banks are failing and investment companies are in such trouble? How will I know who to get it with? And what, if anything, makes a SEP IRA safe or not safe?
I'm advised I must do this before tax year is over, so that I can avoid paying taxes on the income that I will be investing in the IRA. So, can you help? I'm sure I'm not the only one who needs this kind of advice! Thanks in advance! Carolita, NY, NY
Answer: Congratulations on making a profit. That must feel good.
A SEP-IRA is a low cost and simple retirement savings plan for the self-employed. Almost any financial institution, including banks, credit unions, mutual fund companies, discount brokers, to name just a few will be glad to open a SEP for you.
The contributions you make into a SEP are with pretax dollars, so your tax bill will be lower. The money compounds tax deferred until it's withdrawn in retirement. You'll pay ordinary income taxes on the money you withdraw during retirement.In most cases, you have until April 15 to make a contribution. For the self-employed in an unincorporated business, annual contributions to your SEP can range between 0 and 20% of your net adjusted self employment income. You can always skip making a SEP contribution in a bad year without any penalty.
Question is, where to put the money? These are confusing times and the list of unthinkables that have become reality is long and growing. Still, the most important thing is to make the contribution. You're young and time is on your side.
It's absolutely fine to park the retirement money into super-safe, low-yielding Treasury bills. (And I'm not kidding when I say low yield: Following the rejection of the $700 billion bailout by the House, rates on 3-month Treasury bills fell to 0.29%. We haven't seen rates like this since World War Two. According to the Bloomberg news wire, yields did reach 0.01% January 1940, four months after Adolf Hitler's invasion of Poland.) Other safe havens include bank certificates of deposit and Treasury Inflation Protected Securities.
Now, I assume the statement the "market is on sale" refers to the stock market. Problem is, we are in a bear market that could get worse, which is another way of saying that the "discount" could get even bigger. Even if true, it's important to know whether you're comfortable with the stock market? Will the volatility bother you? Can you sleep at night? Don't worry about it if you aren't knowledgeable about the stock market. You have plenty of time to learn. Keep the IRA money safe. But please spend the time learning more about stocks, bonds, retirement savings strategies, and diversification.
Although they have different messages you can't go wrong looking at two books: The Random Walk Guide To Investing: Ten Rules for Financial Success by Burton Malkiel and Worry-free Investing by Zvi Bodie and Michael J. Clowes. Both are in paperback.
Traditional pension and bonds (and stocks)
Question: I am hoping to retire in 5 years at age 62. I've got a three-part retirement plan: a government pension, social security and a 457k. Rather than following John Bogle's advice to invest in bonds at a percentage = to your age, I invest my 457k mostly in stock funds, reasoning that the pension is kind of the equivalent of the more secure bond funds. Also, I expect to be drawing from the 457k for maybe 30 years, which seems like another good idea to keep it in stocks for awhile. What do you think? I've never seen this question addressed before. (I wish I had asked this question before the current financial crisis - I don't mean to gloat over having an actual pension.) Connie, Portland, OR
Answer: Your question illuminates the value of a traditional defined benefit pension plan, the kind that pays out a monthly income to a retiree based on a salary and years of service formula. But fewer and fewer workers are covered by that kind of pension plan. Take this paragraph from a recent research paper by David F. Babbel, finance and insurance professor at the Wharton School and Craig B. Merrill, professor of finance and insurance at the Marriott School of Management.
The economic implications for the average individual are significant. Under a traditional pension program, the retiree receives a set monthly income for as long as he or she lives. Under a defined contribution program, such as a 401(k) or 403(b) program, the amount of income you collect after retirement and how long you continue to receive it is anyone's guess. There are no guarantees. In effect, the risk of retirement has been shifted away from the employer and the PBGC that insures the pension benefits, and placed upon the shoulders of the employee. Put another way, the financial risk of retirement has been transferred from those best able to bear it to those less knowledgeable and least able to bear it.
I think it's a good idea to treat the pension plan as the equivalent of fixed income. Those regular payments make it a bond-like portion of your portfolio. "Too many investors forget that Social Security and pension benefits are fixed-income assets," says Jack Bogle, the legendary founder of the Vanguard mutual fund.
In other words, your overall insight is sound and you can hike the equity portion of your 457 defined contribution pension plan. As an aside, I agree with you that you have time on your side with your equity investments. Brad DeLong, economist at the University of California, Berkeley and former assistant U.S. Treasury secretary during the Clinton Administration, recently made a compelling case for equities. He notes that stocks have been a terrible investment over the past decade, and that the recent 40% or so decline may not be the end of the bad news.
Still, with a time horizon of one to two decades, he argues the math favors stocks. "At the moment, the yield-to-maturity of the 10-year US Treasury bond is 3.76 percent. Subtract 2.5 percent for inflation, and you get a benchmark expected real return of 1.26 percent. Meanwhile, the earnings yield on the stocks that make up the S&P composite is fluctuating around 6 percent: that is how much money the corporations that underpin the stocks are making for their shareholders.... Thus, the expected fundamental real return on diversified US stock portfolios right now is in the range of 6 percent to 7 percent.
The whole article is well worth reading.
As for your traditional pension, a few risks to keep in mind. The insight that it's a bond like part of your portfolio doesn't tell you how much to have in stocks and bonds. For another, inflation can erode the value of that pension. While many government defined benefit plans do increase the payout along with increases in inflation, not all do. Almost all private sector traditional pensions don't take inflation into account. Check out how your pension deals with inflation. I would consider adding Treasury Inflation Protected securities or TIPs to an overall portfolio.
In addition, I wonder if the pension plan should be treated as the equivalent of a corporate bond. After all, many public and private sector pensions are under financial strain and there is always the risk that benefits could be cut into the future.
TIPS
Question: With our 401(k) and 403(b) accounts having seriously tanked during October, we're becoming more intrigued with TIPS. But we don't really know how to go about investing in this vehicle -- or if we should even consider this as an option. Can you recommend a good resource to learn more about this and how one can get started? Fred and Dana, Omaha, NE
Answer: As you know, I'm a big fan of investors putting their safe, long-term money into Treasury Inflation Protected Securities or TIPS. I have just the recommendation for you, too. It's "Worry-Free Investing " by Zvi Bodie, a leading finance professor at Boston University and Michael J. Clowes, a long-time journalist and editor.
Several years ago I wrote a book review of Worry-Free Investing. The review came out around the time that the stock market was finally doing better following the false rallies in the fourth quarter of 2001 and 2002. Here's an excerpt:
...Bodie and Clowes' investment advice resonates with the harsh lessons of a three year long bear market. Instead of asking, "How much money will I make?" their fundamental financial question is "How much can I afford to lose?" Stocks, they believe, are too risky for many people to achieve financial security even when held for long periods of time. Instead, their idea is to lock in a long-term standard of living while taking as little risk as possible. Their preferred investment is U.S. government inflation protected securities that preserve the purchasing power of a dollar against the ravages of inflation. Other investments they highlight include the value of Social Security, annuities, and a home. "Worry-Free Investing" is simply written, and well illustrated with examples. The authors walk you through the mathematics of their computations so you can do them on your own with a simple calculator.
Still, their basic message is timeless. The economic idea underpinning the book is that most people don't want to get rich, or perhaps more accurately, aren't willing to make the gambles that could just as well lead to bankruptcy as a flush bank account. No, most people want to sustain their standard of living throughout their life. The way to accomplish that goal is to limit downside risk and preserve the value of money set aside today that will be tapped in your golden years. "If you want to sleep nights secure in the knowledge that you will achieve your savings goals, you must invest in a way that eliminates the possibility that inflation will undercut your efforts," say Bodie and Clowes. "If you try to do it by saving less and expecting the stock market to do the heavy lifting, you may not get there at all."
The authors don't dislike stocks. They just think stocks are much riskier than conventional wisdom holds and that it's only sensible to roll the stock market dice after locking in your baseline financial goals...
Check it out. I think you'll find solid financial insight along with plenty of details on how TIPS might work for you.
A lay-off and the 401(k)
Question: I am getting laid off at the end of this year. I have been at the company for 12 years and have a decent nest egg in my 401k. What is the best way to preserve the value of my retirement savings as I make the transition from 401k to IRA? Max, Dalton, MA
Answer: Sad to say, your story is far from unique and it will become increasingly common in the months ahead. It's a tough situation. The first thing anyone in your position needs to do is contact human resources and see if you can keep the 401(k) intact at the company while you look for a new job. So long as you have $5,000 or more in the plan--and it sounds as if you have much more than that--federal law says in most cases fired and laid off workers can keep the money in place. That will defer the day of retirement savings reckoning for you in light of today's volatile market. When you do get a new job, you can either have the money rolled over into your new 401(k) plan or into a rollover IRA. (Make sure it's an institution-to-institution transfer so that there are no implications with the shift.)
Two words of caution: First, don't touch the money. Leave it alone. Second, be wary of any so-called financial advisors that might solicit your business when you lose your job. It seems that a number of financial services companies with high fees and poor products troll for victims among laid-off workers with an eye toward tapping into their retirement money.
Good luck finding a new job.
Frontload 401(k) contributions?
Question: I am a married 31-year old. I am a corporate lawyer and my husband is an entrepreneur. I'm in the process of setting my 401(k) contributions for 2009. In the past, I've always contributed up to the annual limit (my employer does not match, but it does invest profit-sharing in my 401(k) account) spread out over the course of the year. This year, I'm considering front-loading my contributions so that my annual contribution of $16,500 is taken out of the first 8 or so paychecks of the year.
I'm considering this because (1) I'd like to take advantage of the market's current low prices; (2) we have enough in liquid assets that I can afford to take home a smaller paycheck for the first three or four months of the year; (3) I'd prefer to make the contribution while my job and income are stable -- who knows what could happen as the year progresses?
In addition, about half of my annual contribution will be in the form of a Roth 401(k), rather than a traditional pre-tax 401(k).
Are there any risks with this plan? Should I avoid frontloading my contributions? Emily, San Francisco, CA
Answer: I can't see anything wrong with what you want to do, but there is a trade-off. If you keep making the same contribution throughout the year, you're dollar cost averaging. That means you're putting the same amount of money into your 401(k) on a regular basis. The true advantage of dollar cost averaging isn't financial, bit psychological. Dollar cost averaging takes emotion --fear, greed, and panic--out of investing.
What you want to do is make a small bet by frontloading your contributions that the market is currently undervalued, and that you'll come out ahead compared to regular dollar cost averaging. I'm sympathetic to your point of view. If you're right, and the market does rebound over the course of next year, you'll come out ahead. If you're wrong, you'll be slightly worse off. That's the risk or trade-off.
