Not quite a year ago, I reported that Congress was considering suspending the required minimum distribution (RMD) requirement for retirees. The reason for this is that the stock market had just collapsed, and they didn’t want retirees being forced to liquidate holdings at the bottom.

While Congress ultimately acted, it was a classic case of too little, too late. What I mean by this is that they did wind up suspending the RMD, but they did so for 2009 instead of 2008.

What is the RMD?

Just to remind you, the RMD is the minimum amount that retirement account holders must withdraw from their tax-deferred accounts when they hit the age of 70-1/2. Your RMD is based on what was in your account on the last day of the previous year, so…

If the market tanks, you’ll need to withdraw a disproportionately large amount from your account

Should you skip your RMD?

To me, the issue of whether or not you should skip your RMD in 2009 hinges on your circumstances. If you need the money to get by, then you don’t have much of a choice.

If, on the other hand, you don’t have a compelling need, you should seriously consider leaving the money in place. Tax-deferred retirement accounts are powerful tools. By leaving your money in place, you’ll avoid paying additional taxes this year, and your investments will have even more time to recover.

If you’ve already taken your RMD in 2009 and wish you hadn’t, you might be in luck. As long as you get the money back into your IRA within 60 days, you can “undo” the withdrawal.

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Taxes are a huge consideration when planning for retirement. As you’re building up your nest egg, one of the big decisions that you’ll face is whether you should put your money in a traditional, tax-deferred account or a Roth-style account.

Of course, we don’t all face this dilemma. After all, access to Roth IRA accounts is limited by income (but see here and here), and access to a Roth 401(k) or Roth 403(b) is limited by whether or not your employer offers one. Many don’t, even if they offer tax-deferred versions of these accounts.

But what if you do have access to Roth accounts? How do you decide where to put your money? What follows is a quick overview of the major issues.

The tax deferred option

One of the biggest arguments in favor of using tax deferred accounts is that you’ll get your tax savings up front. These guaranteed savings can help those with limited means save/invest more money than they might have otherwise.

Taking an immediate tax break might also be a good option if you’re in a relatively high tax bracket. After all, if your income falls in retirement, you’ll have dodged higher taxes during your earning years in favor of lower taxes in retirement.

But what if tax rates increase dramatically between now and retirement? Even if you fall to a lower bracket, the applicable rate might wind up being higher. In that case, you’d have traded lower taxes during your earning years for higher taxes in retirement.

Another downside to tax-deferred accounts is that they effectively convert capital gains (currently tax at a favorable rate) into regular income. This is a very important fact to consider when deciding where to hold certain investment types.

The Roth option

Roth accounts make the promise of completely tax free withdrawals in the future in return for paying your taxes right now. This is a particularly good option if you expect to be paying higher taxes in retirement than you are right now.

Another risk that you’re running by using a Roth account is that Congress might change the rules. I currently view this as rather unlikely, but consider (for example) what would happen if we would adopt something like the Fair Tax between now and when you retire…

In such a case, you would have paid full income tax on your Roth contributions, and then you would be taxed again in retirement when you spend this money. Double taxation. Yuck.

What are we doing?

So how have we solved the problem? As with all things that involve uncertainty in the investing world, we’ve decided to diversify our risks. I honestly have no idea what will happen with tax rates going forward, and I can only project what our income might look like in retirement.

In view of these uncertainties, we’re taking advantage of both tax-deferred and Roth investment accounts. In doing this, it’ll be impossible for us to be 100% right, but we also won’t be 100% wrong. Given that we have both account flavors (not to mention a taxable investment account) at our disposal, we’ve given a lot of thought as to optimal asset locations.

In short, we keep our most tax inefficient investments in retirement accounts, with those with the highest expected rate of return in Roth accounts. Our taxable account, on the other hand, is loaded up with tax efficient investments.

What about you? If given the choice, how would you proceed?

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The topic of safe withdrawal rates is critically important to retirees. Earlier this week we talked about retirement withdrawal strategies, but that was a discussion of how to access your money rather than how much money you can safely distribute per year.

What’s a “safe” withdrawal rate?

While there are no easy answers, the stakes couldn’t be higher. If you pick a number that’s too high, you’ll run out of money before you run out of time. If, on the other hand, you pick a number that’s too low, you’ll wind up leading an unnecessarily ascetic lifestyle, ultimately dying with a huge pile of cash.

If you ask around you’re get a variety of answers. By far the most common one that you’ll run across is the 4% rule. In short, this rule holds that you can “safely” withdraw an inflation-adjusted 4% of your nest egg from the year that you retire onward.

Of course, the topic of safe withdrawal rates is very complex, and the reality is that “it depends.” In other words, it depends on your time horizon, the composition of your investment portfolio, whether or not you retire into a collapsing stock market, and so on.

The only thing that we can say for certain is that higher returns will better support whatever withdrawal rate you settle on. But how can you boost your returns without appreciably increasing your risk? Well… What would you say if I told you that the average investor can easily increase their returns by 1% per year while taking on virtually no additional risk?

Maximizing returns by minimizing expenses

Sounds too good to be true, right? After all, 1% can make a huge difference in the size of your nest egg, but there is (typically) no such thing as a free lunch. Well, consider the following.

The average expense ratio for actively managed mutual funds is in the neighborhood of 1.5%. On top of that, numerous studies have revealed that the majority of actively managed funds underperform their target indices, sometimes by a lot. Why? Mostly because of the added expense of the fund manager.

In contrast, index mutual funds (or equivalent ETFs) have dirt cheap expense ratios (often in the 0.1-0.2% range), thereby allowing them to essentially match the returns of their target indices.

So how can you increase your returns without taking on more risk? Simple. Keep a close eye on expenses. Instead of overpaying for underperformance, focus on constructing a portfolio with using high quality, low cost investment vehicles. Of course, this is often easier said than done.

For example, you might have a fee-laden 401(k) with limited options. Sure, you could lobby your employer for changes, but they might resist. In that case, your best option might be to simply contribute enough to get your employer’s match and then focus on investing outside of your 401(k), where you’ll have complete control.

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The latest issue of Time Magazine featured an article that was very critical of the 401(k) system. In it, they argued that “the 401(k) is a lousy idea, a financial flop, a rotten repository for our retirement reserves.”

Why all the hate?

So just what is it that Time hates about 401(k) plans? For starters, 401(k) plans were never intended to replace traditional pensions. Rather, they were created as an executive perk. Over time, however, their existence allowed many employers to kill off their pension plans.

401(k) plans have also come under fire because:

• Not enough people participate in their employer’s 401(k) plan
• Of those who do participate, many don’t contribute enough
• Many participants invest too conservatively
• Others invest too aggressively

The problem here is that these things aren’t unique to 401(k) plans. Rather, criticisms such as a lack of participation, saving too little, and inappropriate allocations can be leveled at most investment vehicles, including traditional and Roth IRAs, taxable investment accounts, etc.

Beyond this, people choose whether or not they will participate, they choose how much they will set aside, and they choose their investments. If some people wind up making bad decisions, should everyone be forced to give up their 401(k)? Not in my book.

Don’t get me wrong, there are certainly a number of bad 401(k) plans out there. Some of these have very limited investment choices, others have exorbitant fees, and so on. But advocating that we should “retire the 401(k)” is throwing the baby out with the bathwater.

What are the alternatives?

Yes, it sucks that juicy pension plans have largely disappeared, but that’s the reality. With traditional, employer-run pension plans out of the picture, what other options do we have? Well…

The article advocates for guaranteed investment accounts that would essentially function as “retirement insurance.” Every pay period, you’d contribute a fixed percentage of your paycheck and, upon retirement, you’d collect a guaranteed monthly check based on your final salary.

An advantage of such plans, whether they are backed by the government or a private entity, is that they would follow you from job-to-job. You would also be free to invest in addition to these plans, though (presumably) things like tax-deferred 401(k) plans would be off the table.

Setting aside the possible disadvantages of such plans, it’s important to keep in mind that there’s nothing stopping private companies from introducing these sorts of things whether or not the 401(k) still exists. In fact, there are great many annuity products already out there that fill a similar need.

In the end, I’m trying to figure out why killing off the 401(k) is a good idea. Yes, I realize that not everyone has access to them, and that some people can afford to contribute more than others. Given all the challenges associated with saving enough for retirement, however, it seems to me that taking options off the table would be a step backward.

What do you think?

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In honor of National Save for Retirement Week, I wanted to take a minute to point out some excellent books about investing. Truth be told, I thoroughly enjoy reading about money and finance, but I’m a bit of a freak when it comes to these things.

With that in mind, here are three great books that would make an excellent “short course” in investing for the future:

The Bogleheads’ Guide to Investing

Written by Taylor Larimore, Mel Lindauer, and Michael LeBoeuf, this is an excellent introduction to investing which is broken in two main parts. Chapters 1-16 comprise Part I (Essentials of Successful Investing), which covers topics such as:

» Leading a sound financial lifestyle
» The importance of starting early and investing regularly
» The ins and outs of stock, bonds, ETFs, mutual funds, etc.
» Protecting yourself against inflation
» Asset allocation (in simple terms)
» How to invest for college
» How to manage a windfall
» Whether or not you need a financial planner

Chapters 17-23 comprise Part II (Follow-Through Strategies to Keep You on Target), which covers topics such as:

» Tracking your progress and rebalancing
» Mastering your emotions and ignoring the “noise”
» Making you money last longer than you do
» Protecting your assets with insurance
» Estate planning

All in all, this is a very well-rounded book on investing.

The Four Pillars of Investing

Written by William Bernstein, this book turns things up a notch when it comes to educating you about investing. The content is broken into five sections, including:

» Pillar One: The Theory of Investing (Chapters 1-4)
» Pillar Two: The History of Investing (Chapters 5-6)
» Pillar Three: The Psychology of Investing (Chapters 7-8)
» Pillar Four: The Business of Investing (Chapters 9-11)
» Investment Strategy: Assembling the Four Pillars (Chapters 12-15)

For those that aren’t familiar with him, Bernstein is an excellent writer who manages to make otherwise dry topics quite interesting.

The Intelligent Asset Allocator

This is another book by William Bernstein. What can I say? I’m a fan. In truth, “Bogleheads” and “Four Pillars” will provide you with rather thorough coverage of investment-related topics, and might be plenty for the average investor. If you’ve read both of them and are looking for more, then…

“The Intelligent Asset Allocator” isn’t a light read, but Bernstein once again keeps things interesting. This book drills down into portfolio theory, tackling such issues as risk vs. return, asset class correlations, how to properly construct an investment portfolio, how to implement and maintain your plan, etc.

Other options

There are, of course, many other excellent books about finance and investing out there. For example, if you’re more interested in the psychological side of the equation, and getting your head straight when it comes to longer term goals, you might be interested in “Your Money or Your Life.”

Another books that looks promising is “The Bogleheads’ Guide to Retirement Planning.” I haven’t read it (yet), but the reviews are excellent, and it appears to delve into a number of retirement-specific topics.

