As the Great Recession rumbles on and on for just about everyone except those in the top 10% of income brackets, people are increasingly tapping into their IRAs. If you're not 59 and 1/2 or older, you'll pay a penalty of 10% of the amount withdrawn, on top of applicable federal and state income taxes. There is a way, however, to dodge the penalty: substantially equal periodic payments plans (SEPPs). These plans let you withdraw IRA funds without penalty, although regular federal and state income taxes will still have to be paid. SEPP plans can be complex, and you may want the assistance of a tax accountant or financial planner if you're going to use one. Here's a general picture of how they work.
A SEPP plan runs for a minimum of five years or until you reach age 59 and 1/2, whichever is longer. If you start a SEPP plan at age 57, you have to stick with it until you reach age 62. If you're younger than 54 and 1/2, the plan has to continue until you reach 59 and 1/2. So, if you start a SEPP plan at age 45, you'll have to stick with it for 14 and 1/2 years. If you don't stick with the plan and complete it, the IRS will assess a 10% penalty on everything you withdrew before the time you dropped the plan. Since you presumably instituted the SEPP because you were short of cash, that penalty could be painful.
During the time the plan is in effect, you get payments each year (which can be monthly, if the plan is set up that way). The distributions are calculated one of three ways: the amortization method, the annuitization method, and the required minimum distribution method. The first two are somewhat like what you would get from a commercial annuity purchased with the amount of money in the SEPP plan (although this is just an approximate description). You have a fixed amount that is paid out each year, and that amount never changes over the life of the plan. But, unlike a commercial annuity, this payment is not guaranteed and if the investment performance of your IRA lags, you could drain off the balance faster than you expected. (In fact, you can run out of funds before the plan is over; but the IRS won't penalize you for inability to complete the plan because of investment losses.)
The third method, required minimum distribution, is like the formula used for regular required minimum distributions from IRAs (i.e., those for people 70 and 1/2 or older). You take the SEPP account balance and divide it by the owner's life expectancy as estimated by the IRS. The resulting number is paid out. But the distribution has to be recalculated each year (using the owner's ever shortening life expectancy). So the required minimum distribution method is likely to pay out different amounts each year. It also tends to result in smaller payments than the first two methods. But the nature of the required minimum distribution formula means that you'll never run out of the money. You just won't know for sure how much you'll get every year--potentially more after a year of investment gains, and possibly less after a year of investment losses.
If you start with either the annuitization or amortization method, you can make a one-time switch to the required distribution method. This would be advisable if the original method is depleting your account balance faster than you feel comfortable with. Thus, you can reduce the impact that investment losses have on your account balance, but you'll get much lower periodic payments.
You can use some or all of the funds in an IRA for a SEPP plan. If you're going to use less than all the funds, transfer part of your IRA into a separate IRA that is used for the SEPPs. If your retirement money is in an employer sponsored retirement plan like a 401(k) or a 403(b), you cannot do a SEPP plan--it's allowed only for individually owned retirement plans. But if you're no longer employed at that employer, you can transfer the funds to an IRA and do a SEPP plan from the IRA.
A SEPP plan isn't useful for making one-time withdrawals, such as getting a downpayment for a car or house. It's a long term proposition, with a measured payout for each year of the plan. If you need a short term boost in cash flow, look elsewhere, or make the one-time withdrawal and pay the 10% penalty along with income taxes.
The amount you can take out at any one time through a SEPP plan is limited to whatever you can get per year under one of the three permitted methods of withdrawal. You can't use a SEPP plan to take out half the balance of your retirement account at once, or some other ad hoc amount that suits your needs at the moment.
Don't do a SEPP plan unless it's really necessary. You'd be burning up retirement resources earlier in life, which means your golden years may be less golden. Of course, sometimes life isn't kind and you need access to the money in your retirement account. The fact that a SEPP plan avoids the 10% penalty may be significant if you have to make long term withdrawals. For more information, you can visit the IRS website at http://www.irs.gov/retirement/article/0,,id=103045,00.html.