There is a wonderful passage in Reminiscences of a Stock Operator written in 1923 by Edwin Lefevre. (It's a fictionalized biography of Jesse Livermore, the famed 19th century speculator.) Lefevre tells this story: Somebody asked Baron Rothschild, the great merchant banker, wasn't it difficult to make money on the Bourse (the French stock market)? The Baron replied that, "on the contrary, he thought it was very easy." "That is because you are so rich," objected the interviewer. "Not at all," said the Baron. "I have found an easy way and I stick to it. I simply cannot help making money. I will tell you my secret if you wish. It is this: I never buy at the bottom and I always sell too soon."
In a sense, whether you frontload your contributions or stick with the normal payment schedule, you're following Baron Rothschild dictum. Good luck.
No income and an IRA
Question: I have a Roth IRA and traditional IRA, both with Vanguard. I am not employed at this time but I would like to contribute to an IRA or somehow take advantage of the down market with indexed mutual funds. Can I do this without having earned income? Lynn, Mooresville, NC
Answer: You need to have earned income in 2008 to contribute to an IRA of any kind. (If you were employed earlier in the year, however, you got a wage or salary and you can then contribute to an IRA even though you aren't employed at the moment.) The important exception to this general rule is the so-called spousal IRA. A stay-at-home Mom or a stay-at-home Dad can put money into an IRA even if they haven't earned an income during the tax year. (They've certainly worked, however!)
By the way, even if you don't qualify for an IRA and you want to put some money into index funds to take advantage of a down market, why not do it in a taxable account? The annual tax bite of a broad-based equity index mutual fund like the S&P 500, the Russell 3000, and comparable indexes (assuming that's what you are interested in) is relatively small since there isn't a lot of churn with the portfolio by design. You can always tap the money when you need it without paying the 10% penalty that comes with a premature withdrawal of money from a retirement account.
No more 401(k) match
Question: Can a company that has been contributing matching funds on a 401K plan created by the company, suddenly stop contributing claiming economic conditions? Bert, Chatsworth, CA
Answer: Yes, a company can cancel its match. There's no legal requirement that companies offer a match, and firms are free to reduce it, suspend it or even eliminate it at any time. For instance, at the beginning of November the troubled automaker General Motors suspended its match into the company's 401(k). Other companies have followed suit. Right now, many people are getting hit by a double whammy with their retirement savings plan. First, their portfolios are in the tank thanks to the 40% decline in the stock market from last year's peak, and now they're losing the match, which is the real financial benefit of a 401(k), 403(b), and other so-called defined contribution savings plans.
That said, very few companies have eliminated the match. What's more, looking at the list of companies that cut down or suspended their match during the 2000-2001 recession nearly all of them resumed payments once economic conditions improved.
You should still continue saving for retirement in your 401(k) plan even if your company does stop contributing to it. A 401(k) plan is still an easy way to save for the long haul and it's a tax advantaged way to salt away money for later in life.
Bail on 401(k)?
Question: I'm 54 years old with a 401k plan that is pretty much all my savings. I'm married and together we make approx. $80.000/year. We just recently put our two girls through college. In the last year my 401k has lost a third ($90,000)in a conservative very diversified fund. My question; do I cash out my 401k, pay the 10% penalty and put the money in my checking account that gets 5.00% interest? Thanks for your help. Jim, Clarksburg, MA
Answer: No one likes to see their hard-earned money fall sharply in value. It's tough to watch. But I'd leave your retirement savings alone. I certainly wouldn't pay the 10% penalty to get at the money unless I was standing on the financial precipice and it was the only way to prevent my family from falling. After all, you're still young and time remains on your side. You have a long time before it's time for you to consider retiring, let alone start making withdrawals.
A couple of thoughts: First, you could put new contributions into conservative fixed income investments. Second, you could stop funding the plan for a bit if you need to build up emergency savings. Again, it would be preferable if you did continue to save for your retirement. Hopefully, with your two children out of college you have some extra cash around to save outside of your 401(k). Third, I would take advantage of this experience to decide what you want to invest in with your retirement savings once the economy rebounds and the market turns up. (Yes, I am an optimist.) Last, it would still be better if you went even more conservative with the money in the fund--but still not take it out.
In the future, it seems to me that you might want to allocate more of your money into conservative options--such as Treasury Inflation Protected Securities--that preserve the value of your savings.
I think any of these options would be better than taking the money out of the 401(k) and putting it into a checking account.
Join retirement savings plan?
Question: Hi Chris. I have the option to enroll in a retirement plan at the company I work for. In light of the current stock market turmoil, I am a bit weary to enroll and wonder, is it worth it? I do have options of safe, moderate or risky investments, but they all seem a bit risky now. I am a 29 year old, earning about 41000 a year and the only debt I have is student loans, lots of student loans. Thank you for your insight. Janet, Minneapolis, MN
Answer: It's definitely worth it to participate in the retirement savings plan at work--especially if your company matches at least part of your contribution. I think even those financial planners and market forecasters that expect years of low returns and bad markets ahead of us would agree with that. The "match" is where much of the return comes from in a retirement savings plan.
Still, even if your company doesn't match your contribution, I would join the plan. For one thing, it's pretax dollars that goes into the retirement account. For another, the automatic withdrawal from your paycheck makes it remarkably easy to save, something most of us find difficult to do even with the best intentions.
I feel less strongly about which investment option you choose, although I want to stress the importance of building up a well-diversified portfolio. It's impossible to know if the market is hitting bottom now--or might do so in a year or even two. That's why the old proverbs that preach diversification and dollar-cost averaging remain wise counsel to anyone investing for the long haul. Diversification isn't a hedge against any financial crisis over a short period of time, but it's a smart strategy over any length of time. By mixing stocks, bonds, and other assets you can earn the highest potential return for the amount of risk you're willing to accept.
The benefits of diversification in reducing risk have long been recognized. A passage from the Talmud says, "A man should always keep his wealth in three forms; one third in real estate, another in merchandise, and the rest in liquid assets." Antonio in the Merchant of Venice slept soundly because, "My ventures are not in one bottom trusted, nor to one place; nor is my whole estate upon the fortune of this present year." Ideally, some of the assets in your portfolio will zig when others zag. Since no one really knows which markets will soar or sink, investing in all the major asset classes creates an opportunity to limit the damage from a downturn and to be in a position to catch the next big market upturn.
However, if for now your not sure what to do, join the plan, put the money into very safe assets, and then figure out over time how you'd like to create a diversified portfolio.
Convert an IRA?
Question: I am considering converting a Traditional IRA to a Roth IRA. My reasoning for this is: 1.The markets are depressed right now. If I convert now, the tax hit on conversion will be smaller, since my IRA has lost 25% of it's value. I have money outside the IRA which I will use to pay the taxes. Furthermore, I am expecting the market to rebound long term, and when it does, I will eventually get to withdraw the appreciation tax free.
2. I am self-employed, and so my income varies. This year my income is low, so I am in a low tax bracket, so I feel it would be advantage to convert at this time.
Is there any reason to not do this? Any other information I should be aware of?
At one point, McCain was talking about allowing people to withdraw from Traditional IRA's tax free. This would annul the main benefit of a Roth IRA. Do you think this could actually happen? Andy, San Francisco, CA
Answer: For many people, converting a traditional IRA into a Roth-IRA is a smart way to take advantage of the bear market. The gain is that the upfront tax hit on conversion is relatively small and should be dwarfed by the benefit of tax free withdrawals in retirement. Remember, a traditional IRA is funded with pre-tax dollars; you pay your federal income tax rate on withdrawals during retirement. The Roth is funded with after-tax dollars, but when you take the money out you don't owe Uncle Sam anything.
I think you've thought this through well. You're right, you will have to pay taxes on the conversion, but the tax hit will be minimal with the sharp drop in market values and your low income. The finances of a conversion get better if you have savings to tap outside the IRA money to pay the tax bill.
Your modified gross income has to be less than $100,000 to make the conversion, but that doesn't seem a problem in your case. (That rule will be scrapped starting in the 2010 tax year.) And added benefit of the conversion is that unlike the traditional IRA there is no mandatory withdrawal schedule beginning at age 70 ½ with the Roth.
Speaking of withdrawals, the two main law changes that I am aware of involving IRAs is first, allowing retirees to skip their mandatory withdrawals in 2009 and, second, extending the rule allowing each spouse to make a charitable distribution from his or her IRA account of up to $100,000.
To be sure, there are many tax cut proposals floating around fiscal-stimulus Washington at the moment. But it seems unlikely that Congress would let people withdraw money from Ira's tax free--at least not for any lengthy period of time.
No match for 2008?
Question: My company just announced that they are canceling the 401K match for all of 2008. It is now middle of Jan 09. I understand that they are free to cancel matching at anytime, but to cancel the match for all of the past year's contributions? Is this legal? Christina, Los Angeles, CA
Answer: A growing number of companies are saving money by reducing or eliminating the company match, including General Motors, FedEx, Eastman Kodak and Frontier Airlines. The typical matching contribution in a 401(k) or comparable savings plan is 50 cents for every $1 the employee puts in, up to 6% of the employee's contribution. Of course, some companies do more and some do less. Companies are desperate to conserve cash and hold on to employees, which is why they get rid of the match. But from a public policy point of view it's a terrible move.
Now, most publically traded companies that have suspended their match have done it going forward. But what happened to you can be done. It all depends on the plan's details. (The law gives companies enormous flexibility when it comes to their retirement savings plan.) For instance, when your employer set up its retirement plan it had a choice between providing a "fixed" match or a "discretionary" match. The most common--the one we're familiar with--is a fixed match contribution. But with a discretionary match (or profit sharing match) the company doesn't have to do it if dismay sets in among management after tallying up the results for the year. Your employer realized the profit wasn't there, and it took advantage of its "discretion" not to fund the plan.
A sign of the times? According to a recent the Wall Street Journal story Starbucks switched starting Jan 1, 2009 to a "fully discretionary match" from a "fixed employer match." In other words, the company can decide whether or not to match contributions into the retirement plan.
Pay cut and may lose job
Question: A: I am currently employed (Not sure how long this will last?) just took a 30% pay cut and there is a good chance that I will either be laid off or the company will close it's doors within the next two months. I have a good amount of money in my 401K and a separate traditional IRA from a previous job.
My concerns are that I don't have an adequate emergency savings to draw from while I search for work and I will need to pay bills for quite some time as the current job market is awful...I may have to do some re-training/ie.. Find a new line of work.
As much as I hate the thought ...What are your recommendations in regard to an emergency draw of funds from either the 401k or the IRA to ensure my family does not find themselves out on the street? David, Livonia, MI
Answer: I'm sorry for your circumstances. That's tough and, sad to say, you have far too much company these days. The standard advice about not tapping into your retirement savings isn't so standard if you lose your job and your family comes close to finding "themselves on the street." Period.
You take care of your family first. That said, I'm hoping you are far from those dire circumstances. I would urge you to consider tapping retirement savings a last resort. It's the last financial defense in protecting your family.