Finally, I’d be remiss if I didn’t point out Bernstein’s latest book, “The Investor’s Manifesto.” While this books isn’t due out until November 2009, you can pre-order it through Amazon. You can also check out the first couple of chapters for free via Bernstein’s website.

What are your favorite books about finance/investing?

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This is a guest post from Mike Piper, author of Investing Made Simple and proprietor of The Oblivious Investor. If you like what you see here, please consider subscribing to his RSS feed.

The Roth IRA vs. Traditional IRA question gets a lot of press, and that makes sense. By choosing correctly, you can significantly reduce the total taxes you’ll pay over your lifetime.

In a similar fashion, you can reduce your overall tax burden by planning your withdrawals strategically. That is, once you’re retired, how should you order your distributions? Should you take money out of your Roth first? Your 401(k)? Some combination of both?

The strategy: fill the lower tax brackets

The overall goal with planning your withdrawals is to take sufficient distributions from tax-deferred accounts to fill up the low tax brackets. The reasoning is that it’s better to pay 10% or 15% in taxes now rather than wait, take all the money out over the course of just a few years, and have the distributions bump you up into a higher tax bracket.

In fact, it can sometimes make sense to take distributions even if you don’t need the money to cover living expenses. (If that’s the case, it’s likely a good idea to use them for a Roth conversion, if you’re eligible.)

How about an example?

Martha and Mark are retired, and they’re both 60 years old (so they’re not yet receiving social security). Between interest income and Martha’s freelance writing work, they earn $13,000 over the course of the year. They only need $30,000 to cover their living expenses. They could take the extra $17,000 out of a taxable account, Martha’s Roth IRA, or out of Mark’s traditional IRA.

What should they do?

Without knowing the rest of the details of their situation, it’s impossible to say with absolute certainty what they should do. But the following analysis should provide a decent starting point.

Due to the standard deduction and personal exemptions, a married couple’s first $17,900 of income is free from income taxes. So it’s a no-brainer that they should take at least $4,900 ($17,900 minus their $13,000 of other income) from their traditional IRA because it’ll be entirely tax free.

They still need to come up with another $12,100 to pay their bills. If Mark and Martha expect their tax bracket to be above 10% later in retirement (e.g., due to social security or required minimum distributions from their tax-deferred accounts), it makes sense to take that from the traditional IRA as well, thereby paying tax at 10% now rather than at a higher rate later.

[Note: Because of the 10% tax, they'll have to take out $13,444 in order to have $12,100 left to pay bills.]

And by the same reasoning, it’s likely a good idea to take an additional $3,255 distribution from their traditional IRA in order to fill out the 10% tax bracket. They can then move that money into a Roth IRA, thereby paying tax at their 10% rate now and avoiding tax at a higher rate later.

In fact, if Mark and Martha expect to be in (or above) the 25% tax bracket later in retirement, it’s probably a good idea for them to take another $51,200 out of their traditional IRA and move it into a Roth, thereby filling out their 15% tax bracket this year as well.

Social security income complicates matters

Once an investor begins receiving social security income, things become more complicated, and the benefits of tax planning increase even further. The reason for the additional complexity is that, as your income proceeds through the 15% bracket, the portion of your social security income that is subject to income tax increases as well.

By strategically planning which accounts you take money out of each year, you can reduce the tax on both your retirement account distributions and on your social security income.

Takeaway lesson

Making small adjustments to your plans could potentially save you thousands of dollars in taxes each year. Unless you have a tax adviser who plays an active role in planning your finances (that is, he/she does more than just prepare your tax returns), it’s essential to have a solid understanding of taxation.

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Last week I mentioned the possibility that 401(k) limits might be reduced in 2010. This week, I wanted to highlight some proposed retirement savings changes that President Obama outlined in his weekly radio address. Here they are:

• Auto-enrollment in retirement plans. The administration plans on clearing up some of the bureaucratic hurdles that make auto-enrollment a challenge for small and medium-sized employers.
• Tax refunds as savings bonds. To encourage savings amongst those who receive a tax refund, you’ll be able to elect to receive your refund in the form of savings bonds.
• Convert unused sick/vacation days to 401(k) contributions. The White House intends to make it easier to convert unused sick and vacation days into 401(k) contributions.

Note that these changes aren’t forcing anything on employers, they’re just clearing the roadblocks that might be discouraging employers from doing these things. Moreover, these are largely technical changes, and thus don’t require legislative approval.

As for the changes themselves… The first and third sound great. The second one, on the other hand, seems kind of pointless. While it won’t hurt anything, I can’t imagine very many people taking advantage of it.

Source: CNN/Money

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According to human resources consulting firm Mercer, the IRS might be forced to reduce 401(k) contribution limits in 2010. Next year’s limits, which are tied to inflation, will be announced in October.

Inflation has been negative since March so, unless it picks up between now and October, the IRS will have no choice but to reduce contribution limits. If this happens, the contribution limits would fall from $16,500 to $16,000 with catchup contributions falling from $5,500 to $5,000.

Robert Powell from MarketWatch has an interesting take on this. His view is that Uncle Sam would be sending the wrong message to investors by reducing the limits. At the same time, he argues that the change will have very little “real” impact because so few workers actually hit the limit in any given year.

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This is a guest post from Dawn of Frugal for Life. If you like what you see here, please consider subscribing to her RSS feed.

I’ve twice been given the opportunity to rollover my 401(k) instead of cashing it out, and I’ve twice failed to do so. In both cases, I mistakenly placed today’s concerns ahead of those of tomorrow.

Cashing out my 401(k)

The first time I cashed out my 401(k), I had accumulated a little over $5,000 before taxes and penalties. If I recall correctly, I used that money to pay off debt and buy a new washer and dryer.

Unfortunately, I didn’t hold back enough to cover my state and federal taxes, so I had trouble paying my taxes when they came due and had to set up a payment plan. This left a sour taste in my mouth, and I vowed never to make that mistake again.

The second time I cashed out my 401(k), I had accumulated a little over $2000, and once again felt that debt reduction was more important than the long-term goal of retirement. This time around I tried to hold back more for taxes, but once again fell short. Once again, I had to set up payments to the IRS to pay what I owed.

Starting fresh

With a new job and a fresh outlook, my 401(k) has once again started to grow. Moreover, I no longer review my retirement money as an expensive savings account. I’ve learned from my past mistakes, and now consider my 401(k) to be untouchable, off-limits until I retire.

Looking back, I estimate that I’d have over $10k in an IRA if I had just rolled my 401(k) money instead of withdrawing it. Instead, I have a washer and dryer that are not aging well and a few debts that were paid off, but have since grown back.

When the time comes for me to move from this company to another, I will not hesitate to roll my 401(k) into an IRA. When I do this, it will happen electronically so I don’t ever see a check. Unfortunately, I’m just now learning this at 36 years of age, but starting over now is better than never starting at all.

Lessons learned

My experiences have taught me the following:

• Retirement savings, no matter how meager, do add up
• Never pass up matching contributions from your employer
• Always check the fees associated with your investments
• Be an active participant, and move your money if necessary

I also try to imagine myself at 67 as I’m putting the money away.

Hopefully you’ll learn from these mistakes instead of making them yourself.

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Last week, my wife and I received a letter from Vanguard informing us that one of our mutual funds accounts qualifies for conversion to “Admiral Shares.” For those that aren’t familiar with Admiral Shares, this is a very good thing. Here’s why:

“Admiral Shares are a class of Vanguard funds created to recognize and encourage the cost savings realized from large, long-standing accounts, and to pass these savings on to the shareholders who generate them. The ultra-low Admiral Shares expense ratios can reduce your investing expenses 18%–50% below the already low expenses of your Investor Shares.”

How much are the savings?

As noted above, the expense ratios on Admiral Shares are 18-50% lower than for Investor Shares. In our case, we’re talking about converting Vanguard Total Stock Market Index Fund Investor Shares (VTSMX) into Admiral Shares (VTSAX). The Investor Shares have an expense ratio of 0.18% (which is already quite low) but the Admiral Shares will take this down to 0.09%.

While this doesn’t sound like a lot, that translates into an improvement in performance of nearly 0.1% each and every year. Over time, small differences in cost really add up.

How do you qualify for Admiral Shares?

Unfortunately, not everyone has access to Admiral Shares. In order to qualify, your account must:

• Have a balance of at least $100k, or
• Have been established ? 10 years, have a balance of at least $50k, and be registered for online access

Note that these limits are applied on a per fund/account basis. Thus, if you have multiple accounts, it’s possible that some shares will qualify and others won’t even if you hold the same fund in each account.

How do you convert shares?

Beyond offering rock bottom expense ratios, Vanguard also takes a lot of the hassle out of investing, and Admiral Shares are no exception. According to the letter that we received, the conversion will take place automatically during their quarterly conversion process. In other words, we don’t have to do a thing. They’ll mail us a confirmation when the conversion is complete.

What are the tax implications?

Whenever you modify your holdings in a non-retirement account, it’s important to consider the tax implications. The good news here is that “conversions from Investor Shares to Admiral Shares of the same fund are tax-free.”

Hmmm… We’ll save money, we don’t have to lift a finger, and there’s no tax hit. What’s not to love?

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Up until about a year ago, we relied primarily on Vanguard’s Target Retirement funds for our long-term investments. For those that aren’t familiar with them, these funds (and others such as the Fidelity Freedom funds and TIAA-CREF Lifecycle funds) are designed to provide an “appropriate” asset allocation based on the date at which you expect to need access to your money.

Not surprisingly, the more time that you have, the more aggressively these funds invest. Over time, however, they’re designed to automatically move to a more conservative allocation. Thus, they’re a very convenient “set and forget” solution. That being said, they’re not for everyone.

Why we abandoned target date mutual funds

As I alluded to above, we ultimately moved away from target date funds in order to gain more control over our money. We now hold a mix of low-cost index funds at our own, self-determined “ideal” allocation. Here were my four biggest concerns that caused us to move away from target date funds:

1. Inappropriate allocation. The main reason that we moved away from Vanguard’s Target Retirement funds was that they were too aggressive for our taste. For example, the Target Retirement 2035 fund had an allocation of 90% equities and just 10% in bonds. While we could’ve simply selected another, less distant year, we didn’t like the way these less aggressive options re-adjusted down the line. Which brings us to…
2. Inappropriate “glide path.” The glide path refers to the way in which the overall allocation changes over time. In our case, if we had chosen a less distant target date, we would’ve gotten an appropriate allocation in the near term, but it would’ve become too conservative too quickly. In short, we’re looking for a flatter curve — i.e., a bit less aggressive up front, but with a slower transition toward an ultra-conservative mix on the back end. After looking around, we simply couldn’t find the right balance.
3. No control over what goes where. I’ve written in the past about optimizing the location of your assets to maximize tax efficiency. In general terms, you want tax-inefficient investments (such as bonds) in a tax-sheltered account, and so on. But with target date funds, you lose the ability to do this. Indeed, each and every share is composed of both stocks and bonds, meaning that you can’t separate your holdings by account type.
4. Continuous rebalancing. While the auto-balancing offered by these funds is convenient, the fact that they’re continuously rebalanced means that you never really “let your winners run.” While rebalancing recommendations vary, the conventional wisdom is that you should do it periodically (say every six or twelve months) or when your allocation is more than a certain percentage out of whack. Doing this forces you to sell high and buy low.

