BOSTON (AP) — Relief to seniors facing high prescription drug costs is one of the first changes to come under the health care overhaul. But that won’t offset the relentless increase in retirees’ medical expenses. A couple retiring this year will need a quarter of a million dollars, on average, to cover medical expenses in retirement, according to a study to be
released Thursday by Fidelity Investments.

The estimate is up 4.2% from Fidelity’s projection last year. The financial services company has updated its estimate annually since 2002 as part of its business helping employers design workplace benefits programs.  The study is based on projections for a couple of 65-year-olds retiring this year with Medicare coverage. The estimate factors in the federal
program’s premiums, co-payments and deductibles, as well as out-of-pocket prescription costs. The study assumes no employer provided insurance in retirement, and a life expectancy of 85 for women and 82 for men.

The estimate has risen 56% from Fidelity’s initial $160,000 projection in 2002. The average annual increase has been 5.7%, so this year’s 4.2% rise — from $240,000 last year to $250,000 — is modest.  But with broader inflation near zero amid a recession, health care costs continue to rise faster than other expenses, said Sunit Patel, a senior vice president at Fidelity.

The findings illustrate the importance of factoring in health care alongside housing, food and other expenses in retirement planning. “It turns out to be a surprise for many, and one of the largest expenses in retirement,” Patel said. The increase in this year’s estimate was relatively small because a surge in patent expirations for brand-name drugs meant many cheaper generic versions reached the market, Patel said. That helped limit out-of-pocket prescription costs.

Fidelity’s estimate doesn’t factor in most dental services, or long-term care, such as costs from living in a nursing home. A 2008 study by Fidelity estimated a 65-year-old couple would need $85,000 on average to cover insurance costs for
long-term care in retirement. Thursday’s study also didn’t account for the health care overhaul that President Obama signed into law Tuesday. Fidelity was updating its 2010 estimate before legislative details were clear, Patel said.

The law’s focus is expanding access to people under age 65. But it also would benefit many retirees by gradually closing what’s known as the “doughnut hole” coverage gap in the Medicare drug benefit. Seniors fall into that hole once they spend $2,830 per year. The legislation would begin narrowing the gap by providing a $250 rebate this year. The gap would be fully closed by 2020, when seniors would still be responsible for 25% of the cost of their medications until Medicare’s catastrophic coverage kicks in.

Patel said the gap’s closure is likely to yield only a “very modest” reduction to Fidelity’s $250,000 number.

As people move into their 50s and 60s, priorities change. The hours spent on home improvements and the sheer time necessary to maintain a full-sized home seem to be a little more of a burden. As kids move on, there’s all that unneeded space.

Men and women tend to turn on the gas in the last 15-20 years of their working lives to make sure their retirement savings will be adequate to their needs. That’s why the idea of downsizing is a good one to start early. It’s also a good time for a financial check-up as well.

A CERTIFIED FINANCIAL PLANNER™ professional may not be able to help you sort out what dishes and furniture to sell or give away, but he or she would make a good first stop in developing a complete downsizing strategy involving assets, investments, career and overall financial lifestyle planning. With life expectancies lengthening, many people 50-55 years of age could conceivably be at only the midpoint of their lives.

What is the chief advantage to downsizing? Handled correctly, it can save a lot of money. Selling a larger home – possibly one that still has a mortgage – in favor of a smaller house or condo that’s completely paid off can save potentially tens of thousands of dollars in interest payments over time while still building equity. The earlier the process starts, the better.

Here’s a checklist of considerations in downsizing your life:

Get advice first: As mentioned, downsizing should be a holistic process, a chance for a check-up of your overall finances while identifying things, expenses and habits in your life that you can jettison. A CFP^® professional can give you a push by asking important questions that will get you to a better place financially. It’s helpful to set up a plan to extinguish debt in all of its forms and move on to a check-up of savings, investments and estate matters.

Downsize potential health issues: No matter what the final effect of health reform on pocketbook issues, your out-of-pocket and premium-based health costs over time will be cheaper if you take steps to better maintain your health. Make weight and other personal health maintenance issues a new priority as you move into your pre-retirement years.

Plan for a retire-career: You might be working for a company or organization that has a mandatory retirement age or you have a year in mind when it might finally be time to pack up and go. And there’s nothing wrong with a retirement devoted to travel and leisure activities. But if you think you won’t be able to afford to quit working completely or if doing nothing will eventually drive you nuts, consider getting some career counseling, personality testing and do some research now that will help you train for a new full- or part-time career for after you retire from your present job.

Start thinking about real estate and new places to live: Today’s retirees don’t necessarily have to move to predictable retirement destinations. Telecommuting allows many people to continue working lives and education from anywhere. For many people, the magic combination might involve cheaper real estate, desired weather and activities, travel options and access to good doctors and quality health care facilities. Decide what kind of home you could see yourself living comfortably in at age 70 or 80. This combination of factors might happen in a surprisingly large number of places based on individual preference. To get you thinking and hone your expectations, start with resources like U.S. News & World Report’s online “Best Places to Retire” selection tools.

Talk to your family: It’s really important to discuss not only your expectations for later in life with your family members, but it’s important to get their feedback on what they consider good ideas for you. There may come a day when you need to rely on others for help, and it would be a good idea to identify how realistic that is. Also, if you’re talking about downsizing certain assets or property that might have been in your family a long time, it’s important to discuss that with others who might be affected by that decision.