Showing posts with label IRA. Show all posts
Showing posts with label IRA. Show all posts
Sunday, May 1, 2011
Tuesday, April 5, 2011
Roth IRA versus Traditional IRA: a Snapshot of Our Tax Dilemma
Should you have a Roth IRA or a traditional IRA? That's the question for many of today's savers. The answer illustrates a basic problem in America's system of taxation, one that doesn't appear likely to be fixed any time soon.
Traditional IRA. The more or less standard reasons for choosing a traditional IRA is that you can deduct the contributions now, and defer taxation until you begin withdrawals. Generally, speaking, you must wait until you're 59 and 1/2 before you can take withdrawals. You can defer withdrawals, though, and let your savings continue to grow on a tax-deferred basis until age 70 and 1/2. Then, you must begin to withdraw a minimum amount each year or face tax penalties.
You can contribute up to $5,000 a year in 2011 (or $6,000 if you're 50 or older), or the amount of your earned income, if less. You can deduct the contribution if you and your spouse (if you have one) aren't covered by an employer retirement plan. If either of you is covered by an employer retirement plan, the amount of your deduction in 2011 begins to shrink if your adjusted gross income is $56,000 or more (if single), or $89,000 or more (if married and filing jointly). To get a headache reading about the mindlessly complex rules concerning deductibility, go to IRS Publication 590 at http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230433. Keep reading for a while, because the rules really do go on at some length.
The conventional wisdom is that a traditional IRA is good for people who can deduct all or most of their contributions, and are likely to fall into a lower tax bracket in retirement. In essence, the traditional IRA lets you "borrow" the taxes that would otherwise be due on the income contributed and use them for a while to generate investment returns. You'll pay taxes eventually, but eventually could be decades away. This is one of the few loans you can take that might actually make sense.
Roth IRA. The Roth IRA is funded with aftertax dollars, up to $5,000 a year (or $6,000 if you're 50 or over), or the amount of your earned income, if less. You get no deduction from your current tax bill. Note that the $5,000/$6,000 limit is a combined annual limit for all contributions to whatever traditional and Roth IRAs you might have. For example, if you have both types of accounts and contribute $2,000 to a Roth, you can't contribute more in the same year than $3,000 to the traditional IRA.
If you maintain the Roth for at least five years, you will be able to withdraw the earnings tax free beginning at age 59 and 1/2. However, you don't ever need to make withdrawals and can keep the money in the Roth accumulating tax free investment returns until the end of your life. In such circumstances, the beneficiaries you designate will be required to gradually withdraw the funds over their lives, but they won't need to pay income taxes on those withdrawals. The Roth account will be included in your estate for federal estate tax purposes, so it may be taxed in that way if you're well-off enough. But consider yourself fortunate if you have this problem. For those with a very long term perspective, the Roth is a good estate planning device.
The conventional wisdom is that a Roth IRA is good for people who expect to be in a tax bracket equal to or higher than the one they're in currently. That would mean that Roths are basically good for relatively high earners who expect to retire relatively well off. Another consideration is that Roths are administratively easier than traditional IRAs. You don't need to fuss with calculations of minimum annual withdrawals when you get older. You can take withdrawals as and when you choose, and they aren't taxed. Or you can pass the money along to your designated beneficiaries and they aren't taxed.
The Tax Dilemma. All this is well and good if you can reasonably predict what future tax rates will be. But the current modus operandi in Washington is to jury rig ad hoc short term tax provisions, where rates, deductions and other important aspects of the tax code have very limited half-lives. Most recently, the 2010 tax compromise between President Obama and the House Republicans resulted in a two-year tax cut program that will increase, rather than decrease, the federal deficit. So you can now plan as far as two years ahead. After that, it's anyone's guess where tax brackets will be. Realistically speaking, taxes will have to rise in order to bring deficits under control. But politically speaking, the likelihood of tax increases is low, but may be more likely for moderate and low income Americans than the well-off. (If you think I'm kidding, take a look at the 2010 tax compromise: the progressive $400 Making Work Pay credit was eliminated and a less progressive 2% point cut in Social Security taxes was substituted.)