Defining proper allocation

Another interesting point when it comes to target date funds is that the definition of an “appropriate” allocation not only varies across fund families, but can also change on a whim. In fact, back in 2006, Vanguard decided to reduce the bond exposure in all of their funds with a 25+ year time horizon from as high as 24% to just 10%.

While I’m not sure of Vanguard’s reasoning when it came to making these changes, I’d be willing to bet that it had at least a little to do with performance chasing. After all, most investors look at past performance when comparing funds, so taking a more conservative stance in a rising market is a great way to lose business. Of course, the past year has shown us the price of being overly-aggressive.

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As a followup to my earlier post about the worst 401(k) plans, here’s a look at Business Week’s list of the best 401(k) plans. Once again, these were rated based on criteria like participation rate, default rate, fees, and employer match. The full list includes fifty plans. I’ve listed below the twenty best 401(k) plans.

Twenty Best 401(k) Plans

1. Saudi Arabian Oil
2. Bank of New York Mellon
3. Greenwich Capital Markets
4. Southwest Airlines
5. Piper Jaffray
6. Nucor
7. FedEx
8. Amgen
9. McDermott Will & Emery
10. Chevron
11. Mosaic
12. Exxon Mobil
13. ConocoPhillips
14. Hercules
15. Latham & Watkins
16. Sun Microsystems
17. Pfizer
18. AstraZeneca Pharmaceuticals
19. MBIA
20. Church & Dwight

Once again, plans were rated on a wide variety of factors, including participation rate, default rate, fees, and employer match. While the inclusion of participation rate might introduce a bias for or against certain types of employers, I’d still rather see my plan on this list as compared to the other one.

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Curious as to how your 401(k) plan compares to others? Business Week just published a list of the worst 401(k) plans based on criteria such as participation rate, default rate, fees, and employer match (see also “The Best 401(k) Plans). The full list includes fifty plans. I’ve listed the twenty worst plans below.

1. Darden Restaurants
2. Big Lots
3. RadioShack
4. Zale
5. Compass Group USA
6. Bob Evans Farms
7. MPS Group
8. O’Reilly Automotive
9. Best Buy
10. Pep Boys
11. CSK Auto
12. Lowe’s
13. Whole Foods Market
14. Bon-Ton Stores
15. Safeway
16. Northrop Grumman
17. AutoNation
18. Penske Automotive Group
19. TCF Financial
20. OfficeMax

The full list is heavily populated with restaurant chains and retailers. Other notable names include Borders, Kohls, Walmart, Burger King, Target, JC Penney, and Home Depot. Is your employer listed?

Oh, and here’s a bit of 401(k) trivia for you… Total 401(k) holdings across the United States stood at $3 trillion at the end of 2007. Fast forward one year to the end of 2008, and… Poof. $2.4 trillion. That’s $600B that just evaporated.

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Related Articles at fivecentnickel.com:

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I recently received an e-mail from a reader named Chris, who is in his early forties. He and his wife are working on paying off a car loan and a mortgage, and

We owe about $10,000 on a car loan and $105,000 on our mortgage, and we have two newer vehicles. I recently calculated that if my wife and I stopped our 401(k) contributions (mine 6% with a 50% match; my wife’s 8% with a 50% match) that we could pay off our car and our mortgage in eight years (maybe a little faster if we’re REALLY disciplined).

Eight years is a bit magical in that we’ll be just shy of 50 years old, and our oldest will be graduating from high school. My thought is that we’ll then start to save for replacing our vehicles and start to make contributions to our retirement funds again. We’d save about $64,000 in interest, so I thought it might be the way to go.

Being debt free has a great draw to us — probably more than giving up the wonderful company match on the 401(k) plans. What are your thoughts?

Without knowing all of the details (e.g., income level, mortgage terms, auto loan details), it’s hard to say for certain. However, I would personally think long and hard before stopping those 401(k) contributions. Not only will they be giving up a ton of free money (the 50% match), but they’ll also be giving up the opportunity to stash that money in a tax-advantaged account, as well as years of tax-deferred compounding on the principal plus the match. Moreover, once those debts are paid off, they’ll have kids in college — this may wind up being yet another impediment to investing.

If it were me, I would most likely maintain the 401(k) contributions, tighten my belt a bit, and focus on getting rid of that auto loan. The mortgage (assuming that the terms are reasonable) is much less of a concern. Not only does it likely have a much lower interest rate, but the interest payments are also tax deductible.

Bottom line: While being debt free is an admirable goal, my view is that you really need to look at the big picture when making decision like this.

What about you? Any advice for Chris and his bride?

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This is a guest post by Jeff Rose, who is an Illinois Certified Financial Planner(TM) and co-founder of Alliance Investment Planning Group. Jeff is also the author of Good Financial Cents, a financial planning and investment blog. If you like what you see here, please consider subscribing to his RSS feed.

Does anybody feel like the 2008 stock market crash has been one of the worst ever? Unfortunately, the crash in 2008 was the first collision and now 2009 just rear ended you when you thought the wreck was over. If you feel that the the market turmoils are like a severe car wreck, it leads us to wonder how to rehab our way back from such a serious injury.

As you may know, effective rehab is simple and repetitious. The improvements are almost imperceptible, and the real benefit is only recognizable in hindsight. It may take six, twelve, or even more months, but eventually that limp you had will be just a memory.

For those that feel like the recent market crash has left you with more than just a simple limp, here are some pointers that can keep you going as the market attempts to figure itself out.

Continue Funding Your IRA and 401(k)

Yes, I know that sounds insane considering how ugly the market is right now, but you have to have some faith in the U.S. economy. Just because I’m suggesting that you fund your retirement accounts doesn’t mean you have to put in all in the market. You will want to at least fund your retirement accounts to either get the 401(k) match or the tax free savings of the Roth. Even if it’s invested in bonds right now, you’ll be able to transition to stocks later on when you feel more comfortable.

Make Roth Conversions Now or in 2010

If you’ve been wanting to get money into a Roth IRA, now might the opportunity. If your AGI is below $100,000, you are able to convert traditional IRA’s and old 401k’s this year. If not, you’ll have to wait until the 2010 conversion event. Why is this time to do it? You’ll pay less tax on the conversion because most likely your account balances are down (whose isn’t, right?) and you’ll have less of a tax liability on the amount to convert. If you have to wait until 2010, the one upside is that you’ll be able to spread the tax over a two year period.

Diversify Asset Classes

Is diversifying really dead? There’s no question that even a well-diversified portfolio took a substantial hit over the past 6 months. But what about alternative asset classes? Managed futures returned double digit gains last year, showing that only do we need to diversify with stock and bonds, but we also need to consider non-correlated assets. One thing that you must consider is that although alternative assets classes can reduce risk in a portfolio, that doesn’t mean they decreases volatility (ups and downs of the market). That’s a common misconception with most investors that needs to be known.

Review Your Retirement Plan

Face it, things change and you have to adapt and overcome. If you had a well thought out retirement plan last year, it needs to be revisited. A lot has changed in a short amount of time and you need to act accordingly. It’s not time to panic, but you need to be proactive in what is going on around you. Don’t let an opportunity pass you by that could make a serious impact to your retirement plan.

Put Money to Work

I know that this seems almost impossible nowadays. The stock market loses a hundred points every other day it seems and savings account interest rates are dropping just as fast. But even still, there are opportunities to take advantage of.

If your 401(k) has a match, keep contributing and get your free money. If you have a credit card with a 8.9% APR (just as an example), pay it off and you just made 8.9% on your money. Maybe you have a significant amount in your checking or savings accounts and you’re only earning 0.25% (yes, I’ve seen it that low). If so, consider moving your money to an online savings account (just make sure that they are FDIC insured). It may only pay you 2%, but you’ve still increased your payout by 8 times.

It all sounds simple, but these are the kinds of simple things that we can do to get ourselves back on the road to financial health. What about you? What are you doing to recover from the crash?

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As I noted a week ago, both the House and the Senate have voted to suspend the Required Minimum Distribution (RMD) for 2009. Unfortunately for those hoping for relief in 2008, this news was too little, too late. That being said, the Treasury Department has the authority to grant RMD relief for 2008, and they’ve apparently been studying their options.

While I haven’t heard anything official one way or another, a reader named Howard has been in touch with the legislative staff of the House Ways and Means Committee. According to him, the Treasury has decided that there’s nothing that they can do for 2008 (see comments here and here). So… Assuming he’s correct, those hoping for an RMD waiver in 2008 are out of luck.

Not sure what the heck we’re talking about?

Check out “What is a Required Minimum Distribution (RMD)?” In short, it’s a mandatory withdrawal that retirees have to take from their retirement accounts once they reach the age of 70-1/2, and there has been concern that retirees who didn’t take their RMD early in the year would be forced to withdraw a disproportionate amount of their funds.

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Late last week, I wrote about the House voting to suspend the required minimum distribution (RMD) for 2009 (the Senate has since voted in support of this measure). Today I thought I’d spend a bit of time explaining exactly what the RMD is for those that aren’t familiar with the term.

What is a Required Minimum Distribution?

The terms Required Minimum Distribution refers to a minimum amount that a retirement plan account owner must withdraw each year once they reach the age of 70-1/2 (or at retirement if they work past that age). The RMD rules apply to all employer-sponsored retirement plans including profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to traditional IRAs and IRA-based plans such as SEP-IRAs, SARSEP plans, and SIMPLE IRAs. Note that the RMD rules also apply to Roth 401(k) accounts, but they do not apply to Roth IRAs while the owner is alive.

How do you calculate the RMD?

RMD amounts are generally calculated for each account based on their balance on December 31st of the prior year. Calculations are based on a life expectancy table published by the IRS in Publication 590. There are also worksheets available to help with the calculations. Note that you can always withdraw more than the RMD, but that excess withdrawals cannot be credited toward your RMD in subsequent years.

When must your RMD be taken?

As noted above, RMDs have to be taken for the year in which the account holder turns 70-1/2. However, during that first year, the distribution can be delayed until April 1st of the following year. For all subsequent years, the RMD must be taken by December 31st of the year.

Where do the RMD funds have to come from?

While you have to calculate the RMD separately for each IRA account, you can withdraw the total amount from just one IRA if you wish. Likewise, if you have multiple 403(b) accounts, you must calculate the RMD for each account, but you can withdraw the total RMD from just one if you wish. For other types of retirement plans, such as 401(k) and 457(b) plans, you have to take the RMD separately for each account.

What happens if you don’t take your RMD?

If your fail to take your RMD, or don’t withdraw enough, or don’t do it in time, the amount not withdrawn will be taxed at 50%. The additional taxes are reported on IRS Form 5329. The good news is that you can get the penalty waived if you can show that the shortfall was due to a “reasonable error” and that you are taking “reasonable steps” to fix the situation. In this case, you still need to file Form 5329 (read the instruction carefully), but you should also attach a letter of explanation and hope that the IRS agrees with your definition of “reasonable.”

