May

13

5 Mistakes That Will Sink Your Retirement

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From News-Wave: 5 Mistakes That Will Sink Your Retirement

Mistake No. 1: The biggest blunder is cutting back on contributions to a 401(k) plan, since most companies offer matching funds—the ultimate cash freebie. In general, 401(k) plans are set up so that the employer adds 50 cents to each dollar a worker contributes, typically up to 6 percent of the worker’s salary. That’s an immediate 50 percent return on investment. Yet nearly one quarter of American workers don’t contribute to their 401(k), according to the Profit Sharing/401k Council of America, a nonprofit association. And of those who do contribute, many don’t toss in enough to get the full company match.

If you are nearing retirement, don’t make the mistake of easing off your savings. It’s time to juice them up. Many older boomers didn’t save as much as they should have in the early days of their working lives. The cost of the kids’ braces, tennis lessons, and college tuition understandably took a toll on personal savings. The thought of contributing 10 percent of gross income, let alone 15 percent, was a pipe dream.

But it’s not too late. From age 57 to 65 is typically the peak earnings time for most people. “This is when you can do some extraordinary saving,” says Financial Planner Mary Malgoire, president of the Family Firm. “You’re finally freed up to focus on socking it away for retirement. It’s now or never.”

And the IRS will lend a hand. If you are 50 or older, you can make catch-up contributions to your workplace savings plan and IRA. This year, while most workers are eligible to defer up to $15,500 to a 401(k) plan, those eligible for catch-up contributions can toss in an extra $5,000. Employers are not required to provide for catch-up contributions, but most do. The same catch-up provisions apply to 403(b) plans, 457 plans, and SAR-SEP retirement accounts. You can also contribute an extra $1,000 to a traditional or Roth IRA. So, while younger savers can put $5,000 a year into an IRA, people 50 and older can save $6,000.

Mistake No. 2: Using your retirement money as a bank is a major no-no. Yes, it’s reassuring to know you can always borrow from your 401(k). But even when times are tight, that’s bound to be trouble. If you take a loan and then get laid off or bought out, you’ll probably have to pay back the loan right away. If you can’t repay the loan, it will be treated as an early withdrawal. That means you’ll owe income taxes, plus a 10 percent penalty.

Even if you do pay back the loan, it’s a bad idea to tap your retirement funds. After dipping into the account once, you’ve crossed a psychological line and might be more inclined to do it again. Plus, by withdrawing funds, you sacrifice compounding investment earnings.

Mistake No. 3: When you see your retirement account balances falling, it’s reasonable to want to avoid losses by reinvesting in safer bets, as Fuchs contemplated. Don’t. As gut-wrenching as it might be, it pays to hold your ground. “Managing your retirement money has nothing to do with predicting the markets,” says Susan Stewart, president of Charter Financial Group in Bethesda, Md. “Moving money from stocks into more stable investments like money funds or CDs to avoid losses and ride out the downturn assumes you have a special crystal ball.”One danger, if you get out of equities, is that you’ll miss the upturn when markets turn around. That’s costly. “History tells us that timing the market this way doesn’t work and that you’d be a fool to even try doing it,” Stewart says. “So stop stressing out about it. Downturns do end, and if you stay in the market, you’ll be there when things turn around.”

Another problem with dashing for the cover of “safe” investments is that stocks still offer the surest shot at long-term growth, so conservative investing can take its toll eventually. There’s also the lost opportunity of sitting on the sidelines when stocks are cheaper than they used to be. Your 401(k) contributions buy more shares of stocks when prices are lower, so when the markets come back, you’ll see a bigger boost.

To forestall knee-jerk reactions when the market dives, allocate your portfolio among stocks—both domestic and international—bonds, and cash. “Set your mix,” says Stewart, “and stick with it when it’s hardest for you to do so—when the market has fallen for a few days or weeks.” Then rebalance annually.