I'm sure you're already doing all these things, but just in case, while you're still are earning a paycheck I'd cut back on spending, boost savings and plan ahead. This is the time to start going over your budget, and figure out where lie the savings. You also need to get a feel for income. Yes, you'll lose you job, but will there be severance? How much unemployment insurance will you get? Does you spouse work outside the home? What are the training opportunities open to you? Is there state, local or nonprofit money available to help foot the training bill or transition to a new career? I'd also talk to former colleagues, friends, tap deep into the network of people you've developed over the years. There are many steps to take preparing for the possibility of bad days ahead--and hopefully it won't come to pass.
One last thought: If after all this it turns out that you HAVE to touch retirement money, just draw what you need. That way you'll preserve as much of the retirement savings as possible while minimizing the impact of the 10% penalty and taxes on the withdrawal.
Convert to Roth
Question: Given the current Federal deficit, and the way the U.S. Government is currently burning through money, it seems like a sure bet that tax rates will have to eventually start going up in the future. Because of this I've been thinking of converting my current 403(b) into a Roth IRA. And given that value of my retirement account has gone down (like everybody else's) it seems like a good time to make the conversion. In my particular case, if I were to convert the entire amount, according to the calculators I've tried, I would still be able to pay the taxes and penalties for the conversion entirely from current savings. And again, given how little these savings are currently earning, it seems like good timing. What are your thoughts on doing such conversions? Bill, Durham, NH
Answer: Your basic insight is sound. A lot of people are rightly running their calculators to see if conversion into a Roth is a good financial move for just the reasons you mentioned. For many, the answer is coming out yes.
Problem is, you may not be eligilble. If this is an active 403(b) at work you can't convert it into a Roth. You can do it if you're no longer on the job but simply left the retirement plan alone with your former employer and the plan allows you to roll the money over into an IRA. (Before 2008 you had to roll a 401(k)-type plan into an IRA and then roll that over into a Roth. The law has been changed so that you can go straight to a Roth.) You're also eligible If you're over 59 1/2 and your company allows an in-service distribution.
Remember, before 2010 your adjusted gross income has to be below $100,000 to make a conversion. The same $100,000 limit applies to the overall income of couples filing jointly as singles. Those who are married but file separately can't convert at all. (I don't make these rules up; I'm just reporting on it).
I'm glad to see that you have other money to put toward the taxes owed on a conversion. That's an important test to pass to see whether conversion makes sense.
The IRA laws are not simple. You can see if you even qualify for conversion at the Fairmark website. The Roth information is here ( www.fairmark.com/rothira/index.htm.)
Stop making 401(k) contributions?
Question: Hi Chris - I'm 38 and there's a better than average chance that I won't make the next cut when my company has another layoff. I've always socked away 401k money since my 20's but think that now might be a good time to keep that money in cash to help provide even more cushion during a job search.
We currently have almost 3 months salary in the bank. My wife works part time and takes care of our 2 kids. Would it make sense for me to set aside the money that would normally go to the 401k, and then invest in a Roth IRA at the end of the year if I don't have to tap into it? We have no credit card debt - just a couple mortgages, a car loan and several monthly prescriptions. Thanks - Mike, Denver, CO
Answer: Your instincts are right. I would stop contributing to the 401(k) and stockpile more cash in an FDIC-insured account in anticipation of tough times. You don't want to take any risk with the savings for now. Another way to build up savings is to look at what debts can you eliminate. It reads as if you have a mortgage, second mortgage (either a home equity loan or line of credit) and a car loan. Can you get rid of the second mortgage? How about the car loan? Both?
The one caveat to this advice is if your company offers a match in the 401(k). Do you reduce your contributions to the match or just stop altogether? Normally, I would say cut to the match and that may still work for you. But if the odds are high that you'll be laid off soon I'd rather you focus on getting your household balance sheet in good shape to weather a job search. And, of course, it isn't an issue if the company doesn't match a portion of your retirement contributions..
Good luck.
Tax-free alternative to 401(k)?
Question: Hi Chris, Really enjoy your show. I am a retired military living in Germany. I'm presently approaching 66 years old and am told I must cash in my 401K savings by age 70 1/2, which means they would then become part of my taxable income. Are there any programs out there which would allow me to move my pre-tax 401K savings to some other type of pre-tax savings program? Also, I heard a rumor that there is an initiative to extend the age limit past 70-1/2; have you heard anything to that effect? Leonard, Selzen DE
Answer: Thanks. When I was growing up we lived in Bremerhaven, Germany, for several years, and I went to the elementary school on the base. When I was a merchant seaman after graduating from college my first ship used to dock at Bremerhaven, and I got to revisit our old haunts. Anyway, you don't have to cash in all the savings in your 401(k). You just withdraw the amount you need and pay your ordinary federal income tax rate on the withdrawal. The remaining money continues to compound tax free. And, yes, at age 70-1/2 you are required to start taking your minimum required distribution.
The bottom line is that Uncle Sam is going to get paid. You could make a tax free transfer of the money from the 401(k) plan into a traditional IRA, but the same tax and required minimum distribution rules apply.
Now, there is no required minimum distribution with a Roth-IRA. You could convert the 401(k) into a Roth-IRA. The law has been changed so that you can roll a 401(k) straight into a Roth. But you'll pay taxes on the conversion. Remember, before 2010 you're adjusted gross income has to be below $100,000 to make a conversion. You also can't touch the money for 5 years. My guess is that the numbers won't push you toward the Roth option, though, but you could check it out.
One important thing to note: at the moment there is a one-year moratorium on required withdrawals from retirement savings plans for anyone 70-1/2 or older. It's only for 2009, and then the rule comes back in force in 2010. The idea is to buy some time for those retirees with battered portfolios. Although I think the whole retirement savings system will be looked at closely over the next several years, and that reforms will come, I'm skeptical that there will be any wholesale change in the distribution rules. The federal government will need the tax revenue in light of budget deficits as far as the eye can see.
Extra money
Question: My wife and I have transitioned to using cash to pay for daily expenses versus a credit card. As a result of this transition, we have are able to save more money. Now the question for us is where to put the extra savings? We are both in our early thirties, own a home with a mortgage, and have a car loan, a student loan, and a home improvement loan. We have 401K investments, which I have been contributing to since I was 22, but we do not have 6 months of expenses in liquid funds. Should we using our increased savings to increase our 401K contributions, we are not at the contribution limit today, increase emergency savings, or pay down debt? I appreciate any suggestions you can provide. Regards, Tim, Victor, NY.
Answer: Congratulations on getting your finances under control. It's nice to take a question, too, where all three of the money alternatives are good. You can't go wrong if you decide to hike contributions to your retirement savings plan, add to emergency savings, or pay down debt.
Still, I would recommend dividing the extra money into two small streams, one channeled toward extra debt payments and one siphoned off into savings. I'd accelerate debt payments on the car loan and the home improvement loan. I'd put the remaining extra money into an FDIC insured savings account or FDIC insured short-term certificate of deposit (or comparable products at a federally insured credit union). You won't make much money on the savings (okay, that's an understatement these days) but the money will be there if you need it.
One other thought to raise, this one concerning retirement savings. Just make sure you're taking full advantage of the company match if there is one. That's too good to pass up.
401(k) safety
Question: The company that manages our 401k plans for my employer has had its rating downgraded by S&P recently due to concern about making its debt payments. Just before the turmoil in the markets, I changed my investment strategy out of stock funds and moved it all into a product touted as a no risk fund, basically a low, fixed rate deposit product with them. My question is two-fold: First, is there any government insurance for my 401k funds that is similar to the FDIC insurance for normal savings vehicles? Second, if there isn't, and I remain employed where I am, is there any way to transfer my funds from the 401k account to a traditional IRA account covered by the FDIC without incurring a tax penalty? My employer is doing fine and still providing matching funds, so I would consider moving the funds only if the rating continues to deteriorate. My account has approximately $130k on deposit and I am 53 years old. Thanks! Denise, Orange, CA
Answer: To your first question, there is no FDIC insurance coverage or its federal equivalent when it comes to the money in your 401(k) plan. Your money is at risk to what happens in the market. That said, there are multiple layers of protections surrounding your 401(k) to make sure that the account is safe. For instance, pension law requires that retirement plan money is kept separate from your employer's business assets and the money must also be held in trust. So, if your employer went belly up creditors can't get at the money and it is safe.
To your second question, in general you can't take the money out of your employer's plan and roll it over into an IRA until you stop working there. Then you can--and should--do what's called a rollover IRA. But since regulations give plan sponsors a great deal of flexibility when it comes to plan desgn you should check with your human resources folks just to make sure.
03/12/09 by Chris FarrellTIPS
Question: Chris has recommended TIP (Treasury Inflation Protected somethings!) in the past. With the amount of money flowing into the economy from the various rescue plans I am concerned inflation is going to be a big factor in a few years, does he still recommend them? Thanks, Simon, Raleigh NC
Answer: Do I still like Treasury Inflation Protected Securities or TIPS? You betcha. The impact from high and rising inflation--the scenario you're worried about--is what TIPS are designed to protect you against. TIPS are default-free government-issued inflation-indexed bonds that come in 5, 10 and 20 year maturities. (The maturity date of a bond is when you get back the principal amount you invested and interest payments stop.) TIPS offer a fixed interest rate above inflation, as measured by the consumer price index. An additional advantage of TIPS is that they also offer a hedge against deflation--a decline in the overall price level of goods and services--by offering a "deflation floor" that protects principal value. TIPS are an investment for all seasons. They won't make you rich. But $1 saved today will be worth $1 in 5, 10 or 20 years--plus some interest.
TIPS have two drawbacks. The first is that Uncle Sam requires owners of TIPS in a taxable account to pay income taxes on any inflation-adjusted gains before you get any of your inflation-adjusted money at maturity. The easy way to invest in TIPS and avoid the tax problem is to own them in a tax-deferred retirement savings account, such as a 401(k) or IRA. The other issue is that you can't buy TIPS directly from the U.S. Treasury for your retirement savings account. You have to pay a broker to do it for you. The federal government seems to be more worried about lining Wall Street's pockets than making it easy and cheap for savers to own TIPS in their retirement accounts. Shame on Treasury.
Retirement vs. student loans
Question: Hi Chris, my question relates to two subjects: a student-loan for graduate studies and funding my retirement. I am 27 years-old and am planning to enroll in a graduate program (MBA) in the fall of 2010. The total cost of this education is in the vicinity of $100,000. By the fall of 2010, my savings should amount to at least $25,000. So, I will have to obtain financing for the majority of my education costs.
Since I will require a loan for such a large percentage of my educational costs, should I immediately cease contributing to my retirement accounts and, instead, add that money to my savings? Currently, I am contributing 5% of my pre-tax income to my 401k through my employer. Moreover, I am making regular contributions to a Roth IRA so as to achieve a total contribution of $5,000 by the end of the year. Please let me know what I should do. I worry about taking on such a large student loan. But also, I worry about the long-term consequences of not regularly contributing enough to my retirement.