Why all the talk about suspending the RMD?

There has been a lot of recent attention paid to the possibility of suspending the RMD. The reason for this is that, as noted above, the RMD is based on your account balances on December 31st of the prior year. For 2008, that means that people who have waited until late in the year to take their RMD will be forced to withdraw a disproportionate amount of funds.

Take, for example, an individual whose RMD calculation amounted to 5% of their account balance as of December 31st, 2007. If that individual had an especially aggressive portfolio that has since fallen by 50%, and if they didn’t take their RMD early in the year, then the RMD amount would now equal 10% of their balance. That being said, the suspension that’s currently being bandied about won’t actually help, as it won’t go into effect until 2009.

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A Hill staffer wrote in his morning to let me know that the House passed legislation that will suspend the required minimum distribution (RMD) from retirement accounts in 2009. The Worker, Retiree and Employer Recovery Act (H.R. 7327) suspends the IRS requirement that individuals withdraw a minimum amount of money from their retirement accounts every year once they reach the age of 70-1/2.

This waiver applies to all defined-contribution plans, including 401(k), 403(b), 457(b), and IRA accounts, and is good news for seniors whose investments have been pummeled by the recent stock market turmoil. Instead of being forced to sell investments to take their RMD, they’ll be able to sit tight and wait for a recovery. Unfortunately, it’s too late to help for 2008, so retirees will still have to take their RMD this year or face a stiff penalty from the IRS.

Update1: The Senate has also approved this measure.

What follows is a listing of the key provisions of this legislation as it relates to retirement plans:

TITLE II – PENSION PROVISIONS RELATING TO THE ECONOMIC CRISIS

Taxpayer Relief

One-year suspension of the required minimum distribution (RMD): The bill would place a one-year moratorium on the RMD for 2009. This suspension is available to everyone regardless of their total retirement account balances.

Relief for single-employer plans

Allow pension plans to “smooth” out their unexpected asset losses: The bill permits employers to “smooth” the value of pension plan assets over 24 months instead of having to apply the mathematical average that Treasury requires. This change will soften the accounting of 2008 plan losses.

Adjust the transition to the new funding rules: PPA phases in full pension funding targets from 90% to 100% over 5 years (2008 – 92%, 2009 – 94%, 2010 – 96%, 2011 – 98%, 2012 – 100%). If a plan misses its target in a phase-in year, then the target automatically increases to 100%. The bill adjusts the “phase-in” rule to allow plans which miss their phase-in funding target to retain the same target and not jump to the 100% target. For example, plans that are less than 92% funded in 2008, their shortfall would be estimated relative to 92%, not 100%. With a sizable number of plans below 92% funded next year, the adjustment of this phase-in rule could provide significant relief.

Worker protections

Temporary change of the limitation on benefit accruals. For purposes of staving off restrictions on benefit accruals as a result of being < 60% funded, plans would be able to look back to the previous plan year to determine their funded status as it would apply to workers’ ability to accrue benefits.

Relief for multi-employer plans

Plans may elect to “freeze” their plans’ status for one year: For plans starting between October 1, 2008 and October 1, 2009, multi-employer plans may elect to freeze their current funding status based on the previous year’s level. This would freeze the terms of the funding improvement or rehabilitation plan adopted at any time during the previous plan year.

Plans may elect to extend correction periods: Plans generally must bring their funded position up to statutory standards within a correction period (10 years or 15 years). This structure aims at enabling stakeholders in troubled plans to phase in the higher contributions or deeper benefit cuts over a period of time. Plans may elect a 3-year extension of the current funding improvement or rehabilitation period, from 10 to 13 years and from 15 to 18 years. Election of this extended correction period would help offset 2008 equity losses.

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As a followup to my earlier article about Traditional and Roth IRA contribution limits, I wanted to point out that the contribution limits for 401(k), 403(b), and 457(b) accounts are changing for 2009. While the limit on elective deferrals remained steady at $15,500 from 2007 to 2008, it’s rising to $16,500 in 2009. Individuals that will be 50 or older by the end of 2009 can make an additional $5,500 in contributions (up from $5,000 in 2008), bringing their total to $22,000. On top of this, the aggregate limit (also referred to as the 415(c) limit), which applies to employee plus employer contributions, is increasing from $46,000 to $49,000.

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With less than two months to go before 2009, I though it would be worth taking a look at IRA contribution limits for 2009. As of 2008, contribution limits are indexed to inflation and will increase in $500 increments (as necessary). Unfortunately, there’s not much to report here, as the limits are staying the same in 2009 as they were in 2008. What follows is a table of contributions limits starting back in 2002, and running through next year.

The silver lining here is that the cutoffs for making Roth IRA contributions and for deducting Traditional IRA contributions have increased 2009.

Roth IRA Contribution Thresholds

If you’re married and filing jointly, you can make your full Roth IRA contribution as long as your modified adjusted gross income (MAGI) is below $159k, and your ability to contribute phases out entirely at $169k. For single filers, the thresholds are $101k and $116k.

Traditional IRA Deduction Thresholds

If you’re married and filing jointly, you can make deduct your full Traditional IRA contributions as long as your MAGI is below $85k, and your ability to deduct contributions phases out entirely at $105k. For single filers, the thresholds are $53k and $63k.

Deadlines for Contributing

Remember, you can make 2008 contributions all the way up to April 15, 2009. As for 2009 contributions, you can start as early as January 2nd, 2009 with a deadline on the back end of April 15, 2010.

Source: IRS.gov*

*As of this writing, the IRS has not released Publication 590 for 2008. However, this information (for 2008) can be found in the 2007 version of Publication 590, as well as from multiple other reputable sources.

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Are you concerned about not having enough money to support you in retirement? If so, then check out this (tongue-in-cheek) article from The Onion, which suggests that your best option might simply be to “live less.” Here’s a snippet:

“Taking account of inflation and the rising cost of living versus the projected direction of the economy in the coming decade, I told Mr. Hutchinson that he could significantly reduce his spending by simply living less,” Dalton [a fictional financial planner] said. “After looking at his investments, I calculated that he really shouldn’t live a day over 62—or 59 if he wants a funeral.”

Obviously, this isn’t a particularly attractive path, so… Instead of following their advice, I suggest that you first get a handle on whether or not you’re saving enough for retirement. If not, kick things into gear and start saving more. And finally, you might want to consider creative solution for stretching your savings once you hit retirement age.

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The latest issue of Money Magazine had an interesting interview with a retirement expert from York University named Moshe Milevsky. In it, he detailed the three biggest risks of retirement. Any guesses as to what they are? Here’s his view:

1. Longevity risk
2. Inflation risk
3. Market risk

What follows is a quick breakdown of each one…

Longevity risk

Longevity risk refers to the possibility that you’ll outlive your savings. With retirement lasting anywhere from 10-40 years (perhaps longer depending on how early you retire) this is a very real issue for many retirees, especially now that most people are relying on their 401(k) and IRA funds instead of a monthly pension check. Fear that retirees will outlive their savings is one of the reasons that so-called longevity insurance (which is really just a re-packaged, deferred annuity) has become increasingly popular.

Inflation risk

Inflation isn’t so much a risk as an inevitability. When you’re working, your income typically increases to keep pace with inflation. But after retirement, many individuals are living on a more or less fixed income, and inflation becomes a major factor. Consider this… Over a 25 year span, 4% annual inflation will devalue a $1,000 monthly pension to the equivalent of just $375. Even if you’re not on a fixed income, you still have to manage your money in such a way as to minimize market risk (below) while staving off inflation risk.

Market risk

When you’re working, down markets aren’t necessarily a big deal. You’re still smack dab in the middle of the accumulation phase and, as long as you buy and hold, you have plenty of time to recover. In fact, as long as things eventually recover, down markets can boost your returns, as you’ll be buying shares on the cheap. That being said, a down market can wreak havoc if it occurs early in your retirement. The reason for this is that, once you hit retirement, you’ll likely start selling assets to generate cash. And when you pull money out during a down market, you effectively lock in that loss making it hard to recover.

Reducing your risks

As with anything, it appears that the key to defusing these risks is to diversify. According to Milevsky, this might include not just an age-appropriate mix of stocks and bonds, but also fixed and variable annuities. Traditional mutual fund investments help protect against inflation risk, whereas fixed annuities protect against longevity risk, and variable annuities promise some of the gains of the overall market while guaranteeing a minimum payout in the face of a bear market.

Note: Just to clarify the last bit about risk reduction… When asked about the fact that his own previous research that showed variable annuities to be overpriced, Milevsky responded:

If today’s variable annuities looked like the product of the same name 10 years ago, I’d still be opposed to them. They used to promise to make up losses only if you died while the market was down. But the new ones deliver benefits while you’re still alive. And the protection that they provide against market losses would be very expensive if you tried to buy it in any other way — say, in the options market. So I used to be something of a crusader against variable annuities, but now I fall back on what the economist John Maynard Keynes said when someone challenged him for supposedly flip-flopping. “When the facts change,” he said, “I change my mind. What do you do, sir?”

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With all of the recent financial turmoil, I’ve received a number of questions from readers on topics ranging from the safety of their bank to whether or not their money is FDIC insured, etc. While I’ve written about these topics in the past, several of the questions that I’ve received have outlined very specific scenarios, and then asked whether or not their deposits are covered.

Here’s my take… Instead of asking around online, relying on the advice of friends, or even inquiring at your bank, you should go straight to the FDIC for an answer.

Here’s how:

• Use their online deposit insurance estimator
• Drop them a line via their online contact form, or
• Give them a call at 1-877-ASK-FDIC (1-877-275-3342).

The bottom line here is that nobody can speak for the FDIC except for the FDIC. If you have any concerns, it’s best to get the answer straight from the horse’s mouth rather than relying on third-party information.

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Over the past few months, a number of readers have recommended that I check out FNBO Direct as an online savings alternative. Given the interest out there, I thought I should investigate. After a bit of digging, I was impressed enough with what I saw that I decided to open an account this weekend.

Strengths of FNBO Direct

One of the biggest reasons that people have given me for liking FNBO Direct has been their high interest rate. In fact, they have consistently outpaced online bank stalwarts such as ING Direct. Another strength of FNBO Direct is that they don’t have a minimum balance requirement, and there are no monthly fees.

In addition to the above, FNBO Direct is not only FDIC insured (as are all of the major players), but they also have a Bankrate “Safe & Sound” rating of 4 stars, which makes them one of the safest online banks.

Finally, while I have yet to test this out myself, I’ve heard from at least one reader that it’s dead easy to get a real, live human being on the line when you call customer service.

Opening an account

Given the above, I decided that I’d give FNBO Direct a try. What follows is a walk-through of the account opening process. All told, the process took about 10-15 minutes for a joint account (it would be a bit quicker for an individual account).

Step 1: Initiate your application.

Simply visit FNBO Direct and click on “Open an Account.” You should be greeted with a page that looks something like this:

Simply check the box for starting a new application and then click “Next Step.”