When it comes to a choice between a traditional IRA or a Roth IRA, the bottom line is no one knows for sure what's best, and most likely you won't know in the future, either. Much of life involves operating on limited information in foggy conditions. One approach would be to split your contributions between a traditional and a Roth, thereby hedging your bets. Another approach is to use only a Roth. While it's more expensive to fund, a Roth is easier administratively on the back end--when you're 83 and juggling a half a dozen prescription medications, you won't want to fool around with the IRS formula for minimum required distributions from your IRA. And a Roth may be a beneficial estate planning tool if you want to leave money to someone else.
Note to the truly frugal. If you have a moderate or low income, you may actually be able to get a tax credit of up to $1,000 for contributions to a traditional or Roth IRA. The credit is available in 2011 only if your income is $55,500 if married and filing jointly, $41,625 if you file as a Head of Household, or $27,750 if single, married filing separately or a qualifying widow(er). This credit offers a dollar-for-dollar reduction of your tax liabilities, so it's worth claiming if you can (in essence, the government funds your IRA up to $1,000). It isn't easy to save at these income levels, but the 7 or 8 Americans who manage to do so can get a nice tax credit.
Traditional IRA. The more or less standard reasons for choosing a traditional IRA is that you can deduct the contributions now, and defer taxation until you begin withdrawals. Generally, speaking, you must wait until you're 59 and 1/2 before you can take withdrawals. You can defer withdrawals, though, and let your savings continue to grow on a tax-deferred basis until age 70 and 1/2. Then, you must begin to withdraw a minimum amount each year or face tax penalties.
You can contribute up to $5,000 a year in 2011 (or $6,000 if you're 50 or older), or the amount of your earned income, if less. You can deduct the contribution if you and your spouse (if you have one) aren't covered by an employer retirement plan. If either of you is covered by an employer retirement plan, the amount of your deduction in 2011 begins to shrink if your adjusted gross income is $56,000 or more (if single), or $89,000 or more (if married and filing jointly). To get a headache reading about the mindlessly complex rules concerning deductibility, go to IRS Publication 590 at http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230433. Keep reading for a while, because the rules really do go on at some length.
The conventional wisdom is that a traditional IRA is good for people who can deduct all or most of their contributions, and are likely to fall into a lower tax bracket in retirement. In essence, the traditional IRA lets you "borrow" the taxes that would otherwise be due on the income contributed and use them for a while to generate investment returns. You'll pay taxes eventually, but eventually could be decades away. This is one of the few loans you can take that might actually make sense.
Roth IRA. The Roth IRA is funded with aftertax dollars, up to $5,000 a year (or $6,000 if you're 50 or over), or the amount of your earned income, if less. You get no deduction from your current tax bill. Note that the $5,000/$6,000 limit is a combined annual limit for all contributions to whatever traditional and Roth IRAs you might have. For example, if you have both types of accounts and contribute $2,000 to a Roth, you can't contribute more in the same year than $3,000 to the traditional IRA.
If you maintain the Roth for at least five years, you will be able to withdraw the earnings tax free beginning at age 59 and 1/2. However, you don't ever need to make withdrawals and can keep the money in the Roth accumulating tax free investment returns until the end of your life. In such circumstances, the beneficiaries you designate will be required to gradually withdraw the funds over their lives, but they won't need to pay income taxes on those withdrawals. The Roth account will be included in your estate for federal estate tax purposes, so it may be taxed in that way if you're well-off enough. But consider yourself fortunate if you have this problem. For those with a very long term perspective, the Roth is a good estate planning device.
The conventional wisdom is that a Roth IRA is good for people who expect to be in a tax bracket equal to or higher than the one they're in currently. That would mean that Roths are basically good for relatively high earners who expect to retire relatively well off. Another consideration is that Roths are administratively easier than traditional IRAs. You don't need to fuss with calculations of minimum annual withdrawals when you get older. You can take withdrawals as and when you choose, and they aren't taxed. Or you can pass the money along to your designated beneficiaries and they aren't taxed.