Start weeding: Physical downsizing isn’t something that’s done in a month. Give yourself a year to go through each room in your home and prioritize what you’re really going to need if you move to a smaller place. Make a list of what you hope to give to friends and family members and what you’ll donate or trash. Time will give you more opportunities to put good, usable items in the hands of people who could really use them. Develop a recordkeeping system that fits you so you won’t forget any decisions you’ve made along the way. Also, you might want to set up a separate area for family photos and other keepsakes that have high emotional value and set up a hopefully egalitarian system for who will get what either when you move or when you die.

Don’t start upsizing later: When you do move, chances are you will need to invest in some new household items or possibly furniture to match new surroundings. Try to avoid going overboard with this – that’s why thoughtful downsizing should prevent a lot of spending for stuff you’ve already chucked. Oh, and make a permanent life decision if possible not to start re-using credit cards or mortgage debt if you can possibly avoid it in your later years.

March  2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V. Higgins, CFP, CLU, AEP, a local member of FPA.

By Ron Lieber

Annuities: The official retirement vehicle of the Obama administration.

As slogans go, it’s hardly “Keep Hope Alive,” or even “Change We Can Believe In.”

But there were annuities, in a report from the administration’s Middle Class Task Force that came out this week. They are among the tools the administration is promoting as it tries to give Americans a better shot at a more secure retirement.

At its simplest, which is how the White House seems to want to keep it, an annuity is something you buy with a large pile of cash in exchange for a monthly check for the rest of your life.

If the biggest risk in retirement is running out of money, an annuity can help guarantee that you won’t. In effect, it allows you to buy the pension that your employer has probably stopped offering, and it can help pick up where Social Security leaves off.

President Obama did not discuss annuities in his State of the Union address on Wednesday night, probably figuring that viewers had enough problems staying awake. But the mere mention of them by the task force was enough to send executives at the insurance companies that sell the products into paroxysms of glee.

“I never thought I’d have the president as a wholesaler for us,” said Christopher O. Blunt, executive vice president of retirement income security at the New York Life Insurance Company. “This is awesome. I’m trying to see if I can get him to do a big broker meeting for us.”

He’s unlikely to turn up for such an event just yet. After all, the announcement from the White House did make it clear that the administration was looking to promote “annuities and other forms of guaranteed lifetime income.” That suggests the administration is open to other solutions, though there are not many others that are as simple as the basic fixed immediate annuity (also known as a single premium immediate annuity) that delivers a regular check for life.

Still, all of this attention from the president is a stunning turn of events for a rather unloved product. Many consumers reflexively run in fear when salesmen turn up pitching high-cost and complex variable annuities, which evolved from their simpler siblings decades ago. Today, the Securities and Exchange Commission maintains an extensive warning document on its Web site for investors considering the variable variety.

Meanwhile, almost all employees on the precipice of retirement who have access to annuities as a payout option steer clear when their companies offer them. While various surveys show that roughly 15 to 25 percent of corporations offer annuities to workers who are retiring, including big employers like I.B.M., a 2009 Hewitt Associates study reported that just 1 percent of workers actually bought one.

“I joke sometimes that we’re the best ice hockey players in Ecuador,” said Mr. Blunt of New York Life, which sells more fixed annuities than any other company, according to Limra, a research firm that tracks the industry.

So what are these soon-to-be retirees so afraid of? And what makes the White House so sure it can change their minds?

Let’s start with the fears. Early on, the knock on annuities was that once you died, the money was gone. So let’s say a 65-year-old man in Illinois turned over $100,000 in exchange for $632 a month for life, a recent quote from immediateannuities.com. If he died at 67, his heirs would get nothing while he would have collected only about $15,000. (On the other hand, it would take him until age 78 to get $100,000 back, but that doesn’t take inflation into account.)

The industry solved this by coming up with variations on the policy, allowing people to include a spouse in the annuity or guarantee that payouts to beneficiaries would last at least 10 or 20 years. This costs extra, of course, meaning your monthly payment is lower.

Others worried about inflation, so now there are annuities whose payments rise a few percentage points each year or are pegged to the Consumer Price Index. These cost extra, too (often a lot extra).

You see the pattern here. Every time someone had an objection — the need for a bunch of payments at once, a lump sum in an emergency or concern about rising interest rates — the industry created a rider to add to policies to make the concern go away (and make the monthly payment smaller).

Besides, people need to have saved enough to purchase a decent monthly annuity payout in the first place. But plenty of retirees haven’t been saving in a 401(k) or individual retirement account long enough to have a good-size lump sum.

There are also stockbrokers and financial planners standing in the way. Once money goes into an annuity, they can’t earn commissions from trading it anymore and may not be able to charge fees for managing it. Financial advisers have a charming term for this phenomenon — annuicide. You insure, and their revenue dies. So, many of them will try to talk you out of it.

One reasonable point they might make is that insurance companies can die, leaving your annuity worthless. State guaranty agencies exist, but they may cover only $100,000 to $500,000. I’ve linked to a list of the agencies in the Web version of this column so you can see what they insure.

Even if you get over all these mental hurdles, however, the hardest one may be the difficulty of seeing a big number suddenly turn small.

“It’s the wealth illusion, the sense that my 401(k) account balance is the largest wad of dollars I’ll ever see in my lifetime, and I feel pretty good about having that,” said J. Mark Iwry, senior adviser to the secretary and deputy assistant secretary for retirement and health policy for the Treasury Department. “Meanwhile, I feel pretty bad about the seemingly small amount of annuity income that large balance would purchase and about the prospect of handing it over to an entity that will keep it all if I’m hit by the proverbial bus after walking out of their office.” So how might the Obama administration solve this? It could get behind a Senate bill that would require retirement plan administrators to give account holders an annual estimate of what sort of annuity check their savings would buy. That way, people would get used to thinking about their lump sum as a monthly stream.