Here's some information about me that you may find useful when crafting your reply. I am currently employed and am quite confident that my income ($70,000/year) will remain steady for the remainder of 2009. My savings currently amounts to $25,000 and my credit score is 770. I do not have any debt. Thanks Chris. I love the show and it's really helped me in so many ways. Cheers. Mark, Los Angeles, CA
Answer: Thanks for your note. You're making a big investment in your job and career by getting an MBA. You've done the research, and the rate of return on that investment measured in terms of job options, total compensation and career satisfaction will more than pay for the money you borrow. In a sense, your standard of living in retirement will largely be influenced by how much your investment in an MBA pays off over time.
Price matters, and the less you go into debt to get your MBA the more financial and job flexibility you'll enjoy at graduation. That's why I think your instinct to reduce contributions into retirement savings and, instead, put the money into a bank or credit union savings account, certificate of deposit, or some sort of very safe parking place for money is sound.
Here's another thought: Stop contributions into the 401(k), but continue to fund the Roth-IRA up to the $5,000 limit (and that's how much you are setting aside in total anyway). A Roth is a unique retirement savings vehicle. It's a retirement plan and a parking place for emergency savings. The reason is that by law you can withdraw contributions without any tax bite or early withdrawal penalty. You can't tap the earnings without taking a big hit, however. You leave the earnings alone.
You keep your financial options open by funding the Roth. If you decide the smart strategy is to borrow less you can withdraw your contributions from the Roth and just leave the earnings in the account. If it turns out you're borrowing less than you anticipate, well, you leave the Roth alone and let the money compound over time.
Since a Roth is funded with after-tax dollars will give up some income tax advantages with this tactic.
A tenure decision
Question: I am an Assistant Professor beginning my tenure process. The short story: depending on the tenure process, this time next year, I may or may not have a job a year after the tenure decision. Currently, I am "maxed" out on my supplemental giving.
Is this the wise thing? Should I continue to max out for the future, or should I be building a nest egg for the near future that is also liquid? To me this is a tricky question, because now is a good time to be investing for the long run. But having cushion might be a smart thing to do. Thanks, Jake, Doylestown, PA
Answer: Good luck with the tenure review and decision.. I would continue to participate in the retirement savings plan. This way you'll continue to invest for the long haul. But I would back off on investing extra into the supplemental portion of your pension plan. Instead, I'd focus on building up short-term savings. The reason is that you may have to move in the next year or two if you don't get tenure. Its always expensive to pull up stakes and set up home in another part of the country. Of course, I hope the tenure decision goes your way.
I-bonds for Roth?
Question: I was told by my bank that it is not possible to put I-Bonds in my Roth IRA. If not, why not? I want to make a contribution that will not shrink like my mutual funds. Suzanne, Los Angeles, CA
Answer: That's right. There are technical and legal reasons why it's almost impossible to do. For instance, the U.S. Treasury rules say you can't open an account to buy savings bonds electronically through Treasury Direct in the name of an IRA.
Here's the thing: I don't think you should do it anyway. It isn't a good idea even if you could convince a bank to go through contortions to do this transaction for you. In essence, you're wasting a valuable tax shelter with the I-bond. You buy an I-bond with after-tax money. The savings compounds tax free. That is, until you cash it in and then you pay ordinary income tax rates on the gain. The I-bond is like a non-deductible IRA.
By the way, I-bonds are a terrific fixed income investment for most people. I like owning I-bonds, just not in an IRA.
Another inflation-indexed security is the Treasury Inflation Protected Securities, better known as TIPS. These default-free securities are also designed to hedge the value of your money against the ravages of inflation. The big drawback with TIPS is that Uncle Sam requires owners of TIPS in a taxable account to pay income taxes on the inflation-adjusted gains before getting any of the inflation-adjusted money at maturity. That's why TIPS work best in a tax-sheltered account, like an IRA or Roth-IRA.
It would be a better idea to use TIPS in your Roth.
You do need to go through a broker if you want to own the TIPS directly. A number of brand-name mutual fund companies sell funds made up exclusively of TIPS, too.
You could also buy short-term CDs insured by the FDIC at your bank for your Roth. You wouldn't have any credit risk with the FDIC insurance. You'd earn a decent rate of interest. And by keeping the CD terms short you could always be earnings something around the prevailing rate of market interest rates.
I-bonds vs TIPS
Question: I have the opportunity to buy $10,000 worth of I-bonds this year, or $10,000 worth of TIPS in an IRA account. Which is better--or is it more or less the same risk and return? Is it better to by a TIPS bond directly, or in a bond fund?
PS: Your book was great and I enjoy hearing you on public radio. Ken, Swarthmore, PA
Answer: Thanks a lot. Just a quick definition: TIPS are Treasury Inflation Protected Securities. These inflation-indexed bonds come in 5, 10 and 20 year maturities. TIPS offer a fixed interest rate above inflation, as measured by the consumer price index. TIPS are designed to protect the value of an investment dollar against the ravages of inflation (as measured by the CPI). Uncle Sam levies income taxes on the inflation-adjusted gains before you get any of the inflation-adjusted money at maturity. That's why you're right to see TIPS as the better investment in a tax-sheltered account, like your IRA.
Taxes aren't an issue with I-Bonds, a savings bond that is the federal government's other inflation-protected security. There are no commission costs when you buy or sell savings bonds, and your savings compound tax deferred. I-bonds redeemed before the 5 year mark forfeit the 3 most recent months' interest, but after 5 years that there is no penalty at redemption.
The key to answering this question is when do you need the money? It's advantage I-bond if you might tap the savings at some point in the future but before retirement. You can sell the I-bonds without incurring a penalty even if you're under 59 ½. You just pay Uncle Sam whatever you owe in taxes after the sale (and I'm assuming you'll own them for 5 years).
In sharp contrast, if you buy TIPS in your IRA, you can't get at that money without paying taxes on it plus a 10% early withdrawal penalty if you're under 59 ½. You'll have to pay a broker a fee to purchase the TIPS for you in an IRA (although the charge should be very small.) If you're okay with the extra work and monitoring the bonds then I would lean slightly toward owning individual TIPS. This way you know what you have and when the bond will mature. You could care less about fluctuations in the bond market. But a very low cost TIPS mutual fund is just fine for those who favor its convenience.
Socially responsible retirement savings
Question: My retirement begins 01/10. I will receive $148,000 in Feb. 10 and my monthly state retirement check will begin. I must roll-over the lump sum into an IRA, which I do not have. I've never heard of a socially conscious IRA! How can I be sure my hard earned money is only invested in socially responsible ways? (I will be 60 this summer and want to wait til 66 to get my whole SS.) Diane, Perry, FL
Answer: You want to be part of a growth business. The Social Investment Forum estimates that total industry assets were closing in on $3 trillion in 2007 (the latest data available). That's up from $639 billion in 1995. Most of the socially responsible money is managed for institutional investors and high net worth individuals. But assets managed by socially responsible mutual funds, exchange traded funds (ETFs), and the like are also up, to over $200 billion in 260 funds last year. Investing in socially responsible funds remains popular despite the bear market in stocks.
To take a slight detour, the biggest rap against the movement is the belief that marrying personal values to an investment portfolio cuts into returns. In other words, doing good and making money don't mix. I don't agree. A number of studies suggest there's little difference between pooling money to make money and pooling money to make money and express values. This came home to me in a series of papers by Meir Statman, a finance economist at Santa Clara University. Among his conclusions, the risk-adjusted return on socially conscious index funds is roughly comparable to the Standard & Poor's 500 index. His research also showed that the performance of actively managed socially responsible mutual funds is about equal to their conventional mutual fund peers.
Put somewhat differently, socially responsible index funds do better than their actively managed socially responsible peers. One troublesome aspect of the industry is that socially responsible funds tend to have high fees that cut into returns. It always pays to shop around, but it's especially true with these funds.
To your specific question, any socially responsible mutual fund company will open a rollover IRA for you. Two websites for researching socially responsible investing from your computer are socialinvest.org and socialfunds.com. The mutual fund and investment research company morningstar.com also has good information on socially responsible funds and ETFs.
04/15/09 by Chris FarrellTransfer retirement savings?
Question: I know that we're supposed to do an "institution to institution" transfer when we roll over our 401K from one employer's plan to another, but I'm wondering if I should be rolling over my 401K balance from my previous employer at all in this current economic climate. I'm still fairly young (I'm only 41), so my 401K plans are still heavily weighted toward stocks, and I can't help but feel that if I transfer funds out of a mostly stock-based 401K I'm essentially "locking in my losses," even if I'm transferring those funds into another mostly stock-based fund where I'd be buying in at bargain prices. Is the convenience of having all my eggs in one employer's plan worth ignoring my (possibly irrational) fear of locking in losses? Packy, Jersey City, NJ
Answer: You shouldn't be locking in losses with the transfer, although there will be some minor "frictional" costs that will fade with the passage of time. I'm assuming you'll be able to transfer the money reasonably quickly from your previous 401(k) plan into your new 401(k). I'm also supposing that you'll transfer the savings into comparable investment portfolios. The frictional costs come from the inevitable time gap from moving the money, and the market could move agasint you during that time. Of course, it could also shift in your favor. There may be some other minor cost incurred if the investment options aren't exact mirror images of one another.
My general bias is for you to take control of the money by transferring it into your new 401(k) plan at work. (I'm assuming your new employer allows the new money to come into the plan; if not you can always do a rollover IRA.) Now, your previous company will live up to its obligations and behave ethically toward your retirement portfolio. That's not my concern. (And if there is a worry about management I'd get the money out as fast as possible.) It's really a question of control. It's your money and if it's under your control you'll watch it more carefully.
To emphasize a point you made, there are no tax consequences or penalties imposed by Uncle Sam if the money is transferred from your former plan directly into the your new 401(k). Check with human resources at both companies before you do anything to make sure you understand any transfer requirements.
There is one good reason for keeping your money in your former employer's retirement plan: If it has good low cost investment options, perhaps even better than your current plan. If that's the case leave the money alone for now.
401(k) withdrawals
Question: Has the law been changed to allow employees vested under an employer pension plan (401K) to withdraw up to $10,000 without penalty? I am 51 years of age and I have been working for the same company for 28 years. Thank you for your attention and your time. Madeline, Miami, FL
Answer: No, the rules weren't changed. The proposal to allow for penalty-free withdrawal from a 401(k)-type retirement savings plan was one of many options debated in the weeks leading up to the fiscal stimulus package. It never really gained traction. Since you're under 59 ½ you would pay a 10% penalty of the withdrawal, plus ordinary income taxes--a big hit to savings.
