Ask Liz Weston

Dear Liz: I have almost $250,000 in my retirement accounts. I also have almost $50,000 in credit card debt. Should I take $50,000 from my 401(k) to pay off the debt?

Answer: No, no, no.

In case that wasn’t clear: No.

Of all the dumb financial moves you can make, raiding retirement funds to pay off credit card debt ranks near the top. You’ll pay penalties and taxes that typically equal one-quarter to one-half of any withdrawal, plus you lose the future tax-deferred returns that money could make. If you’re 30 years from retirement, that $50,000 withdrawal would cost you $500,000 in lost retirement income, assuming an 8% average annual return.

The fact that you have that much debt puts you at high risk of bankruptcy. In bankruptcy, your unsecured debt can be wiped out or reduced, while your retirement funds would be protected from creditors.

If you can’t figure a way to pay off your debt without raiding your retirement, you need to make two appointments: one with a legitimate credit counselor (visit the National Foundation for Credit Counseling at www.nfcc.org) and another with a bankruptcy attorney.

Dear Liz: My husband is quite a bit older than I (about 18 years). When we married, we agreed that we should put all our savings into joint funds and into his retirement accounts. Our thought was that since I’m younger, we’d have much earlier access to retirement money by funneling it into his retirement accounts (as opposed to mine), and that it was unfair for me to sock away money that he may never have access to.

Intellectually it feels like the fair way to go, since we both work and are equally responsible for our family’s finances. The money we’ve been putting in his retirement accounts will ultimately belong to both of us. But emotionally, I feel anxious about not having my own accounts. Should I just work this out in therapy (joking) or am I right to be concerned? What would you advise for a couple like us with an age difference?

Answer: You are likely to outlive your husband by at least two decades. Rather than focusing on early access to retirement funds, you should be making sure that money lasts for a lifetime: your lifetime, not just his. By the way, considering your own needs is not unfair — it’s sensible. A loving husband wouldn’t want to leave you old, alone and impoverished.

You may not need a session with a therapist, but you should definitely have a meeting with a fee-only financial planner who can review your situation and make sure the needs of both of you are considered.

Dear Liz: I have high credit scores, no debt, a large retirement fund including a generous pension and a home I own free and clear. I plan to retire in four years and am thinking of moving to be near family.

Should I buy my retirement home now while real estate values and interest rates are low? I could make a 20% down payment and rent it out until I can move in. I should be able to sell my current house and pay off the loan when I retire.

Or should I just be patient and buy a place after I retire? If I wait, I could pay cash for the next house, but property values may rise, and I suspect they’ll rise faster in my future town than in my current one.

Answer: Getting a loan to buy a rental property is difficult these days. Although your high credit scores and solid finances will help, you may have to come up with a down payment larger than 20%, and your interest rate almost certainly will be higher than if you planned to live in the home right away.

Then there are all the issues associated with being a long-distance landlord. You would need to screen tenants, respond quickly to repair requests and keep a substantial reserve fund to pay the mortgage when the property is vacant. A property management company could help, but such outfits typically take 10% or more of any rent payments.

Also consider that your plans could change. Although being close to family is important, you may decide you don’t want to give up ties to your current home or its environment.

If you haven’t spent a substantial amount of time in the area where you plan to move, consider taking a long vacation there when the weather is at its worst so you have a good idea of what life there might be like.

That’s not to say your plan can’t work, but you need to do some research, carefully go over the numbers and think about whether you’re up to this task.

Dear Liz: I am 57 and was just terminated from my job of 37 years. I have a pension and a 401(k). I went to see a financial advisor the other day and he suggested I buy an annuity. I know it is not FDIC-insured, but is it a really safe bet?

Answer: Annuities are complicated, often expensive investments that typically offer handsome commissions to the people that sell them. Before you buy one, you should thoroughly research what you’re getting into. A good place to start is AnnuityTruth.org. This site, run by the nonprofit education and counseling center Healthcare and Elder Law Programs Corp., offers a tutorial to understand the basics of annuities, warnings about inappropriate sales techniques and shopping tips for those who want to buy them.

Even after doing your homework, you still may have questions about whether an annuity is right for you. Rather than accept advice from a salesperson, which is what your “financial advisor” probably is, consider consulting a fee-only financial planner. These planners are compensated only by the fees you pay and do not accept commissions for selling financial products.