Tax incentives could help, too. A recent House bill called for waiving 50 percent of the taxes on the first $10,000 in annuity payouts each year. “If this is behavior that the administration is trying to inspire, then it’s not that long of a leap to think that maybe they’ll start to promote some version of these bills,” said Craig Hemke, president of BuyaPension.com, which sells basic annuities (and offers some good educational material for people who are trying to learn about the products).

Mr. Iwry, who is one of the intellectual architects of the administration’s examination of annuities, wouldn’t say much about what might happen next. But one paper he co-wrote two years ago suggests a clue.

As the treatise suggests, the administration could nudge employers into automatically depositing, say, half of new retirees’ lump sums into a basic annuity or other lifetime income product, unless they opt out. Then, they could test the thing out for two years and see how that monthly paycheck felt. If they liked it, they could keep the annuity. If not, they could cancel it without penalty and get the rest of their money back.

Annuities won’t be right for everyone (people in poor health should probably steer clear). And they’re not right for everything because it rarely makes sense to put all of your money in a single product or investment.

You could, for instance, use an annuity to cover the basic expenses that your Social Security check doesn’t cover. You might also use the money to buy long-term care insurance, which would keep nursing home bills from becoming a budget-destroyer.

But the president has one thing right: The basic annuity is almost certainly underused. Sure, you may be able to arrange a better income stream on your own, but not without a lot of help from a financial planner or a lot of time managing it yourself. Then there’s the possibility, however small, that you’ll spend too much in spite of yourself or run into a once-in-a-generation market event that will cause you to run out of money sooner than you expected.

All of that makes basic annuities the ultimate test of risk aversion. If you buy some, you and your heirs may have less money than if you’d kept your retirement savings in investments. Then again, if you guarantee enough of your retirement income, you — and those same heirs — won’t have to worry about how you’re going to meet your basic needs.

Ron Lieber writes the Your Money column, which appears in The Times on Saturdays.
A version of this article appeared in print on January 30, 2010, on page B1 of the New York edition.

“The Number,” a book written by Lee Eisenberg several years ago, generated enough buzz that it became a reference point in financial planning circles. Maybe he should write a sequel called “Life Goals.”

According to the recent Merrill Lynch Affluent Insights Quarterly survey, 51% of retired respondents said if they had the chance to do it again, they’d have focused more on “life goals” and less on “the numbers” associated with reaching a specific nest egg dollar amount in retirement planning.

That said, the other 49% said they’d still focus on the dollar amount, not the life goals.

Among the “life goals” crowd, 38% said they’d have spent more time on how they wanted to live in retirement. In addition, 8% said they’d have created a better plan to support their charitable intentions.

As for “the numbers” group, 23% said they wished they started working with a financial advisor earlier in life and 18% said they would’ve jettisoned more luxuries to help them reach their retirement goals.

The survey, which was conducted in December by Braun Research for Bank of America’s Merrill Lynch Global Wealth Management division, also indicated lifestyle changes made by respondents as a result of the recent economic downturn.

Among the findings: 48% said they were cutting energy costs; 38% were more aware of daily and short-term cash flow; 30% were vacationing less; 29% were cutting back on golf, skiing and other recreational activities; and 16% were delaying home improvements and other capital expenditures.


Even as the economy begins its slow crawl back, college costs are continuing to rise – that means parents are continuing to fight a tough battle between funding college and funding their own retirements.

In October, the College Board reported that the average published price of tuition and fees for in-state students at four-year U.S. public colleges was $7,020 for the 2009-10 school year, up $429 or 6.5 percent higher than a year ago. After adjusting for inflation, the average net price paid for tuition and fees by public four-year college students overall is lower in 2009-10 than it was five years ago — but higher than it was last year. Private four-year colleges saw a smaller increase of 4.4 percent or $1,096, but for a much higher average annual tuition of $26,273 for the school year.

Also in October, the Employee Benefit Research Institute (EBRI) and the Investment Company Institute (ICI) also reported in October that American workers who held 401(k) accounts consistently from 2003 through 2008 suffered a 24.3 percent average drop in their account balance during 2008’s bear market.

Despite these huge challenges, it’s particularly important for parents to make retirement their first priority – kids can always take on loans and search for scholarship and grant funding to tide them over. Parents can offer help in a better economy, but the momentum lost in saving for retirement is much tougher to replace. But not so fast.

There are serious financial consequences to breaking into 401 (k) and other tax- advantaged retirement savings, and parents tempted to do so should look for other alternatives. A July 2007 Country Insurance and Financial Services survey found not only that 25 percent of respondents thought it would cost less than $50,000 to send a child to a four-year college (on average, public schools have surpassed that when you add room and board), but that nearly half believe that saving for college is more important than their retirement, which most qualified experts advise against.

Before you pick between yourself and your child by raiding your retirement accounts, here’s what you should know:

You’ll escape an early distribution penalty, but…

Any withdrawals from an IRA you might take for your child or grandchild’s education (as well as your own or your spouse’s) can be withdrawn without the usual 10 percent penalty on early distributions before age 59 ½. But you really need to talk with a tax advisor or a personal finance expert like a CERTIFIED FINANCIAL PLANNER ™ professional to determine whether your IRA withdrawals will have to be reported on your Form 1040.

You might hurt your kid’s chances for financial aid:

The entire withdrawal from an IRA — whether taxable or not — must be included as income on the following year’s application for the Free Application for Federal Student Aid, or FAFSA. Family income does more to influence financial aid than the size of the family’s assets, and dipping into your IRA can potentially damage your child’s potential financial aid. Check with a trained financial planner expert in financial aid strategy before you make a move.