04/23/09 by Chris FarrellA Roth-IRA conversion in 2010
Question: As I understand it, Congress has lifted the income limits for Roth IRA roll-overs starting in 2010. How likely do you think it is that Congress will leave that tax change in place? Paul, Seattle, WA
Answer: My best guess--and it's just that, a guess--is the shift in the Roth-IRA conversion rule will hold for 2010. After that it all depends on whether the Obama Administration pursues dramatic tax reform and manages to get Congress to agree to a major overhaul of our Byzantine tax code. The Administration has appointed a tax reform commission headed up by former Federal Reserve Board chairman Paul Volcker, but with everything that is going on in the economy and markets it hasn't had much traction.
For the moment it looks like 2010 is fast becoming the equivalent of a conversion gold rush. Here's why: Up until now, you could only convert a traditional IRA into a Roth-IRA if your modified gross adjusted income was under $100,000. The income limit lifts in 2010. What's more, when you convert from an IRA to a Roth you owe income taxes on the amount converted. The reason is a traditional IRA is funded with pretax dollars while a Roth is funded with after-tax dollars but withdrawals are tax free in retirement. Well, the 2010 conversion amount may be included as taxable income in 2011 and 2012. That helps spread out the tax bite. It's a one-time perk.
To convert or not to convert, that is the question. There are many factors to consider, but for many people the answer will be yes. The benefit of tax free withdrawal is huge. The argument for converting strengthens the longer your money can compound after conversion and before retirement. It's also important to have other savings on hand to pay the tax bill. Another advantage of the Roth is there is no required minimum distribution at age 70 ½ as there is with a regular IRA. For those with substantial assets converting to a Roth may make financial sense simply from an estate planning perspective.
There are many twists and turns to this conversion story. For instance, should you pay the tax tab in 2010 or spread it out depend on whether you believe the money you make off the delayed payment will offset the risk of a higher tax bill. What will happen to your income in 2012? Maybe your income will plunge in which case you'd probably elect to pay the tax over two years. But if there's a chance of a big bonus in 2012 you'd get rid of the tax liability in 2010.
One place to get started researching the economics of conversion for your household is at web-based calculator, like this one.
04/28/09 by Chris FarrellCut down on 401(K) contributions
Question: My husband and I are currently putting 9% of our income into our Roth 401K with a 4% match from his employer. We got a late start in contributing to that due to a late change of career which entailed years of schooling, so we currently only have about $40,000 in our 401K.
However, we have almost no savings outside of that. We have $5000 in the bank, some of which we need to use over the summer. I am wondering if we should decrease our 401K contribution and sock that money into savings instead until we have a few months' worth of cushion. Kathleen, Rexburg, ID
Answer: I think your financial instincts are right. It's important to have a decent cash cushion in normal times, let alone during the extraordinary period we're living through today. You'll still be saving money, just not as much in the retirement account (where you would pay a steep penalty if you tapped into that money.)
There are three keys to this strategy: First, continue to take full advantage of your employers match. The real investment kick in a retirement savings plan comes from the match. Second, shift the money into a very safe place backed by a government guarantee, such as an FDIC insured savings account. Third, remember to increase the sums going into the retirement plan when you've built up a large enough cash cushion.
A college savings plan?
Question: We are in our 30's with three kids ages 7 and under. We live simply and have been able to get by on our income around $24,000 per year, plus our tax return which is usually several thousand. Though this seems like pennies compared to what others mention saving and investing, we have over the last 7 or so years managed to save over $10,000. We now find ourselves in a situation where we don't need to buy a house (which is what we originally thought we were saving for) but feel like that $10,000 should be put to use for us somehow. We like the idea of starting 529 plans for the kids' college funds. But we have nothing in the form of potential retirement. Should we invest it in some other way? Or, should we just keep it in our savings account, which is what we have done in the past. Often we have had to dip into several thousand a year between car trouble, and slim employment income. Kari, Eau Claire, WI
Answer: You're terrific savers. Congratulations. I understand your desire to set money aside for your children's college education. But I wouldn't if I were you. Several years ago I interviewed the head of admissions at the University of California, Berkeley. He made several points that have stuck with me. When you have a slim employment income and have to worry about keeping the car running you shouldn't set money aside for college. Instead, focus on making sure that your kids get a good education, one that prepares them for college. But with your income and three kids there will be plenty of money available from the federal government, state government and colleges to help defray the cost of college.
I'd rather you continued to save for a rainy day and for your retirement. You can accomplish both with a Roth IRA. I've written a lot about the Roth on this blog. In essence, a Roth is a retirement savings plan funded with after-tax dollars. When you withdraw the money during retirement it's free of taxes. That's right, Uncle Sam doesn't tax Roth savings. Here's the thing: You can take out your contributions at any time without paying a penalty or taxes. You just can't withdraw any gains (you would pay a penalty and income tax on the gain if you take it out early).
So, a Roth is both a pot of emergency savings and a retirement savings plan. This is a nice article from Kiplinger's that goes into more detail about a Roth.
A loss on a closed Roth
Question: I recently closed a ROTH account, feeling that the money could best be used elsewhere, since I still have a fair amount in other retirement funds, even after all the recent market trouble. I had been contributing $100 per month for about seven years, yet the cash out value, even before 10% government withholding and surrender fees, was less than the total of my contributions by several hundred dollars. What is my tax liability? Can I claim a loss on this year's taxes? Can I expect to get my 10% withholding back at some point? Thanks! Joe, Milwaukee, WI
Answer: There is nothing simple about Roth-IRAs and taxes. Yes, under certain conditions can claim a tax deduction for the loss from closing the Roth-IRA account. But there are a number of twists and turns in the tax code about liquidating a Roth. My best advice is to strongly urge you to consult a professional advisor.
That said, if you're in a similar position as Joe in Milwaukee you can stop reading this post right now. Go get professional help.
Here's a brief overview of the basic rules for those of you that remain curious. In order qualify for a tax loss from closing a Roth you must liquidate all your Roth-IRAs. The amount of money you have at liquidation must be less than your "basis." A basis is defined as the amount of money you contributed to the Roth; plus any money you may have added to it by converting a traditional IRA into a Roth; and subtract any sums of money you've withdrawn. (From Joe's email it looks like he has a loss by this definition.) You must itemize on your taxes to claim the loss. The amount that can deducted is limited to 2% of adjusted gross income. By the way, the 10% penalty doesn't apply if the Roth is made up from annual contributions.
There are a few more wrinkles, but you get the basic idea. And you see why I say work with a tax pro.
06/05/09 by Chris FarrellBorrow to buy land?
Question: My husband is the primary income, and I work 12 to 15 hours per week from home while I take care of the kids. We have a 5 month emergency fund, and he is saving 10% from his pay for retirement. Our only debt is the mortgage. We would love to build a house one day. The question is ... should we take money from our emergency fund to buy the land? We are nervous about doing this. We also hate to add another debt payment. Additionally, we are not investing other than in his 401k fund. Should we do anything differently? It is very hard because the emergency fund was a long hard process to build. Litsa, Charlotte, NC
Answer: When I read your question my first thought was that you've already answered the question. You don't think now is a good time for you and your family to drain your savings and take on debt to buy land. I would agree. Even though the economic news is less bad these days the economy remains weak with the unemployment rate at 9.4% and home prices still trending lower.
That said, it's terrific that you've managed to set aside a 5-month emergency savings account. That isn't easy to do. I would focus on continuing to add to that savings. It's a strong financial foundation for your household.
You should also have your own retirement savings plan. A SEP-IRA is an easy retirement savings plan to set up for the self-employed. You could also open up a traditional IRA (funded with pretax dollars) or a Roth-IRA (the contributions are with after-tax dollars.) You can learn more about these retirement savings IRA options on the Getting Personal site.
When is the company match mine?
Question: I was part of a "downsizing" in late January from an IT software vendor in New York City. During my tenure at the firm I was contributing to the company 401k program which has a matching and vesting component. Now that I am no longer working at the company, how does the vesting and company match work out? (Incidentally on January 1st, the company stopped matching in the 401k -- but most of my contributions predate that event.) In calling the 401k company it sounds like I will not receive the company match and vesting. Is this true, even though it was not my choice to leave the company? I wanted to check before rolling my 401k over to my IRA. There is a 6 year vesting period, and I am fairly happy with the low expense ratio index fund selected in the 401k. PS. I was only out of work for a few weeks. Seth, Forest Hills, NY
Answer: I'm glad you got another job so quickly. That's terrific. By law, any money you contributed to the 401(k) plan is yours. Period.
The issue with vesting is determining when the company's "match" becomes your money. It's a basic equation. It's partly decided by how long you've worked at the company and partly by the vesting schedule the company adopted. The two most common types of vesting timetables with 401(k)s are the "graded" and the "cliff".
Here is the minimum "graded" vesting timetable:
1 year of work: 0% vested
2 years of work: 20% vested
3 years of work: 40% vested
4 years of work, 60% vested
5 years of work, 80% vested
6 years and after, 100% is vested.
An alternative is the "cliff" vesting schedule:
After 2 years of work: 0% vested
After 3 or more years, 100% vested.
These percentages are the minimum standard companies must follow by law. But companies are allowed to be more generous if they choose. For instance, about a third of employers have 401(k) plans with the company match immediately owned by the employee. A four year vesting schedule is fairly common, too.
Now, when it comes to vesting it doesn't matter why you left the company, voluntarily or by being laid off. (The latter in your case.) So, from your email it looks as if you are under the 6 year 100% vesting rule. I'd check out the details of your plan and hopefully you're at least partially vested.
After-tax retirement savings
Question: The company I work for offers a 401k, both normal pre-tax contributions and after-tax contributions, and also a Roth-401K. Can you please explain the differences between the Roth-401K and the post-tax contributions to the normal 401k? Erik, Tulsa, OK
Answer: Yes, in both instances you're making after-tax contributions. There are a number of differences between the two options, but I want to highlight the critical one that becomes apparent in retirement.
When you take the money out of the Roth-401(k), assuming you are at least 59 ½ and have owned the account for 5 years or more, the investment gains are free of Uncle Sam clutches. The same isn't true for withdrawals from the after-tax account in a traditional 401(k). There isn't any tax levy on the amounts you contributed, of course. But you will pay ordinary income taxes on any investment earnings or gains at withdrawal.
By the way, in most cases it makes more sense for savers to open up a Roth-IRA on their own rather than put extra retirement money into an 401(k) after-tax account, assuming your employer offer the option. The reason is the value of withdrawing money free of taxes in old age with the Roth.