You can find fee-only planners who cater to middle-class investors at GarrettPlanningNetwork.com. Another resource is the National Assn. of Personal Financial Advisors at NAPFA.org or (888) FEE-ONLY.

photo credit: Daniel Greene

I’m getting to this good news a little late, but it’s still worth noting. Fidelity Investments reported last month that more workers increased the amount of money they put into their 401(k) accounts during the second quarter than decreased their contributions. In the three months ended June 30, 4.7% boosted their contributions, with just 3% decreasing it.

That was a switch from the previous three quarters, when workers with decreasing contributions had outnumbered those raising them. In those earlier quarters, over 6% of participants cut their contributions.

Note that we’re talking about changes made on the margins, since the vast majority of 401(k) contributors don’t make any changes month to month or even year to year. And that’s a good thing. Those who keep on investing in good years and bad will ultimately make more money than those who try to time the markets.

Maybe it’s time to look at your own 401(k) contribution rate and see if you might be able to boost it a percentage point or two. If you need some inspiration, use MSN’s Retirement Planner to see how much you should be saving.

Other findings from Fidelity:

• The average 401(k) account balance rose 13.5 percent in the second quarter from the end of the first quarter in 2009 to $53,900. The increase was primarily driven by increases in the stock markets as well as worker and employer contributions.
• About 68 percent of the money contributed to 401(k)s  went to stocks, which is down from 75 percent in the past few years and a high of more than 80 percent in 2000.
• About 42 percent of contributions went to domestic and international stocks; 24 percent to blended or lifecycle investments; 8 percent to company stock; 24 percent to conservative investments, such as money markets and fixed-income assets.

Need more info? Check out some of my advice on saving and retirement:

• How to retire in bad times
• No 401(k) match? Save anyway
• Under 35? Hurray for the meltdown!

Dear Liz: I’m 59 and unemployed. My husband, who is turning 65 in July, recently lost his job as well. We’ve saved about $12,000 for emergencies and have a couple of 401(k) accounts totaling about $110,000. My husband receives about $1,800 a month from Social Security and a pension. We’re not too hopeful about finding jobs at our ages and in our area.

Should we begin drawing on the 401(k)s for income to pay our bills after the savings run out, or should we seek credit counseling to reduce our consumer debt? I’m scared of what our future holds and worried about losing my insurance coverage through COBRA after the subsidy runs out.

Answer: You didn’t say how much consumer debt you have or what your monthly expenses are, but the fact that you’re thinking of tapping your relatively small retirement stash indicates you’re probably in deep trouble.

A debt management plan through credit counseling will work only if you have the extra income to pay off your credit cards over the next five years. If you don’t, bankruptcy may be the better option. Even if you think credit counseling will help, consult a bankruptcy attorney so you understand all your options.

In fact, you should talk to a bankruptcy attorney any time you’re considering tapping a retirement fund early to pay off debt. Retirement funds are typically protected in Bankruptcy Court, while most unsecured debt can be wiped out.

And you don’t have that big a nest egg, anyway. At your age, you can draw only $3,000 to $4,000 a year from your retirement funds without dramatically increasing the risk of running out of money before you run out of years.

Target-date funds can be a good choice for people new to investing, or those who simply don’t want to mess with the details of picking asset allocations and rebalancing their portfolio. Many big-company 401(k) plans now offer target-date funds, as do most big mutual fund companies and brokerage firms.

These funds do all the heavy lifting for you, gradually adjusting the investment mix over time so you take less risk as you approach your “target date”–typically a year near when you plan to retire.

But apparently a lot of people have misconceptions about target-date funds and what they can accomplish.

Behavioral Research Associates interviewed 250 Americans and found that many thought the investment option offered some kind of guarantee. For example:

•    Over 60% of employees say that investing in target-date funds means they will be able to retire on the target date.
•    38% think target-date funds offer a guaranteed return.
•    30% of workers think they can save less money and still meet their retirement goals if they invest in a target-date fund.
•    Over 23% of workers believe that there is little to no chance that they will lose money either before or after the target date.
•    41% think there is little to no chance of losing money in any one-year period, and
•    70% think they are equally as likely or less likely to lose money in any one-year period, as compared to investing in money market funds.

Obviously, none of these misconceptions is true. Target funds adjust your risk over time, but they certainly don’t eliminate it. Even when you approach your retirement date, your target fund may still have half or more of its assets in stocks.

That doesn’t mean you should bail on your target-date fund, but–as with all investments–you should understand the real risks and rewards.

