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February 25, 2010

Finding Money to Save

Everyone knows that they should be saving at least 10% of their gross income for retirement, but that can seem like an impossible goal after paying all your bills. However, don't just figure that goal is unachievable without first looking at the after-tax cost.

For instance, assume you earn $50,000 annually and your employer matches 50 cents for every dollar you contribute to your 401(k) plan, up to 6% of your pay. If you put 6% of your pay, or $3,000, in the plan, your employer will match 3%, or $1,500. Your contribution really costs less than 6%, because the money is taken out before income taxes. If you are in the 25% tax bracket, your $3,000 contribution will save $750 in taxes, or 1.5% of your pay. So, between your contributions and your employer's match, you will contribute 9% of your pay toward retirement, but it will only cost you 4.5% of your pay.

Made over long periods of time, those levels of contributions can help significantly in funding your retirement. If you contribute $4,500 annually starting at age 30, you could potentially accumulate $837,460 by age 65 with an investment return of 8% annually. (This example is provided for illustrative purposes only and is not indicative of the return of a specific investment.) If possible, you should strive to contribute even larger sums of money. In 2010, the maximum 401(k) contribution is $16,500, plus individuals over age 50 can make an additional $5,500 catch-up contribution.

What if you don't have a 401(k) plan at work? Take a look at individual retirement accounts (IRAs). While you won't get an employer match, you can contribute to a deductible IRA, if eligible, with pretax dollars, which reduces your contribution's cost by your marginal income tax rate. In 2010, you can contribute a maximum of $5,000 to an IRA, and individuals over age 50 can make an additional $1,000 catch-up contribution. So, if you are in the 25% tax bracket and make a $5,000 contribution, you'll save $1,250 in income taxes. Or, you may prefer to contribute to a Roth IRA. While you won't get a current income tax deduction for your contribution, you can make qualified distributions free from federal income taxes.

February 22, 2010

Updating Your Documents

Whether this is your first, second, or subsequent marriage, take a look at major legal documents to see if changes are needed. Even if you've been married for a while, it's not a bad idea to review these documents:

Estate planning documents -- If this is your first marriage, you may not even have estate planning documents. In that case, at least prepare a will and durable power of attorney, so that state laws won't dictate how your estate is distributed after death. For those entering a subsequent marriage or with children, thoroughly review your estate planning documents. You may need to make changes to provide for your spouse while also protecting your children, which could involve setting up trusts. Due to tax law changes providing for the gradual elimination and then reinstatement of the estate tax, review your estate planning documents every couple of years.

Asset ownership -- Review how assets are titled to ensure they are consistent with your estate planning goals. If assets are owned jointly with rights of survivorship, that will take precedence over any provisions in your estate planning documents. Typically, a home, bank accounts, and brokerage accounts will be owned jointly, but you don't have to title assets that way. For automobiles, consider using the individual name of the person primarily driving the car. If the auto is owned jointly and one spouse's accident results in damages in excess of insurance limits, other jointly owned assets could be put at risk.

Assets with beneficiaries -- These assets would include life insurance policies, retirement plans, and individual retirement accounts (IRAs). For assets with named beneficiaries, these designations will take precedence over your estate planning documents.

Business arrangements -- If you are a partial owner in a business, review any agreements dealing with what happens to the business if you die or sell your interest. The agreement may need to be changed to allow your spouse to continue ownership after your death or for your spouse to become involved in the business.

February 17, 2010

Life Insurance Mistakes

Life insurance can be used for a variety of personal and estate planning needs. To ensure your life insurance policy meets your needs, watch out for these common mistakes:

Not considering life insurance at all. Life insurance forces us to take a look at our own mortality, a subject most people would prefer to ignore. In fact, one third of all adults have no life insurance at all (Source: U.S. News & World Report, April 6, 2009). But without life insurance, you could be leaving your family in dire financial circumstances if you die. You should thoroughly assess your situation to see how much life insurance is needed to provide for your family.

Relying on rules of thumb. When deciding how much life insurance you need, avoid common rules of thumb, such as five to 10 times your annual salary. These are general guidelines and are not meant to be a definitive guide to the amount of coverage you need. Because every family has different needs, you should consider factors such as the number of dependents you have, how much money you have in savings, and outstanding obligations, such as mortgages and college loans. You need to determine how much money your family requires annually to maintain their standard of living and how long they will need that money. Once you have these estimates, you can more accurately calculate the amount of life insurance coverage that is appropriate for your family's situation.

Making your decisions based solely on the premium amount. You should base your policy selection on the amount of coverage it provides, rather than monthly or annual premiums. A wide variety of life insurance policies are available, many designed to meet specific needs. Understand the basics of each before deciding which type is most appropriate for your situation.

Not selecting appropriate beneficiaries. Estate and tax ramifications should be considered before selecting beneficiaries. For instance, naming your estate as beneficiary could cause the proceeds to be included in your taxable estate. Or, if your spouse owns the policy on your life with your children listed as beneficiaries, the policy proceeds may be considered a gift, subject to gift taxes. Be sure to name contingent beneficiaries in case your primary beneficiary dies before you do.

Replacing an existing policy without first evaluating it. Look at an in-force ledger statement to determine the policy's current status and growth projections. If you need more insurance, you can always apply for another policy for the additional amount needed. A policy change may require a medical examination and may incur fees and costs.
Not evaluating your situation periodically. Your life insurance needs are likely to change over time. Thus, you should periodically review your needs to see if charges are warranted.