Don’t even consider a ‘hardship withdrawal’ from a 401 (k) plan:

Earlier this year, the Transamerica Center for Retirement Studies reported an increase in workers taking loans from their 401(k) and other work-based retirement savings. Eighteen percent of those surveyed reported they took loans from their retirement plans in 2007 compared to 11 percent in 2006. Yet keep in mind that while most plans provide an option for hardship withdrawal for emergency medical or funeral expenses, the IRS restricts use of those funds for home purchases or tuition expenses.

So what do you do? Besides talking to a tax professional, it makes sense to find time to speak with a CFP^® professional to take a look at your overall financial situation so you can possibly find alternatives to raiding your retirement. A trained planner can help you look over all the spending, saving and investment decisions you’ve made so far and seal up the leaks – then you can discover whether you have smarter options to pay your child’s tuition. They include:

Starting a search for scholarships and grants with your kid:

See if there are grants and scholarships not only in your community, but also within your industry. Understand what a prospective student’s college choices might offer in terms of aid from its endowment. Also, some employers offer scholarships for their employees’ kids. Start searching online, at the office and by phone for such aid.

Fine-tuning your negotiating skills:

Parents need to become more aggressive about negotiating tuition, room, and board at colleges where either they or their children have been accepted. A financial planner with expertise in college planning can train parents to understand where those savings might be against the student’s qualifications for getting into the program of their choice.

December 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins, CFP, CLU, AEP, a local member of FPA.

As the holidays approach, plenty of couples think about marriage. That includes older couples with kids, accumulated assets and debts and previous marriages behind them.

That’s why marriages for older individuals require a specific sort of planning. For couples making another effort at marriage, a prenuptial agreement can either set the groundwork for a new and trusting relationship or reveal that money issues may prevent the marriage from working well.

It’s actually not the agreement by itself that makes the difference – it’s the way the couple gets the agreement down on paper. When two parties sit down to formalize a prenuptial agreement with their respective mediators or attorneys, it requires both sides to make full disclosure of their current financial situation and long-term money goals.

Prenuptial agreements can be considerably more complex for couples making a repeat trip down the aisle. Money issues are not just a matter of full disclosure between two people – in remarriage, they can affect a much wider audience including aging parents, siblings and children and ex-spouses from previous marriages. In some cases, there are sizable business and personal assets gathered before the upcoming wedding day that must be protected.

It is always wise to consult a financial advisor such as a CERTIFIED FINANCIAL PLANNER ™ professional to set the ground rules for this process, though legal documents that hold up in court generally need review by respective family law and estate attorneys.

Here are the primary issues any remarrying couple should discuss ahead of a formal engagement:

Families first: Blended families bring their own financial complications. Indeed, if couples are bringing children from previous marriages into a blended family, it’s necessary to establish not only how they will be supported and educated, but also what percentage of the family assets they will be entitled to in case their biological parent dies. There may be alimony and other support arrangements already in place for ex-spouses and children from earlier marriages as well as elderly parents to support. All of these financial requirements need to be understood and spelled out beforehand.

Is there debt? And if so, how much?

The first money conversation should take place at a table with both sides showing their credit reports, savings, investments and debt figures – every dime. Both should start the process of talking about how that debt should be paid off – by the person who accrued it, or by both potential spouses. Couples also need to decide how they will handle debt going forward – jointly or separately.

What about investments?

If so, how will they be handled once the couple is married? Will these investments be held after the marriage is in joint tenancy? Are some of the investments promised to children, ex-spouses or other family members? From a tax or estate perspective, does it make sense to do anything specific with those assets before the wedding? And after the wedding – assuming debt is being dealt with – how will you maximize those investments?

What about company assets?

If one or both spouses run their own companies or partnerships, it’s a huge planning priority. That’s particularly true if other family members work for their respective companies. Depending on the size and complexity of the operation, some advisors might encourage couples to go through a formal valuation process of those assets to establish a base of wealth going into the marriage. A prenup could spell out who will get future percentages of those assets if the couple splits – this is particularly necessary if the goal is to keep the company in the hands of the founding family.

Handling daily expenses:

This is a universal question in any marriage, the first or the sixth. Couples need to agree on how they’ll share accounts and pay bills. The most common option is to create one joint account. Others work with three accounts – one joint and then one for each individual.

What about insurance?

Life, health, home, and disability – all coverage that singles hold separately needs to be reviewed and consolidated to make sure the couples and their families have adequate coverage after the wedding.

What about our estates?

Blended families with means produce a surprisingly complex estate picture. Engaged couples need to begin addressing this need before the wedding. A qualified estate attorney who understands the variety of estate issues affecting the assets, business issues and philanthropic commitments of blended families is a particularly good investment and can work with financial planners, tax attorneys and accountants to create an estate plan for the couple that makes sense and minimizes conflict among heirs.

What about retirement?

Retirement discussions go beyond money. Couples should decide how they want to live in retirement, whether they’ll continue to work and what will happen if one or both get sick. This is a particularly important discussion if one spouse is significantly older than the other and may retire years ahead. There needs to be a close look at what retirement assets have been accumulated by both parties and how they’ll be shared during the marriage and after the death of one or both of the spouses.

What about our tax status?

It makes sense for couples to consider their tax status before they marry, particularly if there are sizable business or personal assets being brought into the marriage or past tax liabilities. In any event, remarrying couples should involve a tax expert in all pre-marital financial planning.

November 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins, CFP, CLU, AEP, a local member of FPA.

A May survey by Hewitt Associates noted that despite record losses in their 401(k) savings in 2008, individuals stuck with their 401(k) plans. However, more people dealt with their worry about investment conditions by shifting money into more conservative investments. In addition, a significant number of companies either eliminated or cut back significantly on matching employee 401(k) contributions.