If you’re getting close to retirement, or are already retired, the right asset allocation is more important than ever. Sagging markets, combined with pulling funds out for living expenses, can really wreak havoc on your portfolio. At age 65, it’s probably smart to put half your holdings in stocks or equity funds and the rest in cash and bonds, then slowly reduce equities to a third of your portfolio by the time you are in your 80s. “There is no magic number,” Stewart says. “You need to be comfortable with your risk level, but you still want the growth that stocks can offer over a 10- or 15-year period.”

Mistake No. 4: One fast way to undo all your good retirement planning and squash your future nest egg is cashing out your 401(k) balance when switching jobs or being ushered out the door with an early-retirement plan. Even if you don’t intend it to be a cash distribution, it might be considered one.

Chances are, when you leave your employer, you’ll want to transfer your accumulated retirement savings to a self-directed IRA that offers you more investment choices. But timing is important, and this is where it’s easy to get tripped up.

After you receive the funds from your employer plan, you have 60 days to complete the rollover to an IRA or other tax-deferred plan. If you don’t complete the rollover within the time allowed or receive a waiver or extension of the 60-day period from the IRS, the amount is considered ordinary income. That means you are required to include the amount as income on your tax return, where any taxable amounts will be taxed at your current ordinary income tax rate. Plus, if you had not reached age 59½ when the distribution occurred, you’ll face a 10 percent penalty on the withdrawal.

Mistake No. 5: This is an important error: not creating a post-retirement plan. As you approach retirement, you should know all your sources of income, ranging from pensions to investments to Social Security. Also, consider the amount of equity you have in your home. Then establish a plan for how you’ll spend those funds in retirement. In general, you’ll want to tap into your tax-deferred savings last.

Failing to plan for life’s nasty little surprises can torpedo your retirement plans, even if you’ve been saving faithfully for years. While it goes without saying that regular retirement contributions are critical, living well in your golden years also depends on far more than a healthy portfolio. “Saving is the heart of it,” says Gary Schatsky, a financial adviser in New York, “but you can’t ignore insurance, taxes, and debt management.”

Most corporate health plans, for example, cover you until age 65, when Medicare kicks in. Retire early (whether you want to or have no choice), and you’ll probably need to scout for an individual plan. Your most affordable option may carry a high deductible of $2,500 to $5,000 a year. So plan ahead. Another smart move is paying down your mortgage and slashing your credit card and other consumer debt before you leave the workforce, which will help stretch your retirement savings.If possible, delay taking your Social Security check until age 70. For retirees born in 1943 or later, Social Security benefits increase by about 7 percent each year you delay taking them from age 62 through 66 and by 8 percent until age 70, says Laurence Kotlikoff, an economics professor at Boston University. Plus, your actual payment will be indexed for inflation. So, if inflation is running at 3 percent, your benefit will increase at 10 or 11 percent for each year you delay taking it. Not bad for a little patience.

Good retirement planning does require patience—and fortitude. Though she was on the verge of cashing out, Fuchs, the Washington attorney, decided to stay put. “Part of it was inertia,” she says, “but the other part was my 82-year-old father’s voice in my head, constantly reminding me that investing was something you did for the long term.” That’s one voice in your head worth heeding.

May

12

Retirement Planning: The I.R.A.

Filed Under Fee-only Financial Planning, Retirement Planning | Leave a Comment

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By J. ALEX TARQUINIO
Published: April 27, 2008
A Stalwart of Retirement Planning: The I.R.A.

WITH so much contradictory advice floating around, it is sometimes hard to figure out the best way to save for retirement.

Financial experts say that one often-overlooked resource is the humble Individual Retirement Account, or I.R.A., which has been a part of the personal finance landscape for so long that many of us take it for granted.

More than 90 percent of the money that flows into traditional I.R.A.’s is being rolled over from retirement plans at work, like 401(k)’s. On the other hand, only 14 percent of American households that were eligible to make direct I.R.A. contributions did so in 2006, according to the most recent data from the Investment Company Institute, the mutual fund industry trade group.

The rules for some I.R.A. contributions are so complex that many Americans may not realize they are eligible to make them, said Brian Reid, the chief economist at the Investment Company Institute. Indeed, the I.R.A. rules fill a 108-page brochure on the Internal Revenue Service Web site.