February 11, 2010

Estimating Your Retirement Savings

When determining how much to save by retirement age, several variables must be considered, some requiring estimates that will span decades. Err significantly on those estimates, and you can end up with little or no money left during the later years of your life. Three of the most significant estimating mistakes to watch out for are:

Underestimating how much income you'll need in retirement. The entire point of your retirement savings is to ensure you have sufficient income to spend your retirement doing the things you plan, so make sure you have a good estimate of how much that will cost. Various rules of thumb indicate you'll need anywhere from 70% to over 100% of your preretirement income. At first glance, it seems like you'll need less than 100%, because work-related expenses, lunches out, expensive clothes, and commuting costs will be gone. But look carefully at your current expenses and how you plan to spend your retirement years before deciding how much you'll need. If you pay off your mortgage, remain in good health, live in a city with a low cost of living, and engage in inexpensive hobbies, you might need less than 100% of your preretirement income. However, if you plan to travel extensively, must pay for health insurance, and carry significant debt, you may find that 100% of your preretirement income is not enough. You need to look closely at your current expenses and planned retirement activities to come up with a reasonable estimate.

Underestimating how long you'll live. Today, the average life expectancy is 82 years for a 65-year-old man and 85 years for a 65-year-old woman (Source: Journal of Financial Planning, August 2008). But don't just use those figures without further analysis. Average life expectancy means the woman has a 50% chance of dying before age 85 and a 50% chance of living past age 85. Since you can't be sure which will apply to you, you should probably assume you'll live at least a few years beyond your life expectancy. When deciding how many years to add, consider your health and how long other family members have lived.

Overestimating how much you can withdraw annually from your retirement savings. With a retirement that could span decades, it's important to withdraw a reasonable amount so you don't deplete those savings too soon. A number of factors can make that a difficult number to calculate. First, as noted above, you can't be sure how long you'll be making withdrawals. Live significantly beyond your average life expectancy and you could find yourself with little in the way of savings. Second, inflation over such a long period means you'll have to withdraw increasing amounts just to maintain the same purchasing power. Third, your rate of return on your investments will significantly affect how much you can withdraw annually. When withdrawals are being made, down markets can have a devastating effect on your savings. Not only will your investment value go down, but you will be withdrawing the same amount from a smaller balance. Thus, when the market rebounds, you'll have less capital available to participate in that rebound. Especially if a major market downturn occurs early in your retirement, withdrawing an amount that may have been reasonable during an up market may quickly deplete your assets. Thus, it's generally prudent to keep your withdrawal percentage as low as possible, perhaps 3% or 4% of your balance. With that level of withdrawal, your funds should last for decades.

February 3, 2010

Moving Slowly into Retirement

For most of your working life, you've looked forward to the day when you can quit your job and start enjoying retirement. But in recent years, talk of longer life expectancies, uncertain Social Security benefits, declining pension benefits, unknown inflation rates, and low retirement savings made retiring at a relatively young age seem difficult. Then, in the past couple of years, declining investment and home values made it seem even more difficult to retire at any age. More and more people are coming to the conclusion that either retiring later or continuing to work during retirement is necessary.

Working doesn't necessarily mean that you have to stay with your current employer. Instead, many individuals are taking on totally different jobs, which can allow them to try something new, provide more free time by working less, or ensure less stress. In addition to the nonfinancial reasons for working, there are several financial reasons:

You have more time to save. Each additional year you work is an additional year you can continue to save for retirement. Those age 50 and over have additional means for saving, with annual catch-up contributions of $1,000 for individual retirement accounts and $5,500 for 401(k) plans in 2010.

You shorten your retirement period. The longer you work, the less time you'll spend in retirement, which means you need less money to fund that retirement.

You can delay Social Security benefits. Each additional year you wait to take Social Security benefits, up to age 70, will permanently increase your monthly benefit.

You keep health insurance benefits. One of the most significant costs in retirement is health care, and you can delay that cost by working at a job that provides health care benefits.

Some companies are helping employees with retirement issues by allowing "phased retirement", where hours are gradually reduced until full retirement. One possible advantage of staying with your current employer is that the pay may be higher than if you started over in another profession. If your employer offers a phased retirement program, get specific answers to the following questions:

How will phased retirement affect your benefits? Many pension benefits are calculated based on your earnings in the last few years of your working career. If you don't want to take pension benefits yet, make sure your pension will be calculated using earnings while you worked on a full-time basis.

What will happen to your salary with reduced hours? Will you receive a pro-rata share of your pay, or will a different pay scale be used? Will you be entitled to pay increases in the future?

Will you be eligible for health insurance benefits? Find out the company's policy regarding health insurance benefits for part-time workers. This will be especially important if you move to part-time status before age 65, since you won't be eligible for Medicare.

What other details should you investigate? Make sure there is a mutual understanding about your hours - and get it in writing. Can you take time off to travel? If you don't like part-time work, can you go back to your full-time job?

If your employer doesn't offer a phased retirement program or you want to try something new, investigate your options before quitting your job. Some factors to consider include:

• How do you plan to spend your retirement? If you plan to travel a lot, how will work fit into that schedule? If you plan to split your time between two homes in two locations, how will you be able to work?

• What interests you? Would you be happier pursuing a job that takes advantage of skills from your current job, or would you like to try something totally different? Do you need to obtain additional skills or go back to school?

• Do you want a job with significant responsibility, or are you trying to reduce the stress in your life?

• Are you passionate about an interest or hobby that you may be able to turn into a business? Do you want to start your own business? If so, do you have the financial resources, without risking funds for your retirement?

• Is there a cause that is important to you? Is it time to move to the nonprofit sector, finding an opportunity that matters to you on a personal level?

Retirement is in the midst of being redefined once again. The last generation was able to retire to a life of total leisure due to the generosity of company pension benefits and Social Security. But longer life expectancies, less generous benefits, and declining asset values mean that it is time to redefine retirement. What many are seeking is not so much total leisure as more leisure or a more meaningful lifestyle. Many are finding that those goals can be accomplished while still working, with those additional working years providing more financial security.


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