Hewitt’s annual Universe Benchmarks study, which examines the saving and investment behaviors of more than 2.7 million employees eligible for 401(k) plans, showed that the average 401(k) balance dropped from $79,600 in 2007 to $57,200 at the end of 2008. 44 percent of employees lost 30 percent or more of their savings. Only 11 percent of employees were able to break even or see a gain in their 401(k) portfolios. Even still, 74 percent of employees participated in their 401(k) plans in 2008, about the same as in 2007.

However, the Hewitt survey stated that some workers are reacting to the market downfall by moving 401(k) assets into less risky investment funds to try and blunt their losses. In 2008, 19.6 percent of investors made trades in their 401(k) plans versus 18.7 percent in 2007. And the volume of money they transferred in 2008 was much higher. Nine of the 10 most active trading days were the day after a large downturn in the market, or days with an average return of negative 4 percent. Employees’ average equity exposure dropped to just 59 percent in 2008—which is an all-time low since Hewitt began tracking it in 1997. Stable-value funds, which are considered less risky investments, experienced an 11 percent increase in asset allocation in 2008.

That’s why it might be wise for investors to get a fresh start with 401(k) advice as the economy improves. For existing investors or those who have never begun to save or invest for retirement, it might be time to consult both financial and tax experts such as a CERTIFIED FINANCIAL PLANNER™ professional to make sure both personal and work-related retirement savings complement each other.

Some recommendations to keep in mind:

Save even if your company fails to match: This is not the easiest thing to do, but even if your company cuts back on matching, it’s important to try and put additional money into personal retirement investments outside of work. You will still realize the benefit of pre-tax contributions made to your traditional 401(k). And, when you have money automatically taken from your paycheck you are “dollar cost averaging”. That means the fixed dollar amount that comes from your paycheck buys more shares when prices are low, and fewer when prices are high. Thus your average cost per share is lower than the average price per share.

Make sure you contribute to a plan: According to 2006 data from the Profit Sharing/401(k) Council of America, more than 22 percent of eligible workers don’t participate in available 401(k) plans. For the companies that are still matching, that’s like giving up free money.

Continue to save while you wait to join a plan: A significant number of companies don’t let you join the 401(k) until you’ve been working there a year. If that’s the case, get in the habit of putting money away for retirement anyway. Start an individual IRA with the funds you would put in the company plan, or set aside money in a savings account so you can supplement your cash flow and put the maximum amount into your 401(k) once you’re allowed to join.

Contribute the maximum: Not every employee can afford to contribute the maximum allowed by the plan, but try. In 2009, the maximum 401(k) contribution will be $16,500, and those older than 50 can make an additional catch-up contribution of $5,000.

Don’t let your company do all the work: More companies are automatically enrolling their workers in their 401(k) plans, but some workers fail to take charge afterward. They don’t know how much they’re allowed to contribute and they don’t discuss or review the types of investments they have in relation to their age or retirement plans. It might make sense to bring an outside investment advisor such as a CFP^® professional to review those choices with you.

Avoid poor diversification over time: It’s necessary to do a yearly checkup on all your retirement savings – 401(k) s, individual IRAs and other investments fueling your retirement goals to make sure you’re on track.

Don’t rely on the 401(k) alone: Particularly if matching lags for awhile, 401(k) plans can’t be relied upon as a single source of retirement dollars. You must invest outside your company plans.

Don’t over-invest in company stock: Most financial planners advise that you put no more than 15 to 20 percent of your whole 401(k) portfolio in company stock.

Don’t borrow from the 401(k): The Employee Benefit Research Institute® reports that employees contribute more to plans that let them borrow. Don’t be fooled. A 401(k) shouldn’t be a house fund or a source of emergency cash. You’re taking money out of the account that otherwise would grow tax-deferred, and if you fail to pay back the money, you could face income taxes and penalties. Instead, build an outside emergency fund of three to six months of living expenses you can draw from.

Don’t cash out: Some workers think it’s a great idea to treat a 401(k) as a windfall for when they quit a job. Don’t do it. You’ll pay huge penalties and lose your retirement savings momentum.

Don’t “lose” your old 401(k) accounts: Maybe you’ve changed jobs several times and never got around to moving older, smaller 401(k) accounts from past employers to current ones or into a self-directed retirement account. Always get advice about 401(k) funds when you leave an employer.

September 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V.Higgins, CFP, CLU, AEP, a local member of FPA.

• The IRS offers a 3-year window in 2010 to pay taxes on a Roth conversion.
• The IRS is letting tax payments on a conversion to be made in 2011 and 2012.
• Figuring out the tax due on a Roth conversion is not that complicated.If you have funds in an individual retirement account, converting them into a Roth IRA in 2010 presents an unprecedented opportunity to sock away tax-free retirement income.

The IRS is even offering taxpayers a three-year window in 2010 to pay taxes due on a conversion and is removing income limits that have kept higher-income taxpayers from setting up Roth IRAs.

Many taxpayers have been able to convert their traditional IRAs to Roth IRAs since Roth IRAs were created in 1998. However, income limits and other restrictions have kept many taxpayers from converting. If their modified gross income is more than $100,000, they haven’t been able to convert. But in 2010, they’ll get their first opportunity.

You don’t have to wait until then if your  modified adjusted gross income — your income minus certain deductions — is less than $100,000 and, if married, you file as “married filing jointly.” You could convert in 2009. However, to take advantage of special tax breaks offered only after Jan. 1, it may make sense to hold off, says Brent Lindell, a certified trust and financial adviser with Savant Capital Management in Rockford, Ill.