06/16/09 by Chris FarrellInflation and an IRA
Question: I'm interested in finding a good investment for inflationary times. This would be about 7% of my retirement portfolio; around 10,000 in cash languishing in 2 different IRA accounts. I am 42, and will probably have to work until I croak. I am guessing I'll retire at 75 or so. I considered purchasing some I Bonds in an IRA account. I'd like to be able to sweep the proceeds of a dividend-yielding investment into the bonds once a year. I contacted my stock-trading account - no dice on holding I Bonds in my account there. I contacted Treasury Direct and they told me I needed to find a bank that would hold the bonds in an IRA and also contact the IRS. Do I need to call all the banks in town to see if anyone will do this? Is there a kind of bank that I should focus on? A directory that would help? Am I trying to do something completely wacko and ill-advised? Jill, Northfield, MN
Answer: I wouldn't say "wacko". But ill-advised? Yes. For a number of technical and legal reasons you can't get I-bonds into an IRA. More importantly, you wouldn't want to do that anyway. In a sense, an I-bond acts like an IRA. The money you put into an I-bond compounds tax deferred until you cash it in. At that point you owe ordinary income taxes on the gain. With an IRA, your investment grows tax deferred until you pull it out in retirement and pay ordinary incomes taxes on the withdrawal. You'd be wasting the tax shelter if you could invest it in an IRA.
That said, I like I-bonds. I would just buy them directly from the Treasury.
Inflation isn't much of a problem right now. The government reported this morning that the Consumer Price Index for the 12 months ending in May was down 1.3%, the biggest decline since 1950. I'm not very concerned that the Federal Reserve extraordinary actions to shore up the economy will end in a bout of hyperinflation, either. The formidable combination of an intensely competitive global economy and a competent central bank will keep inflation around its target level of 1% to 2%.
Of course, that forecast could be horribly wrong and a reprise of the inflationary '70s awaits us. Even if I am right low levels of inflation erode the value of a dollar over time. Long-term savers should worry about inflation a lot. That's why I like Treasury Inflation Protected Securities or TIPS. It's an ideal security for an IRA, although you'll have to buy them from a broker. I've written a fair amount about TIPS elsewhere on the Getting Personal site. The best overall source of information for investing in TIPS and similar securities for safety and security is Worry Free Investing by Zvi Bodie, finance professor at Boston University. You can check it out here.
06/17/09 by Chris FarrellIRA contributions
Question: My 18 year old daughter is graduating high school and going on to college. She has had odd jobs, but has earned no more than $600. I would like to open an IRA for her to get her thinking and planning for her future. Can I open an IRA for her for more than what she has earned? Thank you. Olga, Hasbrouck Heights, NJ
Answer: I think it's a wonderful idea for her to open up an IRA. The contribution limit to an IRA if you're under 50 is $5,000 (and its $6,000 if you're 50 or over). However, the law says she can't put more into an IRA than her earned income. So her limit is around $600. By the way, I would set up a Roth-IRA. When she retires several decades from now she can withdraw the gain with no tax liability. What's more, the contributions are a stash of emergency money. She can always tap the contributions without penalty or tax.
06/24/09 by Chris Farrell
"Claim and suspend" Social Security
Question: Is it worthwhile for me to defer receiving Social Security benefits for a few years until I actually need them? I am started receiving benefits at age 62 and am now 66. I would like to defer the payments until the age of 71 or longer, if possible. I have heard that the payments can be stopped and restarted at a later date, but I have been unable to locate any information on this on the Social Security website. Do you have any suggestions or comments? I am a faithful listener. Thank you for the informative and entertaining programs you present each Sunday night! Nancy, Mountain View, CA.
Answer: The tactic is commonly known as "claim and suspend." If you voluntarily suspend your Social Security payments you will earn retirement credits that will permanent increase your future monthly benefits. It can be a smart strategy if you earn enough to support yourself without the Social Security money. If the numbers work in your favor, suspending will increase the amount of future monthly Social Security benefits you'll receive. Those benefits are valuable since they're default free, payable for life and protected against increases in the consumer price index.
You can elect to suspend if you are at your full retirement age, which is age 66 for those born between 1943 and 1954. You must be 70 and under to do it. So, you can't defer to 71. You should be able to go to any Social Security office and make the request and the form. You can also call 1-800-772-1213. Anne Tergesen, a terrific reporter at the Wall Street Journal (and former colleague) did a nice piece on this.
For those interested in going into much more detail, the Center for Retirement Research at Boston College looked into claim -and-suspend. The information is good but the article is dense and scholarly.
What is emergency savings
Question: My husband and I got married recently and we're having a bit of a debate about what constitutes an emergency fund. I believe it is an account (money market, CD, savings) with 4-6 months of expenses stashed away. My husband feels that it doesn't have to be a particular account; in fact he would say that I could count my 401K and IRAs as emergency funds. I completely disagree as my retirement funds are for just that, retirement. In an extreme situation, I could tap into those, but it would have to be from dire need. We'd appreciate your wise counsel on the subject & enjoy listening to your show on Yellowstone Public Radio. Thank you, Rachelle, Bozeman, MT
Answer: I don't want to get between you and your husband, but I'm going to have to take your perspective on "emergency" savings. It's your safe and secure money that you have quick and easy access to without paying a penalty. Emergency savings includes savings accounts, money market mutual funds, short-term certificates of deposit, Treasury bills and the like. Of course, there are differences between these products. You can get immediate access to a savings account attached to your checking account. If you own a 3-month T-Bill that you purchased through treasurydirect.gov you'll have to wait until matures.
The problem with tapping into 401(k)s or a traditional IRA is that you could end up paying a 10% penalty or ordinary income rates on the withdrawal.
However, your husband is right to consider the retirement plans as part of your overall savings. There are ways to get at it, too. You might be able to withdraw some of the 401(k) money as a loan and pay yourself back over time (assuming your employer lets you borrow against your 401(k).) You can take money out of the IRA and, if you return it all within 60 days, there are no penalty or tax implications. You can only do it once a year. Still, both these strategies have significant financial drawbacks, which is why I don't recommend them.
There is an exception: The Roth-IRA. The contributions into a Roth are with after-tax dollars. In a pinch you can withdraw your Roth contributions without paying a penalty or taxes to Uncle Sam. Just leave the investment returns alone, since there is a levy on earning if you do take them out. A Roth is both a retirement savings plan and an emergency pot of money.
Variable annuity
Question: Hi, I know from searching Chris' articles in the past that he's said variable annuities are a bad idea. I recently found out that my dad is 20 years into a variable life annuity. My dad is retired, living off of social security and savings. Should he keep paying into his VLA at this point? I think he only has a few years left before payout. Or is a VLA so bad that he should just get out now? Thanks for your help! Bonnie, Fremont, CA
Answer: No, unless there is some other problem that isn't in your note I would not get out of the variable annuity. You dad has saved for more than two decades and he's about to enjoy the benefits of that savings in retirement. That's good, and he should enjoy the income. .
A variable annuity is essentially a mutual fund wrapped in a tax-deferred insurance firm account. You buy variable annuities with after-tax dollars, but earnings compound tax-deferred until retirement, when any gains are taxed as ordinary income. Variable annuities come with a death benefit. It's part of their appeal. When the owner of an annuity dies, the estate or beneficiary gets back the original investment, plus some guaranteed minimum return.
A variable annuity can be a good niche product, especially for those with lots of savings. For instance, Henry "Bud" Hebeler of Analyzenow.com says he bought low-cost very simple variable annuities for his children. He had maxxed out on other tax-deferred alternatives and he wanted another place to save tax deferred.
My problem with variable annuities comes when it is sold as a primary retirement savings vehicle, especially to younger and middle-aged folks. In too many cases the product comes with a number of drawbacks, including steep fees and limited financial flexibility. Most studies I have looked at emphasize that stocks are probably the best investment for a variable annuity. The fees eat up too much of the return on cash and bonds. The savings are taxed at ordinary income tax rates at withdrawal.
Many financial planners suggest consumers would be better off investing for retirement in a 401(k) and a Roth IRA. I agree wholeheartedly.
I would also consider putting any leftover cash into a broad-based equity index mutual fund. For one thing, withdrawals from a variable annuity are treated as ordinary income, while some of any returns from the mutual fund may be taxed at the lower capital-gains rate. For another, it's a good idea to have some long-term savings in taxable accounts that can be tapped with paying a penalty to the government or a financial institution. Several years ago, Ross Levin, president of Accredited Investors, an Edina (Minn.) financial-planning firm, told me that they "are the fifth-best option for retirement planning, behind everything else." That seems about right to me.
The variable annuity market has improved, however. The competition for customers has increased and that means consumers can get a better deal on fees, surrender charges and the like. So, if your financial circumstances say that a variable annuity makes sense, it pays to shop around. Keep the product simple. Avoid the bells and whistles. They're too expensive.
But for your dad, he should take advantage of the additional income in his Golden Years.
07/16/09 by Chris FarrellThe 60 day IRA rule
Question: This past quarter, I made a series of small withdrawals from my IRA to keep the mortgage and other bills paid. I returned the first draw within the 60 day period, but when I went to return the second I was told I could only do 1 "rollover" per year! Help! How do I get my money back in without the penalty? The irony is that I am only 4 months from being 59.5 yrs. old. Chris, Gypsum, CO.
Answer: Ouch. It's a little known rule, but you can take money out of your traditional IRA penalty-free and tax-free so long as you put it back within 60 days. In essence, you're making an interest free loan to yourself for a brief period of time. The 60 day limit is strict. If you're under 59 ½ and you don't get the money back within the 60 day time period you'll owe taxes on the withdrawal and a 10% penalty. The other restriction is that you can only do this only once within any 12-month period. I don't see any way around it.
This article from Investopedia lays out some exceptions, but I doubt you qualify. Still, it offers a lot of good detail.
How to protect against inflation
Question: I hate to see this happen to the Obama administration; however, if you combine the debt created by the Bush era and the deficit spending (a.k.a. Stimulus Package and Bail Out packages) that Washington is embarking on, how can we not repeat the sky high interest rates that folded the Carter administration where cash was king accompanied by nose bleed inflation rates--especially since manufacturing has all but left these shores for cheap overseas labor? Thank you. Stephen, Cape Neddick, ME
Answer: Many people in the markets are worried that the Fed's quantitative easing will end in a bout of high and rising inflation. Still, it seems to me the fear that inflation lies around the corner is exaggerated. The economy is still weak if not in recession and unemployment is rising. Now, it's likely that inflationary pressures will emerge when the economy finally regains its footing. It's a safe forecast that at some point down the road the Fed will confront a tricky monetary policy act. I'm sure we'll go through some inflation scares. But the Fed is well aware of the risks and, while the conduct of monetary policy is as much an art as a science, Chairman Ben Bernanke thoughtfully discussed the central bank's "exit strategy" in Congressional testimony earlier this week.
But high and rising inflation or hyperinflation? Personally, I don't see it. For instance, the U.S. government's Treasury Inflation Protected Securities or TIPS are forecasting that inflation will average less than 2% over the next decade. You would think investors would demand more of an inflation hedge if the threat of hyperinflation was real. The global competition for profits and markets is intense and that competition will aid central banks around the world in keeping inflation tame. I still think the long term trend is toward minimal inflation rates in an increasingly integrated world economy. Plus, central bankers have a pretty good intellectual tool kit when it comes to bringing inflation under control. What central bankers don't really understand, what they disagree on is how to handle bubbles, market booms and market busts.