You can CLICK HERE to read the researchers’ comments to the SEC and Department of Labor about their findings.

For more on this topic, read:

• One-fund retirement: Buy and forget
• Don’t shy away from target-date funds
• Target-date funds come under fire

Communication about finances is one of the keys to a happy marriage, as I wrote in “7 steps to take before you wed.”

Unfortunately, most of the couples recently surveyed by Fidelity Investments are falling short, at least when it comes to their own finances.

More than half of the older, affluent couples (aged 45 and up, with incomes of $75,000 and above) surveyed said that one of the best pieces of advice they would give to newlyweds is to make all financial decisions together. But fewer than half (45 percent) of the same couples reported making decisions jointly about day-to-day finances. Only 15 percent of couples feel confident that both of them could assume responsibility for their joint finances if necessary.

These couples often weren’t on the same page about their retirement finances, either. Key findings:

• 60 percent of couples do not agree on their retirement ages
• Almost half don’t agree on whether they will continue to work in retirement
• More  than 40 percent don’t agree on their expected retirement lifestyle

Time to start talking to each other and working things out. You need a plan that both of you can agree with and understand. Here are some of my columns with tips to get you going:

• Get real: Marriage is a business
• 9 ways to rein in a spendthrift spouse
• How to retire in bad times

It sounded like a heck of a story–too bad the facts get in the way.

The press release proclaimed that “taxes, not health care, are retirees’ biggest expense when they’re in their 70s,” according to a study commissioned by a financial group to whom I will not give a shred of publicity.

Surprising, yes? Except the only folks surveyed for this study were 70-somethings with a net worth in excess of $1 million.

The median net worth for a household headed by someone in his or her 70s was actually just a hair over $203,000 in 2007, according to the latest Federal Reserve Survey of Consumer Finances. “Median” means half of the households had less wealth. Only 13% of this age group had a net worth over $1 million back then. There are probably even fewer today, what with the housing meltdown and stock market crash.

Median income for this age group, meanwhile, was $30,645. It’s hard to imagine taxes being a major concern to the 50% of 70-somethings making less than $2,600 a month.

In fact, the Consumer Expenditure Survey indicates the average tax burden for those aged 65 to 74 is $1,374 a year, an amount that drops to $865 for those 75 and over.

By contrast, here are average health care expenses for older people from the 2004 National Health Expenditure Survey (the latest year available):

• Seniors age 65 and over spent an average of $4,888 per capita annually out of pocket for deductibles, copayments, premiums and other health care expenses not covered by insurance.
• Their spending is more than twice as high as the average nonelderly adult.
• The largest expenditures occurred among those 85 and older, who spent an average of $8,304, compared to $5,066 for seniors ages 75 to 84, and $3,851 for those 65 to 74.

Why did this release irritate me so? Because it pretended that a minor irritation of a privileged few was a bigger deal than a real, and growing, crisis for many older families.

Taxes are what a friend of mine would call a “quality” problem. You don’t pay them, typically, unless you’re making money.

Health care costs are simply a problem, and a big one for many older Americans.

Dear Liz: I’ve been contributing to a traditional individual retirement account for the last few years. Taking one of your recommendations, I would like to move the money to a Roth IRA. I understand that I’ll have to pay taxes on the conversion, but will there also be any penalties involved? If so, how much of a penalty? If there is no penalty and only taxes, what is the rate I should be expecting?

Answer: Roth IRAs offer tax-free withdrawals in retirement, which is why they’re a great deal for many savers, and conversions are about to become easier.

Currently there is no penalty for converting a traditional IRA to a Roth, but you will owe income taxes that are determined by your tax bracket. If you’re in the 25% federal tax bracket, for example, you’ll owe taxes equal to 25% of the amount you convert, assuming your contributions were all tax-deductible. (If you made nondeductible contributions, those will reduce the tax bill proportionately.) You’ll also need to factor in state and local income taxes.

You can convert to a Roth this year only if your modified adjustable gross income is $100,000 or less. Next year, however, the income limit on Roth conversions is scheduled to be removed. Also, for 2010 only, you can opt to have the taxable income from your conversion reported in two equal installments in 2011 and 2012, putting off the tax bill you owe.

Make sure you have enough cash to cover the taxes without raiding the IRA you’ll be converting. But being able to put off the tax bill, and paying it over two years, should lessen the burden. Talk to your tax pro for details.