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May 28, 2010

Keep Saving Even After Retirement

Just because you're retired doesn't mean you should stop saving. Consider these tips:

Construct a financial plan. Most retirees fear that they'll run out of money during retirement. To ease those fears, create a financial plan detailing how much money will be obtained from what sources and how that income will be spent. Make sure your annual withdrawal amount won't cause you to deplete your savings. Review your plan annually to ensure you stay on course.

Consider part-time employment. Especially if you retire at a relatively young age, you might want to work on at least a part-time basis. Even earning a modest amount can help significantly with retirement expenses. However, if you receive Social Security benefits and are between the ages of 62 and full retirement age, you will lose $1 of benefits for every $2 of earnings above $14,160 in 2010. You might want to keep your income below that threshold or delay Social Security benefits until later in retirement.

Contribute to your 401(k) plan or individual retirement plan (IRA). If you work after retirement, put some of that money into a 401(k) plan or IRA. As long as you have earned income and meet the eligibility requirements, you can contribute to these plans.

Try before you buy. Want to relocate to another city? Before you buy a home in an unfamiliar city, try renting first.

Keep debt to a minimum. Most consumer loans and credit cards charge high interest rates that aren't tax deductible. During retirement, that can put a serious strain on your finances. If you can't pay cash, avoid the purchase.

Look for deals. Take the time to shop wisely, not just at stores, but for all purchases. When was the last time you compared prices for auto or home insurance? Can you find a credit card with lower fees and interest rates? When did you last refinance your mortgage?

May 25, 2010

When to Rebalance Your Portfolio

Simply put, rebalancing a portfolio means restoring it to your long-term asset allocation plan so that you get back on track with the risk/reward strategy that meets your goals and risk tolerance. This allows you to systematically follow an important investment strategy that many investors find difficult to accomplish -- buy low and sell high.

Solving the Seller's Dilemma

As difficult as it can be to make the decision to buy an investment, it's often much harder to decide when to sell. If a stock is on an extended run upward, the common temptation is to let it run.

But once that same stock begins to lose value, another common emotion kicks in -- hope. Hope that it will turn around soon. Yet all too often, the result is that you hold on to the stock until it incurs such deep losses that you finally give up on it. In fact, "waiting to break even" on a stock is one of the most frequent explanations for losses.

Rebalancing solves this dilemma but requires a strategic asset allocation plan. You then know when and what to sell when market forces cause your portfolio to move away from your asset allocation. You sell some of the assets that have grown to take up too large a share of your portfolio, using the proceeds to buy assets that have decreased from their intended size.

If you like theoretical principles, the idea makes intellectual sense. But the real benefit is that through this discipline, you capture gains that might slip away and use the proceeds to buy other investments when their prices are cheap. In short, in a calm and deliberate way, you sell what's currently high in price and buy what's low.

Time to Buy Stocks?

Even with the recent gains in the stock market, most portfolios have still suffered losses over the past couple of years in stocks. Thus, stocks likely will represent a smaller portion of your portfolio than originally intended. If that's true, then the principle of rebalancing requires selling some bonds, using those proceeds to buy more stocks.

There are several ways to execute a rebalancing strategy. You can sell your worst performers, sell a percentage of your best performers, or cut your holdings across the board. As for timing, you can decide to rebalance according to a calendar date, such as annually or every quarter, or when your positions get distorted by a specific percentage, such as 5% to 10%.

May 19, 2010

Estate Planning for Blended Families

While estate planning can be complex for all families, it can be especially complex for those in other than a first marriage. Ensuring that everyone is treated fairly can be a challenge, but these tips can help:

Sit down with your spouse and discuss both of your desires. Make a list of assets you each brought into the marriage as well as assets acquired after your marriage. Discuss how you want these assets distributed after your death. Your estate planning documents should support these decisions. Keep in mind that, even if you have a will, your spouse can often override the terms and elect to receive a statutory percentage of your estate. To prevent this, you typically need a prenuptial or nuptial agreement.