The Tax Dilemma. All this is well and good if you can reasonably predict what future tax rates will be. But the current modus operandi in Washington is to jury rig ad hoc short term tax provisions, where rates, deductions and other important aspects of the tax code have very limited half-lives. Most recently, the 2010 tax compromise between President Obama and the House Republicans resulted in a two-year tax cut program that will increase, rather than decrease, the federal deficit. So you can now plan as far as two years ahead. After that, it's anyone's guess where tax brackets will be. Realistically speaking, taxes will have to rise in order to bring deficits under control. But politically speaking, the likelihood of tax increases is low, but may be more likely for moderate and low income Americans than the well-off. (If you think I'm kidding, take a look at the 2010 tax compromise: the progressive $400 Making Work Pay credit was eliminated and a less progressive 2% point cut in Social Security taxes was substituted.)
When it comes to a choice between a traditional IRA or a Roth IRA, the bottom line is no one knows for sure what's best, and most likely you won't know in the future, either. Much of life involves operating on limited information in foggy conditions. One approach would be to split your contributions between a traditional and a Roth, thereby hedging your bets. Another approach is to use only a Roth. While it's more expensive to fund, a Roth is easier administratively on the back end--when you're 83 and juggling a half a dozen prescription medications, you won't want to fool around with the IRS formula for minimum required distributions from your IRA. And a Roth may be a beneficial estate planning tool if you want to leave money to someone else.
Note to the truly frugal. If you have a moderate or low income, you may actually be able to get a tax credit of up to $1,000 for contributions to a traditional or Roth IRA. The credit is available in 2011 only if your income is $55,500 if married and filing jointly, $41,625 if you file as a Head of Household, or $27,750 if single, married filing separately or a qualifying widow(er). This credit offers a dollar-for-dollar reduction of your tax liabilities, so it's worth claiming if you can (in essence, the government funds your IRA up to $1,000). It isn't easy to save at these income levels, but the 7 or 8 Americans who manage to do so can get a nice tax credit.
Wednesday, January 13, 2010
IRAs and 401(k)s Aren't Retirement Plans. But a Roth Conversion May Help Your Estate Plan.
It's easy to think of IRAs and 401(k)s as retirement plans. They're not. IRAs and 401(k)s are retirement accounts. They serve as tax shelters to delay taxation of the money contributed to them. However, the amounts that you are allowed to shelter have no particular relationship to how much money you need for retirement. The IRS limits on contributions to IRAs ($5,000 in 2009 or $6,000 if you're 50 or older) and 401(k)s ($16,500 in 2009 or $22,000 if you're 50 or older) are simply the amount you can shelter from taxation. In both the saving phase and the withdrawal phase of your retirement planning, don't confuse tax issues with financial planning. Here's why.
Saving. How much you need to save for retirement may be more or less than the amounts the tax code lets you shelter. You should base your saving rate on a prudent estimate of your life expectancy. That is more easily said than done. Life expectancy is influenced by family history, your personal habits and diet, your occupation, the availability and quality of health care, and a host of other factors. If you dabble with life expectancy calculators on the Internet, you're likely to get a range of estimates as wide as 15 or so years. That's a big difference from a financial planning standpoint. Make the best estimate (meaning most accurate) you can of your life expectancy. Then add 10 years to account for medical advances. The resulting lifespan is probably a pretty safe assumption for financial planning purposes. Save in aftertax accounts if the amount that you can shelter in 401(k)s and IRAs isn't enough.
If all this number crunching is painful, then follow a simple formula: if you save 15% to 20% of your pretax earnings over the course of a 30 to 40 year career and invest it in a diversified portfolio, the amount you save plus Social Security will probably let you have a retirement lifestyle pretty close to what you enjoyed while working. For more details, see http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.
Withdrawals. Once you reach the age of at least 59 and 1/2, you can start making withdrawals from your retirement accounts. At the age of 70 and 1/2, you are required to begin making withdrawals, whether or not you want to. The IRS has no objections if you withdraw your savings faster than required; they get more taxes upfront that way. But at 70 and 1/2, the process of minimum withdrawals begins. The exact amount of your minimum withdrawal will depend on IRS formulas designed to increase sales for antacid manufacturers. But the important point here is that the amount you're required to withdraw may or may not be safe for you to spend. If you have a longer than average life expectancy, save some of the aftertax portion of the withdrawal. Remember that the IRS withdrawal formulas are tax rules, not financial plans.