Step 2: Enter your personal information.

On the subsequent pages, you’ll select whether you’d like to fill out an individual or joint application, and then you’ll be asked to provide your name, social security number, date of birth, address, etc. Pretty standard stuff. If you’re opening a joint account, you’ll have to provide this information for both account holders.

Step 3: Confirm your identity.

Next, you’ll be asked a couple questions drawn from your credit record to make sure that you are who you say you are. In our case, we were asked about which bank holds our mortgage and how much we pay per month. These are multiple choice questions, so you just select the proper answer from a list of option.

Step 4: Fund your account.

At this point, you’ll be asked how you’re planning on funding your new account. While they don’t have a minimum balance requirement, you have to deposit at least one dollar to get the account up and running.

You have two options when it comes to funding your account. You can other do so electronically, via an electronic bank transfer, or you can send in a check. We opted for an electronic transfer. At that point, you’ll be present with a screen that looks something like this:

Simply provide the requested information, choose a deposit amount, and then choose an account verification methods, as follows:

We opted for trial deposits, which means it will be a day or two before we have full access to our account. The online verification provides you with instant access to your account, but it requires that you provide the username and password associated with your linked bank account.

The next step

That’s all there is to the account opening process. As I said, very quick and easy. In the next day or two we should be getting an e-mail saying that they’ve made the trial deposits. At that point, I’ll just have to check exactly how much they deposited (it’s usually a few cents) and then hop back on over to the FNBO Direct website to verify the amounts.

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I recently ran across a report from the World Future Society detailing emerging trends that are shaping the world. In it, they argued that “the traditional age of retirement is losing it’s significance.” They went on to argue that:

People in the developed world are retiring well before 65. In fact, they cite data that less than 60% of people aged 54-60 in such countries had a job in 2004.

As of 2006, the average American planned to retire at 61, but… Actual retirement age averaged just under 58 years old.

Many of these retirements aren’t permanent. Americans in particular often return to work after retiring.

Paradoxically, 70% of American Baby Boomers plan to work into their 70s. Supposedly, this isn’t because they can’t afford to retire, but rather because they can’t stand to be healthy and inactive.

The upshot, they say, is that:

People increasingly will work at one career, “retire” for a while (perhaps to travel) when they can afford it, return to school, begin another career, and so on in endless variations. True retirement, a permanent end to work, will be delayed until very late in life.

So… People are leaving the workplace earlier than ever, but are ultimately returning to work well beyond traditional retirement age. I wonder how much of this is a byproduct of older workers being laid off and then having to scramble to find a new job, as opposed to people choosing to switch gears midstream.

Speaking for myself, I can definitely see the attraction of early retirement. That being said, I can also imagine getting restless, especially once our kids are grown. But it sure would be nice to have free rein over how I spend my time — whether it be freelancing, volunteering, or whatever.

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While I’ve written a bit about our investment allocation in the past, we’ve tweaked things a bit recently so I thought I’d lay thing our here for all to see. Before we go any further, I should note that we have a number of different accounts, including two Roth IRAs, three different employer-related retirement accounts, a SEP-IRA, and a taxable brokerage account.

Because of the complexity of our situation, I have decided to treat our investments as one big pot of money rather than trying to manage each account individually. Thus, we’ve locked in certain accounts with just one investment type, and we adjust the overall allocation using my SEP-IRA. This management is made far easier by Vanguard’s Portfolio Watch tool, which allows us to track and visualize everything in one place.

Here goes…

Our current allocation is an 80%/20% split between stocks and bonds. Our stock holdings are further split 70%/30% domestic vs. international, for an overall total of 56% domestic equities, 24% international equities, and 20% domestic bonds. Here’s what it looks like in a bit more detail:

Domestic Equities
51% – Total Stock Market (VTSMX or the equivalent)
5% – Small Cap Value (entirely VISVX)

Foreign Equities
24% – Total International (entirely VGTSX*)

Domestic Bonds
20% – Total Bond Market (VBMFX or the equivalent)

The Total Stock Market fund gives us relatively broad diversification in domestic equities, whereas the small cap value fund adds a bit of additional weight to small, beaten down companies. I’ve considered adding a small amount of REIT exposure (VGSIX) for additional diversification, but haven’t made a final decision yet. If/when we do this, it will likely come out of the Total Stock Market portion of our portfolio.

As far as asset location goes, the taxable portion of our portfolio is entirely invested in the Total Stock Market, with our Small Cap Value, Total International and Total Bond Market holdings residing in tax-advantaged accounts. We’ve further subdivided things by making the Roth IRAs 100% equities in hopes of maximizing growth there (they’re tax free, after all). As noted above, my SEP-IRA contains a little bit of everything just to balance things out.

For the sake of comparison, our previous allocation looked like this:

75% – Total Stock Market
16% – Total International
9% – Total Bond Market

This previous portfolio was based largely on Vanguard’s Target Retirement 2035 (VTTHX). The problem with the Target Retirement solutions (for us) is that we haven’t been able to find our desired level of aggressiveness combined with our desired “glide path” (change in holdings as we approach retirement). The Vanguard funds in particular start out more aggressive than we’d like, and then transition over to the conservative side too quickly. I also wanted a bit more small cap and international exposure.

Now that we have everything set up, we’re on auto-pilot. The only thing we’ll have to do is to periodically rebalance my SEP-IRA holdings to keep things on track.

*Note: If our international holdings were in a taxable account, we’d likely use VFWIX instead.

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I’ve written in the past about the possibility of retiring overseas. While this can be a great way of stretching your retirement dollars, I recently ran across a blurb in Bottom Line/Personal that talked about some of the hidden costs of retiring outside of the United States.

For example, even if you move overseas, you’ll still have to pay income taxes on Social Security benefits as well as distributions from your pension, 401(k), traditional IRA, etc. You’ll even have to pay tax on income earned while abroad, though there are certain treaty provisions as well as the foreign earned-income exclusion that can reduce you liability. In addition, Medicare does not cover treatment outside of the United States. Thus, while many countries provide nationalized health care, you’ll need to check out how they handle foreign residents — you may or may not be covered.

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I frequently find myself musing about the possibility of an retiring early. It’s not that I dislike my job. Rather, I’m just really, really attracted to the idea of total financial independence. While we have four relatively young kids, and thus have a few more obstacles than the average family, I’m still a big fan of running the numbers to see where we stand and how far we have to go. To this end, I wanted to point out yet another calculator that I recently ran across…

It’s called the Capital Needs Analysis spreadsheet, and it allows you to plug in a number of variables including years to retirement, years until retirement, current portfolio amount, inflation rate, investment return, and income required at retirement. It then spits out four different answers, ranging from how much you’ll need such that you’ll run your portfolio down to zero at the end of your projected retirement to how much you’ll need to maintain the same inflation-adjusted dollar amount in your portfolio throughout retirement. Keep in mind here that we’re really talking about net investable assets, and not true net worth.

Running the numbers

While this is a completely deterministic calculation (i.e., it assumes perfectly equal returns over years, and thus doesn’t take into account potential variation in market returns), the answers are still enlightening (and a bit daunting). For example, assuming 4% interest and a 7% return on our investments, then…

If I continue working to the typical retirement age and assume a 30 year retirement period (taking me to age 95), then we’ll need just under $7.5 million dollars to support a withdrawal rate of no more than 4% and still maintain income stream equivalent to $100k in today’s dollars. The calculator then tells me that we’ll have to save $4,329/month to get there. But…

If I push things back to an early retirement at age 55 (and increase the retirement period to 40 years), then we’ll need to amass a nest egg of just over $5 million. This strikes me as somewhat odd, in that the required nest egg is lower here than with the later retirement. But perhaps it’s because these numbers account for inflation, so our required income won’t have to be as high in 2026 dollars to give us $100k in spending power? Regardless, we’ll have to get there in less time, so it’ll cost us much more per month to make it happen — nearly $8,300/month.

If I push things back even further, resulting in a retirement age of 45 (with an increase in the retirement period to 50 years), I learn that we’ll need a bit over $3.4 million at retirement, and that we’ll have to save just shy of $21k/month to get there. Yikes!

The answer? It depends…

Of course, these answers are all highly dependent on the variables that you plug in. For example, is 4% inflation realistic? Or perhaps your cost of living is increasing more rapidly? What about a 7% rate of return? Too generous or too conservative? And will we really need $100k/year, considering that our house will almost certainly be paid off prior to retirement, and that the numbers above assume no further investment contributions and no outside earnings?

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The most recent issue of Money Magazine had an interesting article about early retirement. Included was a small sidebar with tips for getting out of the rat race well before traditional retirement age. While there wasn’t anything earth-shattering about these tips, they serve as a good reminder:

1. Live below your means. Keep an eye on both small and large expenditures, live in a low-cost area, send your kids to public instead of private schools, opt for less expensive vacations, etc.

2. Set lofty goals. Saving 10% of your income isn’t enough if you want to retire early. Instead, aim for 20-25%.

3. Be allergic to debt. Carrying debt is not the path to early retirement. Pay it off and then stay debt free (see Step #1).

Even if you don’t manage to retire early (or don’t want to), these are great steps for building wealth.

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I just wanted to point out an interesting comment that a reader named ‘cheepy‘ left in response to my article on saving for retirement at the last minute:

How about moving to a developing country where a dollar can get you a lot further? Of course, the downside is that it is so far from friends and family, but you can get almost the same lifestyle with much less money… I am an Indonesian who lives in Australia. So if I go back to Indonesia, I practically quadruple my spending power…

This ties in nicely with the idea of reducing your expenses in retirement, although I suspect the majority of retirees aren’t going to be crazy about the idea of moving partway around the world to make up for a savings shortfall.

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I just ran across an article by Mindy Fetterman in USA Today that talks about the effects of procrastination when saving for retirement. She starts out by presenting the same sorts of numbers that we’ve all seen a million times before:

“If you’re 20 years old and you save $100 a month in an investment that earns an average 7% a year until you retire at 65, you’ll end up with $381,472. If you wait until age 40 to start saving $100 a month, you’ll have only $82,056.

If you wait until 50… Well, you get the point.”

So… If you’ve waited until the last minute, what can you do?

This is all pretty much common sense, but here are some steps to consider if you’ve procrastinated:

Save something. Instead of throwing up your hands and saying that it’s too late, save something. Anything is better than nothing, so don’t be paralyzed by fear. Do whatever you can, and start today. Take advantage of any tax-advantaged savings options that you might have at your disposal, and be sure to save at least enough to capture any matching funds offered by your employer — you’re going to need all the help you can get.

Save more. The only way to truly catch up if you start late is (obviously) to save more per month. Way more. The good news is that people 50 and older are eligible to put an additional $5,000/year into their 401(k), so it is possible to make up ground.

Spend less. In order to free up money for additional savings, you’ll need to spend a lot less. Start by plugging the little holes in your pocket, like a daily coffee, lunch out, etc. In all likelihood, that won’t be enough, so you’ll need to reign in your spending on bigger things, as well. The same goes for life after retirement. If you’re getting a late start, you’ll probably have to look at way to dramatically reduce your cost of living in retirement.