And while investors often fund a 401(k) at work before contributing to an I.R.A., particularly if employers offer matching contributions, many people don’t have a 401(k) or other workplace option. Alicia H. Munnell, director of the Center for Retirement Research at Boston College, said that 57 percent of “prime working-age Americans,” defined as 25 to 64 years old, had no retirement plan at work. Contributing to an I.R.A. makes sense for such people, she said.

In a nutshell, the main flavors of I.R.A. — traditional and Roth — have one big difference. You may be able to deduct the money you put into a traditional I.R.A. on your taxes, but you will pay income taxes on all withdrawals in retirement. Contributions to Roth I.R.A.’s are not deductible up front, but there are no taxes on money withdrawn in retirement.

Some I.R.A. rules are simple. Say you are single, do not have a retirement plan at work — like a 401(k) or a traditional pension — and want to contribute to a traditional I.R.A. Whatever your income, you can make the maximum contribution, all of it deductible. (The maximum total contribution for all I.R.A.’s is $5,000 this year, or $6,000 if you are 50 and above.)

But the rules can quickly become more convoluted. If you are single but eligible for a retirement plan at work, you may make the maximum tax-deductible contribution so long as your adjusted gross income is $53,000 or less. The deductible amount whittles away to zero as your income climbs from $53,000 to $63,000.

If you are married and filing taxes jointly, and both of your employers offer retirement plans, both of you can make the maximum deductible contribution so long as adjusted gross household income doesn’t exceed $85,000. The deductible amount phases out at higher incomes, falling to zero at $105,000. And the list goes on.

If you’re considering a Roth I.R.A., it doesn’t matter if you have an employer plan at work. But a single person, for example, can make the full contribution only if income is less than $101,000. The eligible contribution phases out as income climbs to $116,000.

The government slapped income limits on I.R.A.’s in the 1980s to prevent high-income taxpayers from redirecting savings to tax-deferred accounts, said Ms. Munnell at the Center for Retirement Research. “A lot of evidence suggested that higher-income people were simply rearranging their finances,” she said.

A third form of I.R.A., the traditional nondeductible version, is less popular. There are no income limits, and it does not matter whether you have a retirement plan at work. Contributions are not deductible, and you will pay income taxes on investment profits withdrawn in retirement.

Gary Schatsky, a Financial Planner in New York, said the nondeductible I.R.A. was not compelling for most investors. As is the case with all I.R.A.’s, you cannot write off investment losses on your taxes, and you lose the benefit of capital gains tax rates, which are generally lower than income tax rates. If you are eligible to contribute to either a 401(k) or an I.R.A., Mr. Schatsky said, in most cases you are better off choosing the 401(k), especially if your employer offers matching contributions.

Statistically, few people take full advantage of 401(k)’s. Roughly three of four qualified workers participate, but among those who do, only 10 percent contribute the maximum, according to the Center for Retirement Research.

Labor Department rules issued last fall make it easier for companies to automatically enroll workers in 401(k) plans. Now there is talk in Washington about making enrollment in I.R.A.’s automatic for workers who don’t have 401(k)’s, said James Poterba, the head of the economics department at the Massachusetts Institute of Technology.

Mr. Poterba, who is to become president of the National Bureau of Economic Research this summer, said the issues were more complex for automatic I.R.A. enrollment. For instance, he said, employers choose default investments for the 401(k), but he asked, “Who picks the default investment for an I.R.A.?”

While these issues are being worked out, people without employer plans would benefit by opening I.R.A.’s on their own, Ms. Munnell said, adding that they should find motivation in projected shortfalls for the Social Security trust fund.

The government has already been raising the age when most Social Security applicants can retire at full benefits. For those born from 1938 to 1943, full retirement age rose gradually from 65 to 66. It stays at 66 for those born through 1954, and gradually climbs again, to 67, for those born in 1960 or later.

“Those are the changes that are already baked into the cake,” Ms. Munnell said. If the Social Security projections worsen, she said, future retirees may regret not having saved more.