Avoid withdrawals with a Roth Conversion. One step that may simplify your retirement planning would be conversion of your IRA(s) to a Roth IRA. Traditional IRA accounts may be converted to Roth IRAs in 2010 without any income limitations (which were a problem in the past for many people). Conversion requires paying current income taxes on the amount converted, and you have to consider whether you're prepared to do that. There are lots of arguments why conversion will or won't save you taxes. How this analysis turns out could depend on tax legislation that remains to be adopted in 2010 and you may want to delay the decision whether or not to convert until later this year. But if you don't think you'll need your IRA assets, conversion to a Roth will let you avoid mandatory withdrawals altogether. That way, you can pass the entire account onto your heirs. Paying taxes now, but then letting the account grow on an aftertax basis could provide your heirs with quite a tidy sum. They'll have to make minimum withdrawals, but the withdrawals are tax-free and the remaining balance continues to grow tax free. Thus, converting a traditional IRA to a Roth can be an effective estate planning tool.
Saving. How much you need to save for retirement may be more or less than the amounts the tax code lets you shelter. You should base your saving rate on a prudent estimate of your life expectancy. That is more easily said than done. Life expectancy is influenced by family history, your personal habits and diet, your occupation, the availability and quality of health care, and a host of other factors. If you dabble with life expectancy calculators on the Internet, you're likely to get a range of estimates as wide as 15 or so years. That's a big difference from a financial planning standpoint. Make the best estimate (meaning most accurate) you can of your life expectancy. Then add 10 years to account for medical advances. The resulting lifespan is probably a pretty safe assumption for financial planning purposes. Save in aftertax accounts if the amount that you can shelter in 401(k)s and IRAs isn't enough.
If all this number crunching is painful, then follow a simple formula: if you save 15% to 20% of your pretax earnings over the course of a 30 to 40 year career and invest it in a diversified portfolio, the amount you save plus Social Security will probably let you have a retirement lifestyle pretty close to what you enjoyed while working. For more details, see http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.
Withdrawals. Once you reach the age of at least 59 and 1/2, you can start making withdrawals from your retirement accounts. At the age of 70 and 1/2, you are required to begin making withdrawals, whether or not you want to. The IRS has no objections if you withdraw your savings faster than required; they get more taxes upfront that way. But at 70 and 1/2, the process of minimum withdrawals begins. The exact amount of your minimum withdrawal will depend on IRS formulas designed to increase sales for antacid manufacturers. But the important point here is that the amount you're required to withdraw may or may not be safe for you to spend. If you have a longer than average life expectancy, save some of the aftertax portion of the withdrawal. Remember that the IRS withdrawal formulas are tax rules, not financial plans.
Avoid withdrawals with a Roth Conversion. One step that may simplify your retirement planning would be conversion of your IRA(s) to a Roth IRA. Traditional IRA accounts may be converted to Roth IRAs in 2010 without any income limitations (which were a problem in the past for many people). Conversion requires paying current income taxes on the amount converted, and you have to consider whether you're prepared to do that. There are lots of arguments why conversion will or won't save you taxes. How this analysis turns out could depend on tax legislation that remains to be adopted in 2010 and you may want to delay the decision whether or not to convert until later this year. But if you don't think you'll need your IRA assets, conversion to a Roth will let you avoid mandatory withdrawals altogether. That way, you can pass the entire account onto your heirs. Paying taxes now, but then letting the account grow on an aftertax basis could provide your heirs with quite a tidy sum. They'll have to make minimum withdrawals, but the withdrawals are tax-free and the remaining balance continues to grow tax free. Thus, converting a traditional IRA to a Roth can be an effective estate planning tool.
Wednesday, May 30, 2007
Shop for Your Mortgage Loan
Would you pay $30,000 for a car if you could buy it for $20,000? Of course not. But it turns out that many people have done the equivalent with their mortgage loans. On May 30, 2007, CNN.money.com reported that many subprime borrowers could have gotten a prime mortgage. See http://money.cnn.com/2007/05/29/real_estate/could_have_had_a_prime/index.htm?postversion=2007053012. That means a lot of people got stuck with a more expensive mortgage than necessary.