Work longer. Instead of retiring when you first qualify for social security benefits at age 62, you’ll likely need to continue working to age 65 or beyond. Working longer has multiple benefits, in that push back your retirement results in higher social security benefits, gives you more time to earn and save money, and reduces the number of years during which you’ll be dependent your retirement savings.

Of course, if you’re still young and you want to avoid all of this, then you should start saving as much as you can as early as you can.

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Have you maxed out your traditional or Roth IRA for 2007? If not, you have until Tax Day to get it done, so you better get crackin’. Given that the maximum allowable contribution for 2007 is $4,000 ($5,000 if you’re age 50 or more), and assuming that you contribute once a month from now through April, you’ll need to squirrel away just shy of $667/month to reach the max ($833/month if you’re 50 or older).

Even if you can’t hit that mark, you should do what you can to pump money into your IRA. After all, IRA contribution limits are a “use-it-or-lose-it” proposition. If you fail to contribute in any given year, you can’t carry the unused portion of your contribution limit forward to the next year. And remember…

You can withdraw your Roth IRA contributions (but not earnings) at any time, for any reason, without taxes or penalty. Thus, even if you have other savings priorities (e.g., building up an emergency fund) you can safely stretch your budget and stuff a Roth with money.

(Note that this sort of withdrawal flexibility applies only to Roth IRAs, not traditional IRAs.)

Worried that some sort of emergency might arise? No sweat, you can always get your money back out if you end up needing it. And if things work out and you’re able to leave the money in place, then you’ll be one step ahead of the game. You can’t go back and make those contributions in future years if you miss your chance now, so do it while you still can.

Note that IRA contribution limits for 2008 are $1000 higher.

Sound like a plan? Just be sure to keep that money in a safe, stable investment if there’s any chance that you might need to pull it back out and use it in the near future. If things work out and you’re able to leave your contributions untouched for the long term, you can always move into more aggressive investments later.

Note: The point of this article is not to encourage you to raid your Roth IRA in a pinch. Rather, it’s to encourage you to take advantage of a Roth IRA even if you’re not entirely comfortable earmarking that money for retirement.

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A reader named Tom recently wrote in with the following question:

I have been looking online for 2008 403(b) contribution limits and can’t find the info. Can you tell me what the 2008 403(b) contribution limits are? Or where I can find them?

After a bit of digging, I was able to find the answer… Unfortunately, according to a recent press release from the IRS, the limit on elective deferrals will remain unchanged for 2008 at $15,500/year. This applies to things like 401(k), 403(b) and 457(b) plans.

The good news is that aggregate limit (employer + employee contributions), which is specific by Section 415(c)(1)(A) of the Internal Revenue Code, is increasing from $45,000/year to $46,000/year (this is the so-called 415(c) limit). So there’s a bit of extra breathing room for retirement contributions, but only if your combined employee/employer contributions are bumping up against the limit.

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Have you ever heard of “Longevity Insurance?” In short, longevity insurance is a relative new form of insurance that provides you with a guaranteed stream of income later in life, typically starting after you turn 85. To get longevity insurance, you have to make a substantial upfront payment 20 or so years earlier.

Longevity insurance is really just a re-packaged, deferred annuity that’s targeted for retirement-age individuals who are concerned about whether or not they’ll outlive their savings. Because you typically give up any sort of death benefit or early withdrawal options with longevity insurance, however, the monthly benefit can be substantially better than a typical fixed annuity. However, unlike a typical deferred annuity (which offers a guaranteed minimum payout with the potential of receiving more depending on the performance of the stock and/or bond market), longevity insurance locks you in at a pre-determined rate no matter how well the stock and/or bond markets perform. This is really a good news, bad news situation in that you’ll receive a predictable benefit, but you’ll have to give up any sort of flexibility.

The biggest downside? As with any insurance, you run the risk that you’ll end up paying for something that you’ll never need. Given the current life expectancies of 65 year old men and women (they’re the target audience for longevity insurance), it’s questionable whether or not you’ll live long enough to see even a single check. In fact, if you don’t live well into your 90s, you’re not going to get your money’s worth. As with any annuity-based product, cost is also a concern – be sure to run the numbers and make sure you’re getting your money’s worth. Remember… You’re giving up part of your hard-earned nest egg for a future benefit that you may never receive.

The obvious alternative to longevity insurance is to amass enough wealth during your earning years to be comfortable in retirement without having to worry about running out of money. The flip side is that having a guaranteed stream of income later in life potentially frees you up to invest more aggressively as you approach retirement (and beyond).

As for us, we’re saving and investing aggressively, and have no intention of needing longevity insurance as a stopgap during our retirement years. Nonetheless, it’s still worth knowing that it’s out there.

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Yesterday afternoon I received the following question in my inbox:

I’m 43. I’m looking to payoff my mortgage. Can I withdraw from my Roth IRA to payoff my house without penalty? I have $52K in a Roth IRA. My mortgage payoff would be $77K. I have enough in savings to make up the difference. Can I withdraw without a penalty. Is it wise to do so?

There are a couple of questions here, so let’s take them one at a time…

First off, can he do it? As it turns out, first-time homebuyers can withdraw IRA funds to help finance their purchase. As far as I’m aware, however, you cannot withdraw funds to pay off a house that you bought previously without incurring a penalty. That being said, you can withdraw Roth IRA contributions at any time, without taxes or penalty. Moreover, as long as the funds are properly “seasoned” you can also withdraw Roth IRA conversions (typically five years after the conversion event) regardless of your age. But the same is not true of Roth IRA earnings, so be careful or you might wind up having to pay the piper.

Next, should he do it? Without knowing the full details of his situation, it’s hard to say with certainty. However, my view is that it’s pretty much always a bad idea to willingly pull funds out of an account with such favorable tax treatment. There are also those that argue you shouldn’t pay off your mortgage any earlier than absolutely necessary. While I don’t adhere to such a hardline view myself, one thing is certain… Once the money is out of the Roth, it’s out, and you can only put it back via regular annual contributions (currently at $4k/year). While being mortgage-free is an enviable position to be in, having a shortage of retirement savings is a decidedly unenviable position in which to find yourself.

Update: His mortgage rate is a very competitive 5.875% (presumably on a 30 year mortgage).

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I have a tax-related question that I’ve been having trouble getting answered, so I thought I’d throw it out here in hopes that someone can provide any insight… Besides, I’ve searched high and low and haven’t been able to find an answer online, so if we can get this sorted out here, it’ll be available for others to stumble across. This question actually first came up in the comments to my article on how to prioritize your retirement contributions and I’ve been struggling with it ever since.

In short, I’ve been planning on making my required contributions to my employer’s defined contribution plan, maxing out both my optional 403(b) and 457(b), and also contributing to a SEP-IRA based on self-employment income. In response to this, a commenter named CPA1298 asked whether or not I’ll bump up against the $44,000 maximum annual retirement plan contribution limit. As I understand it, the limit that he’s asking about applies to “elective deferrals” in the form of both employer and employee contributions, and is defined in section 415(c) of the Internal Revenue Code (IRC), although it’s actually $45,000 (or 100% of pay, whichever is less) for 2007.

Anyway, I didn’t have a good answer to his question, so I started researching it…

For starters, let’s talk about a bit more about my retirement options:

1. My employer’s defined contribution plan. I had two retirement savings options when I started work — a defined benefit plan (a traditional pension) or a defined contribution plan (I chose the latter). In either case, I would be compelled to contribute 5% of my income to the plan of my choice, and my employer also makes additional contributions. This was a one-time, irrevocable decision that had to be made during my first 60 days on the job.

So how does the 415(c) limit apply to this plan?

As I noted above, my understanding is that this limit deals with elective deferrals (but I may be wrong). Since these contributions are compulsory, and made pursuant to a one-time, irrevocable decision, it seems to me that they should not count toward the limit (but I could, of course, be wrong).

2. My optional 403(b) plan. This account is a tax-deferred account much like a 401(k). I am free to contribute up to $15,500 in pre-tax funds in 2007. There is no employer match.

3. My optional 457(b) plan. This is likewise a tax-deferred retirement savings account. Again, I am free to contribute up to $15,500 in pre-tax funds to it in 2007, and I have confirmed that I can participate in both the 403(b) and the 457(b) up to the full amount (i.e., they don’t share a $15,500 limit, so I can defer taxes on up to $31,000 between them). Here again, there is no employer match.

So those are the options that I have at my disposal through my employer. As I’ve noted previously, however, I also have a decent amount of self-employment income from a sole proprietorship totally unrelated to my day job. Thi brings us to…

(4) My SEP-IRA. I can contribute 20% of my net self-employment income (less 1/2 of my self-employment taxes) to this account. Here again, it’s a tax deferred contribution.

As you can see, depending on how things work, I may or may not run into trouble with the 415(c) limit of $45,000. So that brings me to my main questions…

The most important thing for me right now is determining whether or not the 415(c) limit is applied on a per employer basis. If it is, then it seems that I should have two such limits — one for my day job and one for my self-employment. I have read articles suggesting that this is true (including one from TIAA-CREF, but nothing from the IRS themselves), and the IRC guidance also supports this notion, as they say in section 415(f) that plans of related employers must be aggregated when applying that section’s contribution limitations. The implication here seems to be that plans from different employers should not be aggregated.

The other issue relates to my job-related retirement plans… Am I correct in assuming that the defined contribution plan doesn’t count toward the limit since it’s not elective (or at least it doesn’t appear to be based on my understanding of the term ‘elective’)? If not, then I’m in the clear (assuming the SEP-IRA is subject to it’s own 415(c) limit). If so, then what about the 457(b)? The treatment of this sort of plan seems to be different, and I’ve seen claims that 457(b) plans don’t enter into other plan calculations.

Please not that I’m looking for a concrete answer, so if you disagree with me, please do your best to support your view with information from the IRS. Likewise, if you think I’m right, it would be great if you could point out why.

And before anyone suggests that I seek professional counsel, please note that I’ve already contacted our tax attorney about this. I have, however, yet to receive a clear answer on any of it.

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After sneaking the paperwork in just under the wire, I finally received confirmation that my optional 457(b) retirement account is up and running and ready to receive my contributions. Enrollment actually involved two steps – first, I had to get a signed salary reduction agreement to my employer before the end of the month. Next, I had to enroll with my vendor of choice (TIAA-CREF).

The TIAA-CREF application process itself was a bit annoying, in that I was forced to enroll over the phone, then wait for them to send me a pre-filled application packet. Unfortunately, when the packet arrived it didn’t include a list of my investment choice (not all funds are available in every plan). I tried calling TIAA-CREF for guidance, but they had unbelievable hold times in the days leading up to Tax Day, and when I finally got through I learned that my call had been mis-routed to their insurance division. The guy that answered was pretty helpful though, and suggested that I set it up such that all funds would to go into the CREF Money Market (which is available in all plans) and then tweak it myself once I had online access.