Roth IRAs differ from traditional IRAs in several crucial ways. While you don’t get a tax deduction for making a contribution to a Roth IRA, those contributions you may not have to pay any tax upon withdrawal in retirement. In addition, Roth IRAs aren’t subject to the same minimum distribution requirements that traditional IRAs are, so you don’t have to begin withdrawals from your Roth IRA at age 70½.

And because most retirement accounts took a heavy beating in the stock market in 2007 and 2008 and still haven’t recovered, the taxes due on a conversion are less than they would be had the market risen, making the case for conversion even more compelling, says Dave Sadler, a certified public accountant and Certified Financial Planner with Moneta Group, a wealth management firm in St. Louis.

If that’s not enough, the IRS is allowing taxpayers a one-time opportunity to spread out the payment of taxes due on a Roth conversion in 2010 over 2011 and 2012.

Taxes are due on a Roth conversion because you get a tax deduction on your initial contributions to most traditional IRAs, so you must pay the taxes due on those initial contributions and any growth in your IRA. Your tax bill on conversion also depends on a number of other factors, including your income, your federal tax bracket and your state tax rate.

Roth IRA conversions don’t make sense for everyone, but it’s worth investigating to decide whether it makes sense for you.

“The issue comes down to what your tax situation is in the year of conversion versus what it might be in retirement,” Sadler says.

“It’s a hard thing to know for sure, but I would say it makes the most sense for younger taxpayers who will have their income grow over time,” he says.

7 steps to a Roth IRA conversion

1. Evaluate your IRA and 401(k).
2. Seek advice if you’re unsure.
3. Weigh financial and tax factors.
4. Calculate the potential tax due.
5. Decide when to pay the tax bill.
6. Consider when to convert.
7. Fill out conversion paperwork.

Step 1: Evaluate your IRA and 401(k)

First, you need to get a handle on what assets you’ve got that are eligible for conversion into a Roth. Generally, any assets that you hold in a traditional IRA, whether they are deductible or nondeductible, are eligible. Nondeductible IRA contributions are not taxed when you make a conversion, although earnings from those contributions are taxed.

If you have a 401(k) or 403(b) from a former employer, you may want to roll them into an IRA this year so they will be eligible for rollover along with your other IRA assets. It’s a two-step process, first you roll over your old 401(k)s and 403(b)s into a traditional IRA. Then, you convert the traditional IRA to a Roth. That’s where the tax is due.

The higher the balance in your IRA or IRAs, the higher your tax bill will be if you convert. However, if you invested aggressively in the stock market and your account value is still down from two years ago, you won’t owe as much in taxes as you would have if the account total had been higher, Lindell says.

Under IRS rules, you have to consider the entire value of all of your IRAs when converting and figuring taxes on the conversion, if you have nondeductible IRA contributions.

“(In that instance,) even if you don’t want to convert the entire balance of all of your IRA accounts, whatever percentage you want to convert has to include assets from all of your IRA accounts,” Lindell says.

For example, if you have four traditional IRAs worth $100,000 and those accounts included nondeductible contributions, but you only want to convert $50,000 of those assets (all from one IRA), the IRS won’t allow you to convert only the assets that lost money. You have to take assets from all of your IRAs, not just the losing ones.

Step 2: Seek advice if you’re unsure

If you are considering conversion but are too confused to attempt it on your own, there are lots of places to find help, including the financial services firm that is the custodian of your IRA, or your tax professional or financial adviser.

If you don’t work with a tax professional, get a referral to a reputable local firm. Many offer consultations on these issues for free, says Jim Ciocia, a certified public accountant and chairman at Gilman Ciocia Inc., a tax and financial planning firm in Tampa, Fla. Make sure any advice you get is specific to your situation, he adds.

Step 3: Weigh financial and tax factors

For many taxpayers, the decision to convert is highly individual. How old you are and your present tax bracket all factor in.

“An important factor in deciding whether to convert is considering how much time you have before you retire and will potentially need to use the money,” Ciocia says.

The higher your tax bracket, the more tax you will have to pay on conversion. But if you expect taxes to go up in the long term, conversion makes sense because you may have to pay a higher tax rate in retirement than you expect now, Ciocia says. If you convert, you’ll have a tax-free source of retirement income along with any taxable source of income, such as a traditional IRA, 401(k) or 403(b).

As Ciocia puts it, “Would you rather pay taxes when you plant the seeds or harvest the crop?” In other words, you likely would pay less in taxes on a $5,000 Roth IRA contribution than you would if you had left the money in a traditional IRA and it grew to $34,242 after 25 years of tax-free growth at 8 percent.

In that example, even at a low 15 percent tax rate, your taxes would be $5,136.30 if you left the money in a traditional IRA — far higher than what you will pay now on a $5,000 conversion to a Roth.

Step 4: Calculate the potential tax due

Figuring out the tax due on conversion is not that complicated. Basically, you owe federal and state taxes on your contributions and any gains, meaning the entire value of your IRA, unless you made nondeductible contributions. If you made nondeductible contributions, you would subtract those from your current total IRA account balances to come up with the amount that will be taxed.

Here’s an example:

You’ll still get a break in when you pay your taxes. Using the above example, with $12,000 in federal taxes due, you wouldn’t have to pay any of that in 2010; you’ll owe $6,000 in 2011 and another $6,000 in 2012.

Step 5: Decide when to pay the tax bill

There are a few other issues to consider when deciding whether to pay the tax due immediately after conversion — if you can afford to — or defer it.