That said, the risk of high and rising inflation exists over the next 5 years or so considering the extraordinary actions the Fed has taken to bail out the banking system and avoid a depression. Even small rates of inflation, say, in the 2% to 3% range, reduce the purchasing power of savings with time.
So, since we're dealing with personal finance questions here what's a good way to protect your savings from inflation? A portfolio made up of mostly Treasury bills does an excellent job of keeping pace with inflation. However, the price for that inflation hedge is no growth or no earnings premium over inflation. Most of us would like to make some money on our money. That's why the key investment product for long-term savers is TIPS. Everything can be built on top of a foundation of TIPS. For those who want to take greater risk in the search for higher rewards should allocate a larger portion of their portfolio to stocks. For those who are more risk adverse a larger investment in Treasury bills makes sense.
Retirement savings and taxes
Question: Hi Chris - my husband and I are in our 50's and trying to plan well for retirement, including how to protect our retirement money from being "taxed to death" when the time comes for us to take distributions. I have recently heard lots of "caution" about the inevitability of everyone's tax liabilities increasing greatly in the coming years in order to deal with our national budget deficit, health care reform, etc. What is your advice for how we can best protect our 401-k and IRA money so it isn't taxed to exhaustion when the time comes for us to take distributions? Currently our retirement accounts are invested in index mutual funds linked to the S&P 500. Thanks for your time and expertise, Chris. Helene, Watsonville, CA
Answer: I have a middle-of-the-road position when it comes to future tax rates. In light of the government's obligations that you mention, such as national defense, Social Security, health care, and the budget deficit it's likely that taxes will go up. I agree with Tyler Cowen, the libertarian economist at George Mason University, who argues that the tax cuts from the Bush years were really deferred tax increases. That said, I don't buy the scare stories that taxes will go so high that our savings will be wiped out. My own guess is that the pressure for revenue without pushing rates too high will lead to major tax reform. The deal would be to offer everyone lower rates in return for closing many loopholes. But that's just a guess.
On a practical what-can-I-do-today level, one of the best moves anyone can make is diversify the tax treatment of their retirement savings. When you withdraw money from your 401(k) and traditional IRA it will be taxed at your ordinary income rate. I would also save in a Roth-IRA. Your contributions are with after-tax dollars but your withdrawals will be tax free. That could be a huge benefit in retirement.
The other thing is to consider converting money from a traditional IRA into a Roth-IRA in 2010 (or after). You could only convert an IRA into a Roth if your modified gross adjusted income was under $100,000. But the income limit lifts in 2010. The argument for converting strengthens the longer your money can compound. There is also a one-time perk for anyone who converts in 2010. You can pay any taxes owed on the conversion in one year or spread it out over the following two years.
However, if you have to use tax-deferred savings to pay the tax bill it doesn't pay to convert under most scenarios. You can begin exploring whether conversion makes sense for you at such online sites as rothretirement.com. Amy Feldman of BusinessWeek has a nice story on this: Is a Roth IRA Right for You?
Early withdrawal from 401(k)
Question: Is it possible to move the majority of my balance in my company's 401k to a self-directed IRA without penalty (or quitting my job)? I'm not happy with the investment alternatives available in my company's 401k plan. David, Lewis Center, OH
Answer: In most cases the answer is no. The general rule is that employers aren't supposed to let you take money out of the 401(k) and roll it over into an IRA. You can only do that when you leave the company--voluntarily or involuntarily.
However, there is one important wrinkle (hey, legislators can't make saving for retirement simple, can they?). By law, companies can offer their employees 59 ½ or older the option of rolling over their contributions into an IRA. It's called an "in-service" distribution. In other words, you're still working for the company, you're 59 ½ or older, and you can roll the money over into an IRA. It's legal, but it's up to management whether they offer the option. A majority of large companies seem to allow it.
To learn more about the twists-and-turns in the in-service distribution world, check out this detailed article in Forbes: The Great 401(k) Escape.
401(k) money
Question: Do I have to remove my money from my 401k when I retire from my company (UPS) even if I don't need it at the time of retirement? I know I can't contribute after I leave but is it ok to leave the money in there till I need it or this market turns around... (I'm being optimistic!) Patricia, Cleveland, OH
Answer: I like your optimism. The law gives company's a great deal of leeway when it comes to their retirement savings plan. The terms of the plan may say its fine to leave the money where it is for now or it may call for a fairly quick withdrawal. So, place a call to human resources and you'll get you the answer you need right away.
What to do with an annuity
Question: I retired in 2007 from a university. My retirement funds are with TIAA-CREF, split roughly in half in 2 annuities. One is a fixed annuity and the other is a variable annuity, balanced 50/50 between bond and stock funds. I probably lost 20-25% on that fund in the crash last year. The 2 annuities together provide about 40% of my monthly retirement income.
I have resisted freezing the variable annuity and making it fixed because that would provide NO chance to recoup some of my loss. When I set these up in the first place, the fixed annuity was my hedge against the kind of crash we suffered in the past year. I'm not feeling the pinch although my income dropped a little this year but income tax adjustments offset the loss--and I do a little consulting for "egg money." I also have a savings account equal to 1/3 my annual income. I rent, so as not to have house expenses.
Am I crazy to hold firm? If I look at a 20 year time horizon, isn't it likely that my annuity will slowly come back over time (and maybe I could fix it then)? I would be interested in Chris Farrell's opinion about this. Thank you. Elaine, New Berlin, WI
Answer: One reason why I'm posting your question is that I admire your retirement strategy. We can all learn from how you have thought through your finances and what you have done. You set up a smart hedge against a bad market environment. You have savings. You still have some earnings coming in. Your expenses are under control. As far as I am concerned, you've really come up with a sensible strategy for all seasons.
As to your question, I still like the idea of you keeping the hedge with the floating annuity. It allows you to participate in the good times. But your other savings buffer you against the bad times when they come again.
One other thought: I would hold off freezing the variable annuity until you had an answer to this question: How much of your portfolio do you want exposed to stocks, if any? Right now, it seems to me that you're mostly fixed income between the savings, the fixed annuity, Social Security and the 50% of the variable annuity that is in bonds. So, one issue for you is how much of your portfolio would you like exposed to stocks? More? Less? The same?
What do other people think?
A more conservative portfolio
Question: After listening twice to your recent commentary about Wall Street and having recently read Robert Reich's blog titled 'The Continuing Disaster of Wall Street, One Year Later' I'm concerned about our stock investments and retirement timeline.
We're looking at retiring at the earliest in 2012. Our present investment portfolio is weighted to 'aggressive' mutual funds. Given our (hopefully) short retirement timeline another major downturn of the market would put us in a serious retirement hole to dig out of. It seems to me that we'd be better off shifting our stock to bond ratio to a safer mix. As always, we enjoy your advice and commentary. Joe, Hagerstown, MD
Answer: You're right to be concerned. We've had two recessions, two bear markets, and a credit crunch in 8 years. My basic assumption is that everyone needs to build a substantial financial buffer with their savings. Economic downturns are as much a part of a capitalist system as expansions and bull markets.
I like the approach of Jack Bogle, the founder of the Vanguard mutual fund behemoth and a regular guest on Marketplace Money. (By the way, any of Bogle's books on investing and money are worth reading.) His rule of thumb is that the fixed income portion of your portfolio should equal your age. So, if you are 30 years old, fixed income securities should be 30% of your portfolio; 55 years old, the fixed income portion is 55% of your portfolio. Bogle walks his investment talk, too. When I talked to him several months ago he was 80 years old and with that much of his portfolio in fixed income securities he didn't really even feel the sharp drop in stocks.
Of course, like all rules of thumb your age is just a starting point. You can decide to be more or less conservative, depending on your circumstances and household wealth. And with your fixed income investments I would stay conservative. For instance, Treasury Inflation Protected Securities, Treasury bills, Treasury notes are default free investments. So are I-bonds. Certificates of deposit and savings accounts that come under the FDIC insurance limits are good, too.
So, I'd play with the numbers and see if this approach works for you.
Investing for retirement
Question: After many years of false starts, my wife and I will soon be able to finally start saving for retirement. I'm 38 years old, and after watching so many 401ks turn into 201ks, I'm more than a little worried about saving with this method. I've listened to the show for years, so I know about TIPS, I Bonds, etc, but I'm hoping you may provide some more advice about ways to save for retirement that don't involve taking on all of the risk of a 401k. Thank you very much. Andy, Spring Hill, TN
Answer: Congratulations on getting started. . Most of us are reluctant plungers in the market these days. We're supposed to figure out how to invest our money for when we retire in 10, 20 or 30 years. Yet in today's world, the biggest mistake you can make is not saving for the long haul. The financial penalty for not participating in a long-term savings plan is far bigger than the risk of picking a poorly performing mutual fund.
That said, a 401(k), an IRA, and similar retirement savings plans are simply tax sheltered parking place for savings. You can put the money into more conservative investments, like Treasury securities and certificates of deposit, as well as riskier investments, such as stocks and junk bonds. So, the risk to your savings is minimal if you invest in Treasury Inflation Protected Securities, short-term CDs, and the like. The gain won't be much either. That's a reasonable trade-off for most people to make, especially anyone who doesn't want to see their 401(k) become a 201(K)--and is willing to give up the possibility that it becomes a 601(k).
When it comes to retirement savings the basic money question you should ask yourself is not "How much money will I make on my investments?" The real question is "How much can I afford to lose?" You then lock in a standard of living for your old age with a conservative investment strategy. You don't want to be 70 years old with a portfolio that has lost half its value.
I have two books to recommend. The main points of both books can be quickly absorbed, so this isn't like assigning homework. But you've raised a huge important topic and both of these books cut to the core issues in easily digestible chunks. Worry Free Investing by Zvi Bodie and Michael Clowes advocates a very conservative approach to retirement savings (largely based on TIPS). The Random Walk Guide to Investing by Burton Malkiel is also conservative (he strongly advocates for diversification) but he makes a stronger case for putting a portion of the portfolio into equities. Good luck.
Too much in retirement savings?
Question: This may be an odd question in this economy. I've always tried to max out my pre-tax retirement savings. However, I'm wondering if this philosophy still holds true when your employer's contribution is significant (i.e. it's over 10%)? This is a *contribution*, not a *match*.
This puts me at pretty much 25% pre-tax retirement savings. I'm 35. Am I better off taking some of my money and putting it into something post tax for more diversification? Or should I still contribute the maximum because of the pre-tax benefits?
Basically, is there such a thing as putting too much into pre-tax retirement? Renee, Minneapolis, MN
Answer: You're right--you are in a different situation than most people. It's a nice place to be, too. But yes, I do think it's possible to put too much into a particular tax-sheltered retirement savings plan. The reason is that you can't get access to the money without paying a steep 10% penalty as well as ordinary income taxes if you withdraw the money before 59 ½.