Determine whether trusts are necessary to protect your children's inheritance. When assets are left outright to your spouse, your spouse controls the ultimate distribution of those assets. You may want to use a qualified terminable interest property trust (commonly referred to as a QTIP trust) to protect your children's interests. Assets you designate are placed in this trust, with income distributed to your spouse during his/her lifetime. After your spouse's death, the principal is distributed to your heirs.

Review beneficiary designations and life insurance amounts. It's not unusual to forget to update beneficiary designations for retirement accounts, individual retirement accounts, and life insurance policies. These assets will be distributed to your named beneficiaries, regardless of the terms of your estate planning documents. Thus, take a look at those designations to ensure they are coordinated with your estate plans. While you're at it, review how much life insurance you have. You may find that you need more life insurance.

Check how your property is titled. Jointly owned property automatically passes to the co-owner. You cannot change this distribution through a will.

Discuss your plans with your family. Especially in situations involving stepparents and stepchildren, you should communicate your plans for your estate. You don't want your children to believe that your spouse has unduly influenced you or that you don't care about them. Being open and upfront about your estate plan will hopefully prevent misunderstandings after your death.

May 12, 2010

Advice for Children in their First Full Time Job

Your child has finally finished college and started his/her first full-time job. What is the most important financial advice you can give your child?

The first piece of financial advice you should give to your child is that they participate in their 401(k) plan as soon as they are eligible. The quality of your child's retirement will largely be determined by the amount of money he/she saves, and a 401(k) plan is a great place for him/her to start. Before marriage, a new home, or other obligations consume his/her entire paycheck, get him/her into the habit of saving. Since the contributions are deducted before he/she even sees his/her paycheck, it's a great way to get him/her into the habit of saving on a regular basis.

Having trouble convincing him/her that this is a good strategy? Perhaps some numbers will make the point. Assume your child starts contributing to his/her 401(k) plan at age 25, contributing $6,000 per year (substantially below the maximum contribution in 2010 of $16,500), with matching employer contributions of $3,000. If he/she earns 8% annually, he/she could have a balance of $2,331,509 at age 65, before the payment of any taxes. What if he/she waits until age 35 to start contributing? At age 65, the balance could be $1,019,549, still a substantial amount, but $1,311,960 lower than if he/she started participated in their 401(k) plan at age 25. (This example is provided for illustrative purposes only and is not intended to project the performance of a specific investment vehicle.)

What if your child still isn't convinced? Consider reimbursing him/her, as part of your annual gift tax exclusion, for any 401(k) contributions. You can reimburse the entire amount or offer to make a partial reimbursement.

Don't let your child procrastinate because there are too many decisions to be made. Just encourage him/her to start contributing, reassuring him/her that none of the investment decisions is permanent. He/she can still review contribution levels, investment choices, beneficiary designations, and other matters at a later date.

If your child has the option to contribute to a regular 401(k) plan or a Roth 401(k) plan, you may want to suggest contributing to the Roth 401(k). Employer matching contributions will still be made to a regular 401(k) plan, but your child's contributions can go to the Roth 401(k). Your child won't get a current tax break for contributions made, but he/she will owe no taxes on the contributions or any earnings when withdrawals are made. This can make a huge difference in the amount of money available for retirement.

What if your child doesn't have a 401(k) plan at work? Encourage him/her to contribute to an individual retirement account (IRA). Although contributions are limited to $5,000 in 2010 compared to $16,500 for 401(k) plans, IRAs are still a good way to save for retirement.

May 5, 2010

Should You Convert to a Roth IRA?

Effective in 2010, all taxpayers, regardless of the amount of their adjusted gross income (AGI), can convert a traditional individual retirement account (IRA) to a Roth IRA. Amounts converted must be included in income if taxable when withdrawn (i.e., contributions and earnings in deductible IRAs and earnings in nondeductible IRAs), but they are exempt from the 10% early withdrawal penalty.

If you make a conversion in 2010, the tax can be paid in two installments in 2011 and 2012, with no tax due in 2010. However, if you prefer, you can elect to pay the tax in 2010, which may make sense if the current lower tax rates are not extended beyond 2010 or you expect much higher income in 2011 or 2012. Taxes on conversions made after 2010 must be paid in the year of conversion.