“Whether you want to pay the taxes in 2010 or spread it out over the next two years depends on how consistent your tax situation is,” Sadler says. “If you’re a W-2 employee and don’t have any capital gains or other types of holdings that might create surprises along the way, … you aren’t likely to see a huge tax increase. So I would think deferring those taxes over a two-year period would make sense.”

Many tax advisers agree that for a Roth conversion to make sense, you should be able to pay taxes from your income or another source, not from funds taken from your IRA.

“If you’re thinking about cashing in part of your IRA to pay the tax bill on it, forget it,” Savant Capital’s Lindell says. “You’re defeated already.”

That’s because you’ll have to pay interest and penalties on any IRA funds you remove from your account to pay taxes. Paying the taxes from your IRA account also will reduce your balance and your ultimate nest egg when you retire, he adds.

Step 6: Consider when to convert

The earliest you can convert if you want to take advantage of the two-year tax deferral is Jan. 1, 2010, if your income is currently over the $100,000 limit and/or you plan to file as “married, filing separately.” If your income isn’t over the limit and you can afford to pay the tax now, there’s no reason to wait, especially if your traditional IRA dropped in value. If it appreciates between now and Jan. 1, your taxes in conversion will be higher, says Ciocia of Gilman Ciocia.

For many taxpayers, it makes sense to convert as early in 2010 as possible to gain as much possible from the tax-free growth that a Roth offers. However, if you’re unsure of what your income will be and what tax bracket you’ll be in, it makes sense to wait until the second half of 2010 to get a better handle on the tax consequences, says Sadler.

And don’t forget, there are no income limits beginning in 2010. So if you wait to convert, you can do it regardless of your income.

Step 7: Fill out conversion paperwork

The conversion paperwork isn’t that complicated. If you have made nondeductible contributions to your IRA, you will need to know how much you contributed in nondeductible contributions, which you can find in your income tax forms on Form 8606, Nondeductible IRAs.

You’ll need to let the custodian of your IRA — the mutual fund, bank or other financial services company that holds your account — know certain information, including:

• How you want your converted assets invested.
• Whether you will pay the taxes due yourself or want the custodian to withhold the amount from the IRA’s assets to pay them.
• Who you want to name as a beneficiary to receive the money upon your death.

By Amy E. Buttell • Bankrate.com

Amy E. Buttell is a frequent contributor to Bankrate.com, Interest.com and Better Investing Magazine. From her home base in Erie, Pa., she is studying accounting and financial planning with the goal of earning the certified public accountant and certified financial planner designations.

One of the least understood and most confusing aspects of Social Security benefits are the spousal benefits. Much attention is devoted to the best time for an individual to begin receiving retirement benefits, but how that choice can affect the benefits of a spouse receives much less attention.

In this visit we primarily are going to discuss spousal retirement benefits, but lets first briefly discuss the rules for survivor benefits.

A survivor receives the higher of his or her own earned benefit and the survivor benefit. A surviving spouse who already has reached full retirement age is entitled to a survivor benefit equal to what the deceased spouse was receiving. A surviving spouse who applies for survivor benefits before full retirement age will have the benefit reduced 0.42% for each month survivor is below the full retirement age. The age at which the survivor began collecting his or her own retirement benefits will not affect the amount of survivor benefits.

Strategy: The longer one delays one’s own retirement benefits, the higher the amount a spouse could receive in survivor benefits.

Spouses also are entitled to retirement benefits. A married person can receive retirement benefits based on either his or her own earnings record or on the spouse’s earnings, whichever is higher. The general rule is that a spouse receives the higher of his or her own earned benefits and half of the spouse’s earned retirement benefit. But the spousal retirement benefit is reduced if either spouse begins benefits before full retirement age. We’ll look at some examples shortly. To keep it simple, we’ll assume the wife is the lower-earning spouse.

For a spouse to receive retirement benefits, the other spouse first must be receiving retirement benefits. If the wife is ready to retire and wants to receive benefits before her husband, the wife’s benefits will not be based on the husband’s earned benefits. Theoretically the husband can begin receiving retirement benefits while continuing to work. If the husband is under full retirement age, however, the earnings limit will reduce the amount of those benefits and that in turn will reduce the amount received by the wife. If the salary of the husband is high enough, the benefits either spouse is eligible for will be zero.

The wife, however, can begin receiving benefits based on her own earnings record when the husband is not yet receiving benefits. After the husband begins receiving benefits the wife can receive benefits based on the husband’s earnings record. The benefits received by the wife at both times, however, will be reduced if the wife begins benefits before his or her full retirement age (FRA). Let’s look at some examples.

Rosie Profits wants to begin receiving benefits while her husband Max wants to delay benefits. Rosie is entitled to $500 monthly at full retirement age based on her own earnings. When Max reaches FRA he will be entitled to $1,800 monthly. Rosie can begin taking $500 now. When Max begins benefits at FRA, Rosie will receive an additional $400 to bring her total to $900 monthly—half of Max’s benefits. That assumes neither of them began receiving benefits until reaching FRA.

Suppose Rosie begins receiving her benefits before her FRA. She will receive a reduced benefit of let’s say $400 monthly. When Max retires at FRA, she still will receive the additional $400, bringing her monthly benefit to only $800. By beginning benefits before FRA she permanently reduces her monthly benefit, even after Max retires at FRA.

Now suppose Max begins benefits before Rosie reaches FRA, and Rosie already began receiving $400 monthly before her FRA. Rosie’s spousal benefit will be reduced again, based on a formula. She should receive less than the $800 monthly in the previous example. A calculator on the Social Security web site at www.socialsecurity.gov can compute the actual benefits for individual situations.