I have two suggestions for you to consider. Both assume that reducing the amount going into your pre-tax retirement plan doesn't affect the company's contribution, which is incredibly valuable. First, if you come under the income restrictions I would set up a Roth IRA. The contributions are funded with after-tax dollars, but the gains are tax-free on withdrawal in retirement. An additional benefit is that you can always withdraw the contributions without penalty or tax if you need the money.
The other is to set up a long-term savings plan that minimizes your annual tax hit. But you can always access the money. For instance, you could set up an automatic savings program--a set some of money is invested every month. Some of your savings could be regularly invested in a broad-based stock index fund, such as the Wilshire 5000, the Russell 3,000, or the Standard & Poor's 500. Uncle Sam annual levy is minimal since there isn't a lot of trading activity with an index fund and when you sell stocks much of the gain will come under the lower capital gains tax rate. You could also load up on tax-deferred inflation-protected I-bonds for the fixed income portion of your portfolio (or Treasury bills, certificates of deposit, and other safe investments). It provides an anchor to your savings.
A regular monthly investment into a mix of secure and riskier savings in taxable accounts accumulates with time. It may be tapped to fund a career change, a medical emergency, a home, or retirement. This approach is a simple strategy that gives you a lot of flexibility.
Required minimum distribution
Question: What exactly is involved in "distributing" your IRA'a by / at age 70 ½? Beverly, Flagstaff, AZ
Answer: In the calendar year following the year you turn 70½ you must start withdrawing a minimum sum of money from your tax-sheltered regular IRA. (You don't have to with a Roth-IRA; it doesn't require minimum distributions.) The jargon term is "RMD" for required minimum distribution. Of course, you can take out more money than the RMD if you want to or need to.
The basic formula is composed of two parts: The adjusted market value of your IRA as of December 31 of the prior year divided by your life expectancy taken from the Uniform Lifetime Table published by the IRS. But most major financial institutions that are in the IRA business offer calculators to figure out your RMD. If your IRA provider doesn't offer one you can turn to calculators at websites such as dinkytown.net.
The exact amount of your RMD does change from year to year.
Participating in 401(k)
Question: My fiancée has about $40K in student federal loans outstanding and because of that, has yet to contribute to her company's 401k program. I think her company matches dollar for dollar up to $2000 and .50 cents up to $4000. What's the best "financial equation" to use to figure out how much to contribute to the 401k and how much to set up for monthly deductions for her student loan payments? DJ, San Francisco, CA
Answer: The simplest answer is that she should invest enough to take full advantage of the employer match. Warren Buffet, David Swensen, and any other investing superstar of recent decades can't come close to the kind of investment performance recorded by the match. Plus, most of the growth in a 401(k) plan doesn't come from investment earnings but from the match. (And that's why it's doubly devastating when employers reduce or eliminate the match.)
There are additional issues she could consider. For example, she could look at the interest rate she's paying on her student loans. She can put in more money than the match if she thinks she'll do better than that interest rate over time. She should also increase her contributions as her income grows.
Still, for now, the simplest equation is to "invest to the match."
10/20/09 by Chris FarrellRollover IRA
Question: I was recently laid off and told that because my 401k balance was below 5k I would need to move the money. I do not want to cash out and would like to avoid paying any taxes on the funds. I currently have 3 other 401k accounts with previous employers. What are some of my options for these investments? Natalie, West Chester, OH
Answer: You'll want to do what's called a "rollover IRA." There are no tax consequences or penalties so long as the money is transferred from your former employer directly into the rollover IRA account. Check with human resources before you do anything to make sure you understand any requirement the company may have about a rollover. The same goes with the company you've chosen to place your rollover IRA. And if you put the money into a comparable investment you shouldn't take much of a hit on the transfer, either.
Now, as to your other 401(k) accounts at 3 previous employers, why are you keeping the money there? If it's because you really like the plan options offered by these employers, fine. But my bias is for you to take control of the money through a rollover IRA. "It's great anytime you can take control of your money and take it out of your company plan," says Ed Slott, head of his eponymous company and a leading IRA expert.
You're no longer working for these companies. It's your money and if it's under your control you'll watch it carefully. Plus, you get to chose the investment company and investment options, not your former employer.
10/21/09 by Chris FarrellRoth conversion
Question: My wife has a combined income that is over the limit for a traditional IRA tax deduction or for contributing to Roth directly. We both also have employer sponsored retirement plans. Since there is no income limit for conversion from a traditional IRA to a Roth in 2010, I want to establish a traditional IRA now so that I can convert it to Roth next year. My question is, because I will be contributing to my traditional IRA after tax (or without any tax deduction), how I will be taxed when I convert my traditional IRA to a Roth coming 2010? Thanks. Andrew, Norman, OK
Answer: What you're planning on doing can be a smart move. Let me just give a bit of the background behind your question.
The Roth-IRA is a terrific retirement savings vehicle, probably the best available. The main reason is that all accumulated investment gains are free from Uncle Sam's clutches when withdrawn during retirement. The other attraction of the Roth is that it offers unusual flexibility for managing finances. For instance, there is no required minimum distribution at age 70 ½ with a Roth as there is with a 401(k) or a traditional IRA.
In the past, you could convert money stashed in a traditional IRA into a Roth, but you could only do it if your adjusted gross income was under $100,000. That earnings cap on conversion disappears next year. That's why the Roth conversion equivalent of a gold rush is about to be unleashed in 2010. Conversion calculators have sprung up all over the web. (The contribution limits to a Roth and the income phase-outs all remain essentially the same in 2010 and on. What have changed are the rules with conversion.) There are a lot of twists and turns to the Roth conversion question in 2010 and after. But it's an issue well worth researching.
Now, to your question. Many financial planners I've talked to are advising folks that earn too much to contribute to a Roth and a traditional IRA to open up what is called a non-deductible IRA. This is what you're planning to do. The non-deductible IRA is funded with after-tax dollars. The gain is tax-sheltered over the years and the earnings are taxed at your ordinary income tax rate on withdrawal during retirement.
But you're not going to wait that long. You'll convert the non-deductible IRA into a Roth in 2010. The only tax you will owe on conversion is on whatever gain you've earned in the meantime--in other words, not much. You won't owe anything on the contribution since you've already paid the tax tab on that money. And, of course, with this maneuver you won't pay any taxes on the investment earnings when you withdraw the money in your retirement years.
As I said, it can be a savvy move.
10/22/09 by Chris Farrell
Military thrift plan
Question: Hi, I recently left active duty military service and am trying to decide what to do with my Thrift Savings Plan. I've got about $40k saved in it right now.
When I look at the options for withdrawing, it seems like I'll be paying either 10 or 20 percent penalty fee.
I was thinking about starting a ROTH IRA. Should I take the penalty and roll it over into a ROTH IRA? Or am I better off just letting the money sit in the TSP until I retire? Thanks, Spencer, Humble, TX
Answer: You have a number of good options to think through. And you shouldn't pay a penalty or taxes with them. The one exception on taxes is the Roth option. I'll explain in a moment.
First of all, the Thrift Savings Plan is a really good, low-fee plan. It's hard to beat. You might want to simply leave your retirement savings in the plan.
If you still want to move your savings out of the Thrift Savings Plan you can roll it over into another tax sheltered plan. For instance, if your current employer's savings plan allows it you could transfer the money into your new 401(k). Alternatively, you could roll it over into an IRA. In both cases you don't take the money out. You'll make an institution to institution transfer of the money, preserving its tax-sheltered status. No penalties will be imposed, either.
You could put the money into a Roth-IRA. Since the Thrift Savings Plan was funded with pre-tax dollars and a Roth is funded with after-tax dollars you'll owe taxes on the money your transfer into the Roth. However, when you pull the money out during retirement the gain is free of Uncle Sam's levy. By the way, in most cases it does not make sense to Roth if you have to use your retirement savings money to pay the tax levy. It reduces the amount that can grow, free of tax, in the Roth.
I'm not sure which branch of the military you served in. But the Navy offers a clear brief explanation of your choices.
Inflation indexed bonds
Question: Is there a way I can buy "I" series treasury bonds with pre-tax money? I would like to hedge a little bit against inflation with these bonds, but don't like buying them with after tax dollars. Does this make sense? I am open to suggestions. Jeff, Sparta, TN
Answer: Let me clarify the choices. In an IRA or comparable retirement savings plan you can't buy Treasury Inflation Protected Securities directly from the U.S. government. However, you can purchase them through a broker with pretax dollars in an IRA, 401(k), and the like. (And commission costs are low.) You can also buy mutual funds that invest in TIPS with pretax money.
The I-bond is a savings bond that also offers investors an inflation hedge. It is purchased with after-tax dollars. But the money compounds tax free until you cash them. You don't want to buy I-bonds with pretax dollars since it's already a tax-sheltered form of savings.
Both TIPS and I-bonds are good long-term investments for savers.
ETFs
Question: I've just opened a Roth IRA to start saving for retirement. However, as a graduate student, the amount I'm starting with and able to contribute monthly is well below the minimum investments for various mutual funds. I've been looking at ETF's, which seem to have the same diversification with lower expense ratios. Is there a reason to prefer one over the other that I'm not seeing? Thanks much. Drew, Atlanta, GA
Answer: The exchange traded fund (ETF) is a genuine innovation. ETFs are investment vehicles that track indexes but an ETF is traded like a stock. The most popular ETFs are based on broad stock indexes such as the S&P 500 and the Dow Jones Wilshire 5000. There are also a number of broad-based socially responsible ETFs. It's also another way for the small investor to take a plunge in windmill energy, solar and other energy alternatives.
Problem is, there has been an explosion of ETFs that slice and dice the market into smaller and smaller and smaller pieces. Intrigued by patents? There's an ETF for you. Think the Austrian economy is poised to rebound? Yes, there's an Austrian ETF. That's why I'm cautious with ETFs in general. It's a product increasingly designed for speculation, not investing.
That said, an ETF is fine if you want to buy a broad-based index all at once. You pay the brokerage fee, and then hold on to the investment. An ETF works for a buy-and-hold strategy. But a no-load equity index mutual fund is better if you're adding to the investment in small increments over time, say, $100 a month or a similar investment disciple.
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Chris Farrell Marketplace Money personal finance guru
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Latest Comments
- Roth conversion (2)
- Eric wrote: More info on the "non-deductible IRA", please!... [read]
- Jeremy wrote: Be careful if you do a partial conversion of your IRA's... Say you have a rollover IRA from an old ... [read]
- Rollover IRA (1)
- Scott K wrote: It's quite possible that the plan providers from your 3 old jobs have been charging you above marke... [read]
- Participating in 401(k) (1)
- Jeff wrote: You can use an online mortgage calculator to find the difference between taking advantage of the emp... [read]
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- 401(k) money (1)
- Jeff wrote: If your assets in the 401k are stock mutual funds, should the fact that they are down now affect you... [read]
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