Subprime mortgages can have an interest rate 3% higher than a prime mortgage. As the CNNMoney article points out, that difference can increase the monthly payments on a $200,000 mortgage by $300, or $3,600 a year. Can you afford to throw away $3,600 a year? That would be almost all the money you’re entitled to contribute annually to an IRA.
Why does this happen? Because mortgage brokers are rewarded to sell subprime loans. They are paid by commission, and a subprime mortgage’s commission can be as much as 5 times greater than the commission for a prime mortgage. So, like the car salesperson who wants you to buy a model with all the options, a mortgage broker has the incentive to sell you a subprime mortgage, whether or not you need one.
Who do you think covers the cost of the high subprime mortgage commissions? You, the borrower, do, if you take out a subprime mortgage.
What can you do? If you’re already in a subprime mortgage and think you're prime quality, try to refinance into a less expensive mortgage. If you're just looking for a mortgage loan, comparison shop. Shop for a mortgage just like you would shop for a car. People routinely contact several car dealers when looking for the best deal on a car. (See our recent blog on how to get a good deal on a new car: http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.) Contact several lenders—try the bank where you have an account, or a credit union if you can join one. Then try the next few banks and credit unions down the street. Do this without going through a mortgage broker, and see what quotes you get.
If you want to use a mortgage broker, look for one who will work for a fixed fee that is set in advance, without any commissions or compensation from anyone but you. A fixed fee will reduce the incentive for the broker to put you into a high-interest rate mortgage you don’t need. An organization called Upfront Mortgage Brokers Association (www.upfrontmortgagebrokers.org) may be able to help you find a broker willing to work for a fixed fee.
Interview a mortgage broker before hiring him or her. Ask about all of his or her sources of compensation and whether the broker will be paid more if you are sold a mortgage with features that may be costly to you (like higher or increasing interest rates or a prepayment penalty). Also ask the broker how many lenders he or she deals with regularly. You want to find out if the broker will work aggressively to get you the best deal, or will simply place you with a lender with whom he or she has had a long-standing relationship. Not all mortgage brokers are crooks, but it pays to be careful.
Keep your mortgage loan simple: look for a 30-year or 15-year fixed rate mortgage. These loans are pretty straightforward, which makes comparison shopping easier. Also, your risks are lower because by definition the interest rate won’t go up. See our earlier blog about why the right mortgage loan helps you build wealth
(http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html).
Crime News: You’ve heard of cat burglars stealing jewelry. This one must have been a tiger burglar. http://www.wtop.com/?nid=456&sid=1153406.
Subprime mortgages can have an interest rate 3% higher than a prime mortgage. As the CNNMoney article points out, that difference can increase the monthly payments on a $200,000 mortgage by $300, or $3,600 a year. Can you afford to throw away $3,600 a year? That would be almost all the money you’re entitled to contribute annually to an IRA.
Why does this happen? Because mortgage brokers are rewarded to sell subprime loans. They are paid by commission, and a subprime mortgage’s commission can be as much as 5 times greater than the commission for a prime mortgage. So, like the car salesperson who wants you to buy a model with all the options, a mortgage broker has the incentive to sell you a subprime mortgage, whether or not you need one.
Who do you think covers the cost of the high subprime mortgage commissions? You, the borrower, do, if you take out a subprime mortgage.
What can you do? If you’re already in a subprime mortgage and think you're prime quality, try to refinance into a less expensive mortgage. If you're just looking for a mortgage loan, comparison shop. Shop for a mortgage just like you would shop for a car. People routinely contact several car dealers when looking for the best deal on a car. (See our recent blog on how to get a good deal on a new car: http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.) Contact several lenders—try the bank where you have an account, or a credit union if you can join one. Then try the next few banks and credit unions down the street. Do this without going through a mortgage broker, and see what quotes you get.
If you want to use a mortgage broker, look for one who will work for a fixed fee that is set in advance, without any commissions or compensation from anyone but you. A fixed fee will reduce the incentive for the broker to put you into a high-interest rate mortgage you don’t need. An organization called Upfront Mortgage Brokers Association (www.upfrontmortgagebrokers.org) may be able to help you find a broker willing to work for a fixed fee.