The question is whether it makes financial sense to pay what could be a large income tax bill now to avoid any future income taxes on your IRA. Several factors need to be considered before answering that question:

What is your income tax bracket now, and what will it be when the funds are distributed? If your tax bracket will be the same at both times, the financial results will be similar. Increasing income tax brackets generally make it advantageous to convert to a Roth IRA, since you are paying the tax bill while income tax rates are lower. Decreasing tax brackets generally favor leaving the balance in the traditional IRA.

How will you pay the income taxes due from the conversion? If you can pay the tax bill from sources outside your IRA, that is a strong factor in favor of conversion. By doing so, you are in essence making an additional contribution to the IRA in the amount of the tax paid. Conversely, paying the tax bill from your IRA account can be a strong factor against converting, since you are withdrawing funds from your IRA and may also have to pay a 10% penalty on that withdrawal.

When will you make withdrawals from your IRA? If you'll make withdrawals within five or 10 years of converting, that may not be enough time for the benefits of tax-free compounding to compensate for the current payment of income taxes. But if you don't need to make withdrawals, your balance in a Roth IRA can grow tax free for a longer time, since you don't have to make required minimum distributions after age 70 1/2.

How will the income from the conversion affect your overall tax situation? That additional income could raise your overall income to a point where you lose some tax credits, deductions, or exemptions in the year of conversion.

Will your Social Security benefits be subject to taxes? In the year of conversion, the income from the conversion may affect your Social Security benefits. However, going forward, distributions from Roth IRAs are excluded from taxable income, while distributions from traditional IRAs may affect your benefits.

Are you interested in other estate planning considerations? Paying income taxes currently means that you remove those assets from your taxable estate, thus reducing estate taxes owed at your death. If you plan to leave the IRA balance to your heirs, they receive the Roth IRA proceeds free of income taxes, while income taxes would be due on the traditional IRA. Also, if you don't take withdrawals from the Roth IRA after age 70 1/2, you may end up leaving your heirs with a much larger balance.

After considering all of these factors, you can decide whether converting makes sense for your situation. Keep in mind that you do not have to convert your entire IRA balance at one time. You can convert over a number of years or only convert a portion of your IRA balance. However, be aware that if you have both deductible and nondeductible IRA balances, you cannot just convert the nondeductible balances to reduce your tax liability. You have to assume a pro-rated portion of both the deductible and nondeductible IRA funds are being converted.

Know When to Recharacterize

If you convert and your investments then decline, you end up paying taxes on more than the current market value. However, you can then recharacterize your conversion. For conversions made in 2010, you can recharacterize until October 15, 2011, meaning you can convert back to your original IRA. After the recharacterization, it is as if you did not convert, so you owe no taxes. You can then reconvert at the later of 30 days after the recharacterization or the beginning of the tax year following the first conversion.

You can recharacterize just a portion of the conversion. However, if you have several investments in the IRA, you can't simply choose the ones with the largest losses. In that situation, a pro-rated portion of all the investments in the account will be considered in the recharacterization. You can bypass this rule by setting up separate Roth IRA accounts for each investment. Then, if one declines substantially, you can recharacterize that one Roth IRA account, leaving the other accounts intact.

Roth IRA Contributions

This new conversion provision effectively removes the income limitations for contributions to a Roth IRA. In 2010, Roth IRA contributions can be made by single taxpayers with AGI less than $105,000 (contributions are phased out with AGI between $105,000 and $120,000) and by married couples filing jointly with AGI less than $167,000 (contributions are phased out with AGI between $167,000 and $177,000). It doesn't matter whether you participate in a company-sponsored pension plan. Individuals with incomes over the limits can make contributions to a nondeductible traditional IRA and then immediately convert the balance to a Roth IRA. However, keep in mind that if you have other deductible IRA balances, you will have to assume a pro-rated portion of both the deductible and nondeductible IRA funds are being converted.


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