Do You Have Retirement Doubts?

There is absolutely no doubt that the retirement planning horizon is as diverse as those who are attempting to navigate it. In other words, there is no set formula for one group that can be used for another. On one side of the equation, we have those who can see the chance that they might retire and on the other, are those with doubts.

Those doubts exist in both groups. Older workers have seen the deterioration in their defined contribution account balances, the gradual and systematic elimination of pensions and the growing pressures that being sandwiched between both children and parents who are beginning to accept what they see as inevitable. That inevitability has been translated into simply working longer than they had previously anticipated to get the retirement that resembles that of a generation prior.

This group knows that they will need to invest more for their future at a time when they can't seem to free up any extra income to do so. They run calculations. They do math. And then, with all of this somewhat depressing information in front of them, they seem to be doing what would be counterintuitive: they become conservative in those investments.

The younger group, the college graduate, the young workers just entering the workplace and those who have been struggling with new families have a unique opportunity that has long since past the other group. They have time.

Many of these workers will enter the workforce where there is no pension, where they anticipate the benefits of Social Security will be limited and attainable farther away than that of their older cohorts and a marketplace that served the older workers with longer bull markets that are not likely to exist in the future. That bull market, a term defined as positive movement in the stock market, helped their parents in ways that will not be there for them. From 1982 to 2000, most of those in 401(k) plans saw balances rise without limit - or so it seemed. Since that point, we have seen two bubbles burst, stock market returns become more volatile and faith that this investment vehicle has stalled.

Yet those 401(k) plans still offer the best opportunity to do better than their parents at battling the potential of increased taxes, rampant inflation and that volatility. these 401(k) plans are shifting, often in dramatic fashion. Matching contribution are less than in those bull market years and for this group, they can expect that they will stay that way. But there are some changes taking place that could help this group more so than their older counterparts.

These changes include the increased presence of Roth 401(k)s in those defined contribution plans. Whereas older workers would need to calculate their taxes when making a change into these sorts of plans from a traditional 401(k), younger workers can begin at this point. The Roth 401(k) allows for after-tax contributions, which for most younger workers means that earning less (being taxed less) is a hidden benefit. Rollovers from a traditional plan comes with a tax bill. Beginning at this point, as younger workers can do, will not have any taxable impact.

But the best way for younger workers to avail themselves of this opportunity should be done in a tandem approach to the plan. If you contribute 5% of you pre-tax income, you will not in most instances, impact a dime of your take-home pay. At this point, finding an additional 5% to put in the Roth 401(k) side of the plan not only hedges against taxes in the future but gives you the ability to know this money is yours, the taxes you paid at a younger age will be less than at rate you might receive as you age, get pay increases and promotions.

This group should also know that this should be the time of your most aggressive investment strategy. Yes it will be a rough ride. But having time to recover is worth the risk. You have to contribute and stay in it through thick and thin to benefit. You can retire doing this even if you have no idea what your retirement will look like.

Paul Petillo is the managing editor of Target2025.com/BlueCollarDollar.com

The Roth Debate

You don't know what your taxes will be when your retire.  You don't really know whether your retirement expenses will exceed your projections or not.  In fact, your retirement picture might just be a little on the hazy side of things.  So how do you make the decision of whether to use a Roth 401(k) or the traditional 401(k)?

This can be easier than you think.  More...

Why Investors Do What They Do: Mental Accounting

Many of us can rattle off the balance in our set-aside accounts, the small stashes of money we allot for some special purpose. These accounts, whether they be for a down payment on a house or a vacation have been designated for something and when you mentally account for this money, you put a barrier around your access to it.

These are essentially illiquid accounts - at least in your mind. This type of thinking and the ability to strictly categorize is a special talent that many of us have and some of us need to work on. If you are able to keep even so much as a general budget of your household, you are probably using this kind of separation technique to make sure ends meet and the other accounts you have set-aside do not become victims of a small loan.

Retirement accounts, even those with restrictions on how you may access the principal amount you have contributed (penalties for early withdrawal, tax consequences) are good examples of this kind of behavior. Setting aside money to grow and adding to it on a regular basis is mental accounting. These kinds of accounts are often of the traditional 401(k) and IRA variety. It should be noted that one of the major selling points of the Roth IRA and Roth 401(k) is the access you have to your principal.

Mental accounting really becomes a problem, almost without noticing it has, is when you separate different elements of an investment. Some are willing to pay higher fund expenses in return for a riskier fund that has done well in the past. This is a cost trade-off that you make using this type of accounting error. Another example might be a bond fund that entices investors with a high yield but the underlying investment is losing capital.

(This last example is why there may be a flaw in the thinking that we overload a portfolio with dividend paying investments at the end of our careers. Once we begin drawing down the underlying investments, the dividends will also fall and this will lead to a quicker drain on the account.)