As you can see, the rules and scenarios can get complicated. Social Security’s web site calculators can help explore results under different scenarios. Others have studied the issue and concluded the best strategy for most couples. Under these studies lifetime payouts are maximized if the lower-earning spouse begins taking benefits early, say when first eligible at age 62. The higher-earning spouse should wait to at least age 68 before taking benefits and preferably to age 70.

Here’s a peculiar scenario the law apparently allows. Max and Rosie Profits are the same age. Rosie would be entitled to $1,000 monthly at her FRA; Max would receive $2,000 at his FRA. Rosie begins benefits at 62, receiving $750. Max wants to wait until age 70, but decides he needs some cash flow before then. At FRA, Max applies to receive one half Rosie’s benefits. He would receive $500 (half Rosie’s benefits at her FRA). At 70, Max can apply for benefits based on his earnings record, which would pay benefits over $2,000 monthly.

What if a spouse now believes he or she made the wrong choice and began benefits early? A retirement benefits recipient can change his or her mind by filing a Withdrawal of Claim with SSA. Along with the form, the benefits received to date have to be repaid. In the year prior benefits are repaid, the recipient will receive a Form 1099 from SSA with a negative number, and that amount might be either deductible on the tax return or taken as a credit for income taxes paid on the previous benefits. For details check IRS Publication 915 and the Social Security benefits handbook. Both are available on the agencies’ web sites.

The bottom line is that it usually pays for at least one spouse to wait before receiving benefits. Married couples should consider their benefits jointly to maximize the family income, the benefits paid to each, and future survivor benefits.

. About Bob Carlson

Bob Carlson is editor of the monthly newsletter, Retirement Watch. In it, he provides independent, objective research covering all the financial issues of retirement and retirement planning. Carlson also is Chairman of the Board of Trustees of the Fairfax County Employees’ Retirement System, which has over $2.8 billion in assets, and has served on the board since 1992. He was a member of the Board of Trustees of the Virginia Retirement System, which oversaw $42 billion in assets, from 2001-2005.

His latest book is Invest Like a Fox…Not Like a Hedgehog, published by John Wiley & Co. in 2007. His previous book was, The New Rules of Retirement, as published by John Wiley & Co. in the fall of 2004.

© 2003 – 2009 Retirement Watch, L.L.C.
All rights reserved.

As you are painfully aware, the before-tax money you’ve put away for retirement, and which has been growing tax deferred, has a co-owner: Uncle Sam. The tax laws say you must start withdrawing and paying taxes on this money when you reach age 70½. If you fail to take the Required Minimum Distribution (“RMD”) there is a penalty tax of 50% on the amount you should have taken and did not. The reason the government mandated the RMD is to assure they get their share in taxes before you expire. For 2009, the government will not impose a penalty for skipping the RMD, because withdrawing money would compound the market losses suffered by many. But, in 2010 you will again be required to withdraw from your qualified retirement money if you are 70½ or older. What can you do if you don’t want to take withdrawals?

The only solution is to convert some or all of your qualified retirement to a Roth IRA if you can qualify. If you make more than $100,000 in taxable income during 2009, you cannot convert money to a Roth IRA; however, in 2010 this income limit will be suspended and you can qualify. When you convert your retirement money to a Roth IRA, you will pay income taxes on the amount converted, but the converted amount will not be included in the $100,000 income qualification limit. Thereafter, all the principal converted and future earnings will be 100% tax-free to you and whoever inherits the money after your death. What’s more, annual distributions from a Roth IRA are not required. You can let it accumulate tax-free, or you can make tax-free withdrawals: your choice. There is one small drawback: even if you’re over 59½, you cannot withdraw earnings tax-free until after five years. You will still have immediate tax-free access to 100% of the money converted to a Roth, but withdrawn earnings will be taxed during this five-year period. Withdrawals come from converted money first.

If you cannot now qualify for a Roth IRA conversion due to your annual income, you will qualify in 2010. If you convert in 2010, you will get all the benefits discussed above, but you will have to take your RMD for 2010 prior to converting. You can stretch the taxes on the amount converted over the following two tax years. One-half of the taxes will be due with your 2011 return filed in 2012 and the remainder with your 2012 tax return. Best of all, you can change your mind on a Roth conversion up until the time you file your tax return for the year in which you converted, including extensions. This means that if you convert in 2009, you can change your mind, undo the conversion anytime before October 15, 2010, and avoid the taxes. If you think you could benefit from a Roth, you should convert knowing that you can change your mind anytime up to the tax filing deadline for the year of conversion.

Other than avoiding the RMD, why would you want to convert to a Roth IRA? First of all, the IRS now owns a percentage of your qualified retirement money, and the best time to buy them out is when the price, and tax, is the lowest. If you have suffered market losses – and who hasn’t – your tax bite will be less than if you wait until after the market recovers. What’s more, if you expect future tax rates to rise – and that is the consensus forecast – you’ll want to pay now in advance of the tax hike. Additionally, if you move retirement money from the “taxable” category to “tax-free” you will probably pay fewer taxes on your Social Security benefits since Roth IRA income is not counted when computing taxes on SS benefits.

Converting to a Roth IRA is not for everyone, especially if you’ll need to use part of your qualified retirement money to pay the associated taxes. If you have investment losses to offset the taxes associated with Roth conversion, you certainly need to consider converting some retirement money to a Roth IRA. You’ll want to work with your financial advisor to make sure you can benefit. If converting to a Roth makes sense for you, it can be done easily, without delay and at no cost other than the taxes. The Roth IRA conversion is undoubtedly one of the best ways to lower taxes and manage your estate without giving up flexibility. If you haven’t already, you need to investigate this opportunity immediately.

Shelby J. Smith, Ph.D.