Last night I created my online login, pulled up a list of available investments, and then set up our fund allocations. Here’s what they look like:

72% CREF Equity Index (tracks the Russell 3000 Index)
18% International Equity Index (tracks the Morgan Stanley EAFE Index)
10% CREF Bond Market (tracks the Lehman Brothers U.S. Bond Index)

This mix is based loosely on the Vanguard Target Retirement 2035 holdings, which likewise have 10% in bonds, 72% in domestic stocks (albeit with more small cap representation) and 18% in international equities.

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I’ve said it before (twice), and I’ll say it again…

This coming Tuesday, April 17th, marks the cutoff for IRA contributions for the last year. And I’m here to tell that if there’s anyway possible that you might have the money to contribute to a Roth IRA before the deadline, then you should seriously think about it. You see, non-rollover contributions to Roth IRAs can be withdrawn at any time, for any reason, without taxes or penalties. Don’t believe me? Check out IRS Publication 590 for details. See also Fairmark.com (here and here). Or read my handy-dandy primer on withdrawing Roth IRA contributions.

Here’s a particularly pertinent snippet from the latter Fairmark page:

In most cases the best strategy is to leave as much money in your IRA as you can, and for as long as you can. But if you need early access to that money, you’re generally in better shape with a Roth IRA than with a regular IRA. You’re allowed to withdraw your non-rollover contributions at any time without paying tax or penalty. This is not the case for the earnings, however. Unless you meet the tests described below, a withdrawal of earnings will be taxable — and may be subject to a penalty as well.

In general terms, the ability to pull money out of a retirement account on whim might be viewed as a bad thing. After all, you don’t want to be able to raid your retirement to buy that new Jet Ski, do you? But the ability to pull your money out of a Roth does give you the flexibility to hedge your bets and make that contribution even if your not sure that you can afford it right now.

Since you can only contribute a limited amount per year, savvy savers shouldn’t pass up an opportunity to stuff their IRAs full of money. Of course, you need to make sure that you don’t lock up dollars that you’ll end up needing — it’s always good to have money socked away in a rainy day account. And therein lies the beauty of the Roth IRA contribution/withdrawal rules…

Go ahead and make that contribution and think about it later. If it turns out that you car doesn’t break down, you don’t lose you job, and nobody in your family gets sick (or worse) before you have a chance to rebuild you rainy day fund, then you’ve just come out way ahead. And if the worst does happen, you can always yank that money back and put it toward whatever emergency just came up.

A few things to watch out for:

(1) Make sure you do this with a Roth IRA, not a Traditional IRA. The withdrawal rules are different between the two.

(2) Make sure you don’t exceed you contribution limits. The IRA limits are for the combined total of Roth and Traditional contributions. Thus, if you’ve already contributed to a Traditional IRA, you’ve effectively reduced (or even reached) your limit.

(3) Make sure that a Roth is right for you. In general terms, if you expect to pay the same or higher taxes at retirement than you do right now, then a Roth probably makes sense. If you expect your tax burden to fall, however, it might be better to contribute to a Traditional IRA (assuming that you qualify for the deduction). Here again, keep in mind that the Traditional IRA doesn’t offer the same level of flexibility.

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I just received the following comment from NCN of NoCreditNeeded, and I thought it was worthy of a post of its own:

Suppose you could invest in any and all types of retirement accounts, and there were no income limits, etc… How would you “rank” the different types of accounts? In other words, if you could invest in a 401(k), 403(b), Roth IRA, etc., how would you decide which to invest in FIRST, SECOND, THIRD…

Off the top of my head, here’s my answer…

I would start by making any contributions that come with matching funds. Once I maxed out the matching funds (= free money), I would move on to the Roth IRA. After that, I would go back to making deductible contributions. In some cases, there’s no choice left to be made at this point… Many people have a 401(k) and that’s it.

Assuming that I had more than one choice, such a a 403(b) and a 457(b), I would rank these by the available investments. If one has great, low-cost funds, then that’s the one I would go with first. After that’s maxed out, then I would move on to the other one.

In fact, this is exactly what I’ve done. My employer compels me to contribute 5% (no more, no less) to a defined contribution plan, to which they add a little better than 8%. In the past, my top priority after that has been maxing our Roth IRAs, although that’s no longer an option for us as we’re bumping up against the income limits.

After that, I turned to an optional 403(b) (and I later increased our contributions to take full advantage of it). This year I opened the 457(b) in order to maximize our retirement savings.

The reason that I opted for the 403(b) ahead of the 457(b) is that Vanguard is available through the former, and I’m a total Vanguard junky. The best option in the 457(b) is TIAA-CREF which is a bit more costly.

Of course, I’ve also been able to take advantage of a SEP-IRA to make additional deductible contributions above and beyond what’s available through the more ’standard’ options. And in my case, I would rank the SEP-IRA ahead of the 457(b) for the same reason that I prefer the 403(b) — the ability to invest through Vanguard.

With all of that being said, I’d love to hear what you guys think…

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» Save for College or Retirement?
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» FDIC Insurance Higher on Retirement Accounts
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Here’s a bit of FDIC trivia for you… Most of us know that the FDIC insures deposit accounts up to $100k. But did you know that a year ago they increased coverage on certain retirement accounts held at FDIC-insured institutions to $250k? This higher insurance covers Roth IRAs, SEP-IRAs, SIMPLE IRAs, Keogh accounts, 457 accounts, and self-directed employer-sponsored “defined contribution plans” including 401(k) accounts.

Here’s the deal:

Under the FDIC’s new rules, which took effect on April 1, 2006, all of your deposits at the same insured bank that are in this broad category of retirement accounts are added together and the total is insured up to $250,000. Your retirement accounts also are separately insured from any other deposits you may have at the same institution.

However, it’s very important to keep in mind that FDIC insurance applies to deposits, not investments:

The FDIC protects checking accounts, savings accounts, CDs (special accounts you’d typically hold for anywhere from one month to five years) and other types of deposits. The FDIC does NOT insure the money you invest in products such as mutual funds, stocks, bonds, life insurance policies and annuities – even if you purchased them from an FDIC-insured institution.

That being said, if your account qualifies and you bank or savings institution were to fail, the FDIC insurance would cover your losses (again, in deposit accounts only) dollar for dollar, including principal and accrued interest, up to the insurance limit.

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When it comes to things like saving for retirement, there’s nothing like waiting until the last minute! The last minute of the current month, that is… As I noted the other day, I’ve been thinking about increasing our retirement saving by opening a 457(b) retirement savings account, and my employer requires retirement-related paperwork to be filed before the end of the month in order for it take effect the following month. After a bit of hand-wringing and a last minute change of heart when it comes to the vendor, I snuck my 457(b) paperwork in just under the wire late in the day on Friday.

Regarding the vendor, I was planning on using Fidelity, mainly because Vanguard isn’t an option like it was for my optional 403(b) account. When I started looking for the application materials, however, I learned that Fidelity was only offered through a third-party. It’s a long story, but suffice it to say that Fidelity wasn’t willing to manage the 457(b) accounts directly for my employer, so they opted to have a “capital management” firm serve as the go between. This didn’t actually add to the cost, as the money management firm is eating the cost in hopes of making contacts for fee-only financial planning.

The problem with this is that I’m not completely comfortable having our funds held in an omnibus brokerage account that relies on a third-party. Moreover, we wouldn’t be able to access our account info through Fidelity’s NetBenefits; rather, we’d have to use a third-party website. Finally, I’m not crazy about the idea of getting hassled by some money manager looking to upsell me. Thus, I ended up going with TIAA-CREF, which offers a similar suite of mutual funds with remarkably similar fees. TIAA-CREF is fractionally higher, but I’m willing to forego 0.10% for the resulting peace of mind.

As far as opening the account with TIAA-CREF goes, I had to go through their phone enrollment hotline. It took about ten minutes, during which time they asked me a bunch of questions and then promised to send me a pre-populated application packet within three days. Apparently I just have to sign it and mail it back. Not as easy as opening my SEP-IRA online with Vanguard, but it definitely wasn’t hard.

The bottom line here is that we’ll be socking away an additional $1722.22/month toward retirement for the rest of the the year — this will leave us $0.02 shy of the $15,500 457(b) contribution limit. This money will be invested in a combination of domestic and international stock mutual funds and a domestic bond fund.

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Related Articles at fivecentnickel.com:

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» TIAA-CREF Sure is Slow
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Given the recent uptick in our income due to my new job and our growing self-employment income, I’ve recently been thinking of ways to reduce our 2007 tax liability. The first step, of course, is to contribute to my employer’s basic retirement plan, which is held at Fidelity. But… I want to do way more than that.

Thus, I opened a Vanguard SEP-IRA and have been making employer contributions to that on my own behalf (these contributions can be made in addition to traditional/Roth contributions – see here for a handy calculator). Another piece of the puzzle has been to open an optional 403(b) (also with Vanguard) and max out the $15,500 contribution limit.

This is all well and good, but I really, really, really hate paying taxes (don’t we all?), so I’d like to do even more. And then it hit me… In addition to the optional 403(b) plan, my employer offers an optional 457(b) plan. The contribution limits for both of these are listed at $15,500 for 2007, and I have always assumed that these two types of accounts share a common contribution limit (i.e., that your total contributions to both couldn’t exceed $15,500).

Guess what? I was wrong. Over the weekend I finally got around to looking into this, and here’s what I learned over at 457bwise.com:

The Economic Growth and Tax-Relief Reconciliation Act of 2001 (EGTRRA) repealed coordination of contributions between 457(b) plans and 403(b) plans [and 457(b) plans and 401(k) plans]. This means that employees with enough includable compensation can contribute the maximum elective deferral limit to both a 403(b) and a 457(b) [and a 457(b) and a 401(k)]. For 2007, this is $15,500 for a whopping total of $31,000. Participants eligible for catch-up provisions can include even more.

Holy cow! I can shield up to $31k from taxes using these two accounts! While I realize that not everyone is in such a favorable position with regard to the availability of such plans, and that not everyone could afford the contributions even if they were, I now have a new goal… Continue making the 5% contribution to my basic retirement account (this comes with a match of a little better than 8%), max out my SEP-IRA employer contributions (20% of net self-employment income), max out my 403(b), and max out my 457(b).

As I’ve noted previously, it’s looking like we’re not going to be eligible for a Roth or deductible traditional IRA contributions this year, so those are currently on the back burner. If we somehow manage to do all of this and still have money to spare, our next step will be to make non-deductible traditional IRA contributions. In case you haven’t heard, the income limits for traditional-to-Roth IRA conversions are scheduled to go away in 2010. Assuming that’s still the case when 2010 rolls around, we’ll be able to convert these funds into our Roth accounts, effectively allowing us to circumvent the contribution income limits.

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Related Articles at fivecentnickel.com:

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Guess what? If you’re single and your adjusted gross income (AGI) is $25k or less ($50k for married couples), then you’re entitled to a credit of 10-50% on up to $2,000 in contributions to qualified retirement savings plans. Eligible plans include 401(k) and 403(b) plans as well as traditional and Roth IRAs. This credit comes in addition to the tax deduction that you get for making the contributions (except on the Roth, for which contributions aren’t tax deductible). Free money in return for saving for your retirement is a fantastic deal — if you qualify, you should definitely try to take advantage of it. For more information on figuring your credit, which goes on line 51 of Form 1040, see IRS Form 8880.