Much of this has to do with our love affair with our investment picks. Only the most hardened among us can engage in the cold-calculations that stock pickers really employ. Listen for the insincerity when a talking head on television begins a conversation about an investment with "we really like this stock...". That is, until something changes.

Mental accountants ignore these warning calls and often miss selling winners when they are winners and even worse, selling losers when they are losers. This throws the whole diversification within a portfolio out of whack. While we are still working, it pays to focus how we bracket our investments. Keep in mind that studies have proven beyond a doubt, bets on long shots increase as the last race approaches.

If you find evidence that an investment has changed, and some suggest that loss aversion plays a role in this type of mental reasoning, you need to reposition your portfolio. This is not as hard as it seems nor does it require as much time as you might think.

It does however require you open your statements when they come each quarter or look at them online once a month. Set-up a Google alert for each underlying investment (a good retirement account should have no more than eight mutual funds and as little stock as possible) or build a sample portfolio at anyone of the sites that provide the free service. At the first hint of doubt, investigate and make a decision on what you should do with the whole of the portfolio as the benchmark, not the performance of the individual holding.

Next up: Diversification

Retiring with a Plan: Is the Roth 401(k) Conversion Worth Trying?

In 2010, you will be allowed to convert not only your current 401(k) plan but your IRAs and any 401(k) plan you might have rolled over into an IRA. The question: is rolling your retirement money into a Roth 410(k)the right move to make?

As with all financial decisions, this takes a little bit of planning and consideration. The conversion will cost you money, mostly in tax dollars paid because your 401(k) plan, IRA or rollover action, saved you from paying on taxes that a Roth 401(k) will require you to pay.

Traditional plans defer those taxes. But once you opt for the Roth 401(k) or even a Roth IRA, the taxes on the transferred amount will need to be paid. This is because the money invested in a Roth is done after taxes. The first consideration is whether you will be able to pay those taxes.

A Window Of Opportunity
You do have a window of opportunity though. Taxes due on these types of conversions in 2010 are payable in 2011 and you have two years to pay them. Estimate the taxes on what you have in these accounts based on your ordinary income tax rate. There are no penalties other than this in the conversion. But depending on the size of your account balance, you will need to set aside this amount starting before you make the conversion.

The simplest way to do this is to set aside the money in a separate account - preferably away from your emergency account. (An emergency account is savings set aside for emergencies and if you can have a minimum of three months set aside, you are well ahead of what you neighbor probably has.) On the other hand, this money should not be invested either. This is cash for taxes and has no risk potential. Some of you might be tempted to put it in a taxable indexed mutual fund to get some work out of the cash, but this would not necessarily be the wisest choice.

This is also an opportunity best used for those who are above the current $100,000 a year income threshold. These folks have been unable to save more for their retirement because of this ceiling. Expect this group to do this in droves - if they are smart. For the rest of us, the transition may not be worth it.

Many of us are underinvested as it is. We cannot accurately see what the future tax rate will be on these invested dollars yet we can be assured that we will not have the same tax rate as we do know. If studies are correct, most of us will be in a far lower tax bracket, lower than most of assumed we would be in come retirement.

Keep in mind that if you do exceed the AGI (adjusted gross income) of $100,000 the conversion doesn't necessarily mean that you will be able to contribute more. There is way around this. If you were to make nondeductible contributions to a Traditional IRA and roll them into a Roth IRA in 2010, but only the contributions, not the investment gains, that part of the rollover is not taxable. The gains on those "nondeductible" contributions would however be taxed.

Ultimately a Tax Issue
Phase-outs are linear, meaning what you make determines the level of contribution. Because this is a tax issue and you should always consider speaking with a tax professional first, the following is just a guide to see where you fall in terms of income, phase-outs and contribution levels.

If you are a Single filer, your Roth contribution limit is reduced when your modified AGI or adjusted gross income exceeds $101,000.00, It is eliminated completely when it reaches $116.000.00

A person wishing to determine their contribution status if they are Married Filing Jointly will find their limit is reduced when their modified AGI exceeds $159,000.00 and is eliminated completely when it reaches $169,000.00. When it falls in between those amounts, the linear contribution phases in. For instance, if you were half way between, your contribution would be reduced by 50%.

Another tax filing status might affect your contribution levels differently. A person Married but Filing Separately, (and) Living Apart would find their Roth contribution limit is reduced when the AGI income exceeds $101,000.00. It would be eliminated completely when your modified adjusted gross income reaches $116,000.00

Those choosing the Married Filing Separately, or Other has a limit as well. These folks will find their contribution is reduced when their modified AGI exceeds $0 and is eliminated completely when your modified adjusted gross income reaches $10,000.00.

Once it exceeds those limits, you will not be allowed to contribute.

But as with all financial investments, they are not static. They may in fact be worth less. Because of that, you may want to look into a IRA Recharacterization.