Interview a mortgage broker before hiring him or her. Ask about all of his or her sources of compensation and whether the broker will be paid more if you are sold a mortgage with features that may be costly to you (like higher or increasing interest rates or a prepayment penalty). Also ask the broker how many lenders he or she deals with regularly. You want to find out if the broker will work aggressively to get you the best deal, or will simply place you with a lender with whom he or she has had a long-standing relationship. Not all mortgage brokers are crooks, but it pays to be careful.
Keep your mortgage loan simple: look for a 30-year or 15-year fixed rate mortgage. These loans are pretty straightforward, which makes comparison shopping easier. Also, your risks are lower because by definition the interest rate won’t go up. See our earlier blog about why the right mortgage loan helps you build wealth
(http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html).
Crime News: You’ve heard of cat burglars stealing jewelry. This one must have been a tiger burglar. http://www.wtop.com/?nid=456&sid=1153406.
Wednesday, May 16, 2007
Investing Made Simple
There's a simple way to invest that gives you the diversified portfolio designed for long term growth that financial experts recommend. And the best part of it is that you don't have to a lot of research into stocks, mutual funds or other investments. We're talking about lifecycle funds, which are also called target date funds.
Lifecycle and target date funds solve two basic problems investors face. First, you should diversify your investments, so that you don't have all your eggs in one basket. Typically, a variety of stocks and bonds is recommended.
Second, you should change the focus of your diversification as you grow older. In your 20's and 30's, your portfolio should be heavily weighted toward stocks, since they have greater potential for long term growth. Of course, stocks can nosedive in value if the market stumbles--and you can be sure it will stumble every now and then. But when you're young, you still have plenty of time to ride through market turbulence and profit from the next upswing. As you grow older, you have less time to recover from investment losses. Therefore, you should shift more of your portfolio into bonds and even money market funds in order to lock in the gains you've achieved and stabilize your financial foundation.
Given the vast array of investments available, how could an ordinary investor figure out how to diversify, and then how to change the diversification appropriately over time? If you have time every week to devote to investment research and strategizing, you could probably do reasonably well. But what if you have a job to keep, kids to raise, housekeeping to do, and fun to have?
The solution is to invest in lifecycle and target date funds. These mutual funds provide a diversified portfolio for you. All you do is pay in your money and they automatically invest it in a diversified way. They have "target dates," which are years (usually in increments of 5, like 2010, 2015, 2020, 2025, 2030, etc.). You pick a year that's close to the time when you plan to retire. For example, if you were born in 1975 and expect to retire around age 65, you'd invest in a fund with a target date of 2040. Right now, this fund would probably be mostly invested in stocks (probably somewhere around 80% in stocks, with the remaining 20% in bonds). As you grow older, the management firm operating the lifecycle or target date fund will gradually reduce the stock portion of the fund's assets and increase the bond portion. By the time you reach 65, the fund might have something like 30% to 40% of its assets in stocks, and the rest in bonds and money market funds. This conservative allocation is meant to lock in much of your investment gains so that you'll have some certainty for your retirement finances.
As with any mutual fund, you should look closely at the fees and expenses of lifecycle and target date funds. Some are noticeably more expensive than others, and in the long run, high fees and expenses can be costly. Vanguard and Fidelity offer lifecycle or target date funds that have pretty low costs. Other mutual fund management companies may also offer low cost funds.
If you are a bit of a stock market buff, you may want to think about the diversification philosophies of the lifecycle or target date funds you consider. They tend to have slightly different approaches--some are more heavily weighted toward stocks, while others have a greater preference for bonds. Make sure you are comfortable with the fund's diversification philosophy.
With a lifecycle or target date fund, all the investment strategizing and diversification happens automatically. You just pay in your money and the fund's managers do the rest of the work.
More and more 401(k) plans are offering lifecycle or target date funds as an investment option. If your employer doesn't offer them, lobby for them. They'll make the process of retirement saving much simpler for you. You can invest in these funds through an IRA--just open the IRA with the mutual fund management company offering the funds in which you are interested. If you've maxed out your retirement accounts and want to save more, you can always open a taxable account with a mutual fund management company and invest in a lifecycle or target date fund that way.