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Awhile back I mentioned that I had opened an optional 403(b) account with Vanguard. I have a basic defined contribution plan into which I contribute 5% of my salary, and my employer contributes an additional 8.2% of my salary. We also have Roth IRAs. However, we’re in a position to do more in terms of saving for retirement, and I’d also like to minimize our tax hit at the end of the year. So how much can we stuff into our 403(b)? I’ve alluded to this previously, but here’s are some details regarding 403(b) contribution limits for 2007…

» Basic salary deferral limit (how much you can contribute): $15,500/year

» Lifetime catch-up: $3,000/year*

» Age 50+ catch-up: $5,000/year**

» Total (employee + employer): 100% of your “includible compensation” ($45,000 max)

Keep in mind that these are based on IRS guidance, and your employer may or may not have additional restrictions.

*Available to employees with 15 or more years of service with a qualified organization. May allow you to increase your contributions above the basic salary deferral limit by up to $3,000 per year, up to a lifetime catch-up limit of $15,000. To qualify, the participant has to have contributed an average of less than $5,000 per year to the plan.

**Participants age 50 and over may be eligible to make additional annual contributions beginning in the year in which they turn 50. If the participant is already making the maximum contribution, then he/she may be able to contribute an additional $5,000/year. This $5,000 annual limit refers to the total catch-up contributions made to qualified retirement plans, 403(b) plans, simplified employee pension (SEP) plans, and SIMPLE plans in any one year.

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Effective this month, I’ve enrolled in an optional 403(b) retirement plan through work. I’m contributing the max to my ’standard’ defined contribution retirement plan (5% of my salary). When combined with the matching funds (a bit over 8% of my salary), I’m stashing a little better than 13% of my annual salary in that account. On top of that, my wife and I have both been maxing out our Roth IRAs (we do this every year). So what’s the point of the optional 403(b)?

Well, we can afford more than the 5% + $8k that we’re currently saving, and the 403(b) let’s us do it in a tax-deferred fashion. Moreover, my employer’s 403(b) is pretty flexible in terms of vendors. In fact, we can even use Vanguard, which is unavailable to us through the standard defined contribution plan (we’re using Fidelity). For now, we’re pouring eveything into the Vanguard Target Retirement 2035 Fund which provides us with instant diversification at a low cost.

The only thing that I’m not crazy about is the fact that Vanguard charges an annual administrative fee of $15/year for 403(b) accounts. This fee is in place for all customers with less than $250k in total assets at Vanguard (this is where their so-called ‘Voyager’ service kicks in).

Right now, our only other retirement savings option is my SEP-IRA. Since we’re maxing out our Roth IRAs, we can’t make any ’standard’ employye contributions to that account (Roth, Traditional, and SEP contributions all count toward the same limit). However, I’ll be able to make 2006 employer contributions to that account on my own behalf (which I plan on doing). The limit here is 25% of my net self-employment income (which is a good bit less than 25% of my gross self-employment income).

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Related Articles at fivecentnickel.com:

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Over the past few days I’ve written a good bit about Roth IRAs and their associated contribution limits. Today I want to talk a bit about converting funds from a traditional (or SEP) IRA to a Roth IRA. This is actually something that I’ve been mulling over a good bit lately… Now that I’ve taken my 403(b) funds from my old employer’s retirement plan and rolled them over into my newly opened Vanguard SEP-IRA, I can potentially shift (i.e., convert) some or all of these funds to my Roth IRA. The critical issue here is eligibility…

While the rules are slated to change drastically in 2010 (more on this in a susequent post), there are currently several criteria that you need to satisfy in order to be eligible for a Roth IRA conversion…

First of all, if your filing status is married filing separately then you can’t convert a traditional IRA to a Roth IRA. Like all good rules, however, this one has an exception… If you lived apart from your spouse for the full year, then you are still potentially eligible for a conversion. But you still have to satisfy the other criteria.

Second, you can’t do a conversion if your modified adjusted gross income (MAGI) is more than $100,000. The tricky part here is that this limit is the same whether or not you are married, so it’s a lot easier to qualify for a conversion if you’re single than if you’re married and both you and your spouse work.

Third, if you inherited your IRA from someone other than your spouse, then you can’t convert it into a Roth IRA.

And here are a few other things…

You can’t currently roll an employer plan directly into a Roth IRA. Rather, you need to roll those funds into a traditional (or SEP) IRA and then do the conversion from there. SIMPLE IRAs can be converted, but only after you have participated for two full years. Until then, you can only roll a SIMPLE IRA into another SIMPLE IRA.

Assuming you qualify for a conversion, you can convert all or only a portion of your traditional IRA funds to a Roth IRA.
Keep in mind, however, that a conversion is a taxable event, and you can’t pick and choose and convert only the non-taxable portion of your IRA (nondeductible contributions can be rolled over tax-free since you’ve already paid taxes on them).

Finally, while you are limited to rolling over an IRA (traditional or Roth) no more frequently than once every 12 months, this rule doesn’t apply to conversion from a traditional IRA to a Roth IRA.

I’m pretty sure that we’re in the clear, although I’m still unsure where our modified AGI while wind up for the year. The good news is that I can just go ahead and do the conversion (it has to be done before December 31st) and then just fix (i.e., recharacterize) it later if need be. I just have to have things sorted out before our taxes are due.

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Related Articles at fivecentnickel.com:

» Roth IRA Conversion in a Down Market
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In case you haven’t noticed, FiveCentNickel has a new advertiser — Nationwide — featured at the top of the right sidebar. Beyond placing an ad, they also asked me to take a look at their new RetirAbility calculator and post my thoughts. So here goes…

The whole point of the calculator is to tell you how you’re doing when it comes to retirement savings. It’s actually a pretty nifty tool, resulting in what they term an “R-Score,” where 100 means that you’re on track for a comfortable retirement at 100% of your current living standard. Lower numbers mean that you’re lagging behind, whereas higher numbers mean that you’re an over-achiever, and on track to have more than enough money for a comfortable retirement.

After plugging in my year of birth, income, balances of our current accounts, etc. I learned that we’re more than on track… We scored a 163. We were certainly helped along by a complete lack of debt (except for the mortgage on our house).

According to their stats, the average for “people like me” (hmmmm, how did they know that I’m stunningly handsome, and well above average in the IQ department?) is 139, whereas the national average is 116. This latter number makes me wonder a bit… Given all the news about a negative savings rate in this country, I find it hard to believe that the average American is well ahead in terms of retirement savings. Be that as it may, it’s still a fun little calculation.

I’m actually really happy about the results for a couple of reasons. First, I changed jobs earlier this year and landed a 45% raise. Thus, I was expecting our retirement savings to be running a bit behind relative to our new, higher standard of living. Second, I told the calculator that neither my wife or I will be receiving Social Security. Call me a pessimist, but I’m not holding my breath about there being any money left in 30 years. If there is, great. But if not, I don’t want to end up eating in a soup kitchen.

My only real complaint about the calculator has to do with presentation… The calculator is accompanied by a video narrator, and I couldn’t figure out how to skip the chit-chat and get on with it. Even still, it only took a few minutes, so it’s probably worth doing, if for no other reason than to see how you stack up against others.

So… Hop on over to the calculator, plug in your numbers, and then be sure to come back and tell us all how you did.

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Having just moved and changed jobs, I still have a few loose ends to tie up when it comes to things like my retirement plan. At my old job, I had a 403(b) held through Vanguard, and I received a double-match on contributions up to 5% of my annual salary (so when I contribute 5%, my employer kicked in 10% for a total of 15% — nice). Since I’m a huge fan of Vanguard, I wanted to keep the money in place. However, I have no interest in keeping the money in the 403(b) — I’d really prefer to have a bit more control over those dollars.

Because I now have a decent amount of self-employment income, I decided to open a SEP-IRA and then do a direct rollover. The advantage of the SEP-IRA is that I can make ‘employer’ contributions on my own behalf that aren’t subject to the traditional/Roth IRA contribution limits (we’re already maxing our Roths for 2006).

Before I could do the rollover, however, I needed to establish an account. Fortunately, Vanguard makes this really easy to do — in fact, you can handle everything online in about five minutes. I didn’t bother funding the account, as I need to sort some things out before I’ll know exactly how much I can contribute. But they let me open the account just the same. As for the rollover, I actually had to get a special form, fill it out, sign it, have my wife sign it (and get it notarized), and then forward it to my former employer with instructions. From there, it will get redirected to Vanguard.

I have no idea how long this will all take, but hopefully it will go off without a hitch. And since I’m rolling money from one Vanguard account to another, we won’t actually be out of the market — rather, they’ll just swap things around at the end of the day (or so I’ve been told). We shall see…

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» SEP-IRA Funded for 2006
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I’ve been meaning to write something about this for quite awhile, but I never got around to it. Anyway… This past June, Vanguard introduced another set of their Target Retirement Funds, which are asset allocation funds based on an underlying set of low-cost Vanguard index funds. Previously, they had a series of ‘mid-decade’ funds spaced every ten years for those planning to retire around 2015, 2025, 2035, and 2045. But they didn’t have anything for those in between.

Because I’m slated to hit retirement age a bit after 2035, and because I didn’t think that their funds were aggressive enough for my taste, I responded by mixing the Target Retirement 2035 and 2045 funds to achieve my proper investment mix. With the new funds, however, they have options for those retiring in 2010, 2020, 2030, 2040, and 2050.

On top of this, they changed up the investment mix such that the various Target Retirement Funds are now considerably more aggressive. Indeed, for all funds with a 25+ year time horizon (i.e., 2035 and beyond), there is now a maximum of 10% bond exposure, meaning that all of these longer term funds look almost identical right now. The only difference is that they’ll start ratcheting back their aggressiveness at different points in time (for the 2035, this will happen in 2010).

For the sake of comparison, the bond exposure was a bit over 24% bonds in the 2035 option and 12% in the 2045 option when I last wrote about these funds. But now that the various longer-term options are virtually identical, I no longer see a need to split our funds into more than one. We will, of course, have to revisit this in 2010 when the 2035 fund starts ratcheting down the equity portion of our portfolio.

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Related Articles at fivecentnickel.com:

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Is it possible to save for retirement and your kids’ education at the same time? According to Walter Updegrave, it’s possible, but you really should prioritize instead of trying to do everything at once…

I think most people have enough trouble just saving adequately for their retirement. Throw in college education and it just becomes too overwhelming. Too often the result is that people don’t address either goal adequately, or they get so discouraged that they sometimes give up altogether, figuring it’s hopeless.

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

He then goes on to rank things as follows:

(1) Emergency fund
(2) Stuffing your retirement accounts with as much money as possible
(3) Everything else (including education)

This is pretty sound advice in my book. As they say, you can’t borrow for retirement, so make sure that’s taken care of before you start saving for other things.

Source: CNN/Money

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