Doing things the simple and easy way means you're more likely to do them. We all recognize the importance of saving for retirement. Keep lifecycle and target date funds in mind as one of the easiest ways to build wealth.
Entertainment News: Celebrity phobias. You've heard of some of this stuff--claustrophobia, fear of flying, fear of heights, and fear of snakes. But pigs? Eggs? Ferns? Gerbils? Houseplants? Antiques? Silver cutlery? Bright colors? And chewing gum? We're not making this up. See www.nbc4.com/slideshow/entertainment/13331800/detail.html.
Lifecycle and target date funds solve two basic problems investors face. First, you should diversify your investments, so that you don't have all your eggs in one basket. Typically, a variety of stocks and bonds is recommended.
Second, you should change the focus of your diversification as you grow older. In your 20's and 30's, your portfolio should be heavily weighted toward stocks, since they have greater potential for long term growth. Of course, stocks can nosedive in value if the market stumbles--and you can be sure it will stumble every now and then. But when you're young, you still have plenty of time to ride through market turbulence and profit from the next upswing. As you grow older, you have less time to recover from investment losses. Therefore, you should shift more of your portfolio into bonds and even money market funds in order to lock in the gains you've achieved and stabilize your financial foundation.
Given the vast array of investments available, how could an ordinary investor figure out how to diversify, and then how to change the diversification appropriately over time? If you have time every week to devote to investment research and strategizing, you could probably do reasonably well. But what if you have a job to keep, kids to raise, housekeeping to do, and fun to have?
The solution is to invest in lifecycle and target date funds. These mutual funds provide a diversified portfolio for you. All you do is pay in your money and they automatically invest it in a diversified way. They have "target dates," which are years (usually in increments of 5, like 2010, 2015, 2020, 2025, 2030, etc.). You pick a year that's close to the time when you plan to retire. For example, if you were born in 1975 and expect to retire around age 65, you'd invest in a fund with a target date of 2040. Right now, this fund would probably be mostly invested in stocks (probably somewhere around 80% in stocks, with the remaining 20% in bonds). As you grow older, the management firm operating the lifecycle or target date fund will gradually reduce the stock portion of the fund's assets and increase the bond portion. By the time you reach 65, the fund might have something like 30% to 40% of its assets in stocks, and the rest in bonds and money market funds. This conservative allocation is meant to lock in much of your investment gains so that you'll have some certainty for your retirement finances.
As with any mutual fund, you should look closely at the fees and expenses of lifecycle and target date funds. Some are noticeably more expensive than others, and in the long run, high fees and expenses can be costly. Vanguard and Fidelity offer lifecycle or target date funds that have pretty low costs. Other mutual fund management companies may also offer low cost funds.
If you are a bit of a stock market buff, you may want to think about the diversification philosophies of the lifecycle or target date funds you consider. They tend to have slightly different approaches--some are more heavily weighted toward stocks, while others have a greater preference for bonds. Make sure you are comfortable with the fund's diversification philosophy.
With a lifecycle or target date fund, all the investment strategizing and diversification happens automatically. You just pay in your money and the fund's managers do the rest of the work.
More and more 401(k) plans are offering lifecycle or target date funds as an investment option. If your employer doesn't offer them, lobby for them. They'll make the process of retirement saving much simpler for you. You can invest in these funds through an IRA--just open the IRA with the mutual fund management company offering the funds in which you are interested. If you've maxed out your retirement accounts and want to save more, you can always open a taxable account with a mutual fund management company and invest in a lifecycle or target date fund that way.
Doing things the simple and easy way means you're more likely to do them. We all recognize the importance of saving for retirement. Keep lifecycle and target date funds in mind as one of the easiest ways to build wealth.
Entertainment News: Celebrity phobias. You've heard of some of this stuff--claustrophobia, fear of flying, fear of heights, and fear of snakes. But pigs? Eggs? Ferns? Gerbils? Houseplants? Antiques? Silver cutlery? Bright colors? And chewing gum? We're not making this up. See www.nbc4.com/slideshow/entertainment/13331800/detail.html.
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