retirement savings

Playing it safe could mean losing money

April 29, 2013 By Liz Weston

Dear Liz: The certificate of deposit I owned in my Roth IRA recently matured. I’ve put the money into a Roth passbook account until I can figure out what to do with it. I’m a public school teacher and have a 457 deferred compensation plan to which I contribute monthly. I am 57 and will need to work until I am at least 65. What should I do with the money in my Roth?

Answer: As a public school teacher, you probably have a defined benefit pension that will give you a guaranteed monthly check for life once you retire. Depending on how long you’ve taught and where, this pension could cover a substantial portion of your living expenses.

The guaranteed nature of this pension means that you may be able to take more risk with your other investments. That would mean your Roth could be invested in stock mutual funds or exchange-traded funds that offer potential for growth. CDs and other “safe” investments can’t offer that — in fact, your money loses purchasing power since you’re not earning enough interest to even offset inflation.

Since you’re so close to retirement, you should invest a few hundred dollars in a session with a fee-only financial planner who can review your situation and offer personalized advice.

Use windfall to boost retirement savings

April 8, 2013 By Liz Weston

Dear Liz: What would you suggest that someone do with $20,000 if the someone is closer to 40 than 30, single, with $100,000 of student loan debt and a $250,000 mortgage? My salary is around $100,000 a year. I have an emergency fund equal to six months of expenses and I make an annual IRA contribution since my employer doesn’t offer a 401(k) plan. Should I accelerate my student loan payments, since the interest isn’t tax deductible for me because my income is too high? Or should I invest instead? If I invest, should I put it all in a total market stock index fund or is that too risky?

Answer: Even if you’re making the maximum annual IRA contribution of $5,500 (people 50 and older can contribute an additional $1,000), you’re probably not saving enough for retirement. You can check the numbers using a retirement calculator (AARP offers a good one at its website, http://www.aarp.org). If indeed you’re coming up short, then consider opening a taxable brokerage account and earmarking it for retirement. You can use a chunk of your $20,000 windfall to get started, but also set up regular ongoing contributions.

The bulk of your retirement money should be invested in stocks, since that’s the only asset class that consistently outperforms inflation over time. If you try to play it too safe and avoid stocks, your purchasing power is likely to decline over the years instead of growing. A total market index fund with low expenses is a good bet for delivering diversification at low cost. But leaven your portfolio with bonds and cash as well, since these assets can cushion market downturns. All the returns that stocks give you in good markets won’t be much help if you panic and sell in a bad market. People who try to time the market that way often miss the subsequent rally, so they wind up selling low and buying high — not a winning way to invest.

If you don’t want to try to figure out an asset allocation, look for a low-cost target date fund. If you plan to retire in about 25 years, you’d want to look for a “Retirement 2040” fund.

Once you get your retirement savings on track, then you can start paying down that student loan debt. Target private loans first, if you have any, since they’re less flexible and have fewer consumer protections than federal student loan debt.

My book is out! Get it for free.

March 7, 2013 By Liz Weston

“Deal with Your Debt” is now available, and I’m giving away five copies this week.

To enter to win, leave a comment here on my blog (not my Facebook page).

Click on the tab above the post that says “comments.” Make sure to include your email address, which won’t show up with your comment, but I’ll be able to see it.

If you haven’t commented before, it may take a little while for your comment to show up since comments are moderated.

The winners will be chosen at random Friday night. Over the weekend, please check your email (including your spam filter). If I don’t hear from a winner by noon Pacific time on Monday, his or her prize will be forfeited and I’ll pick another winner.

Also, check back here often for other giveaways.

The deadline to enter is midnight Pacific time on Friday. So–comment away!

Combat zone contractors don’t get Roth IRA perk

March 4, 2013 By Liz Weston

Dear Liz: I’m working as a contractor in Afghanistan. Since we are overseas in a combat zone, our pay is nontaxable. Can I contribute some of this untaxed money to a Roth IRA and still be able to withdraw it tax free in retirement? I’ve heard that’s true, but the way I read the law it seems that the money has to come from “taxable” wages or something along those lines. I need clarification.

Answer: If you were serving in the military, rather than as a contractor, you would be able to contribute some of your untaxed combat-zone pay to a Roth IRA and have tax-free withdrawals in retirement. That’s a unique perk of the military, however.

Service members’ tax-free combat zone pay qualifies as income for purposes of making an IRA or Roth IRA contribution because of the 2006 Heroes Earned Retirement Opportunities Act, said Joseph Montanaro, a certified financial planner with USAA.

If your pay is tax free as a contractor, it’s probably because you qualify for the foreign earned income exclusion, which protects some or all of your pay from U.S. taxes (up to $95,100 for 2012), Montanaro said. Your eligibility for this exclusion has nothing to do with working in a combat zone. It has to do with your residence or physical presence abroad.

Income that is excluded this way cannot be used as compensation for the purpose of making an IRA contribution, Montanaro said. It would, however, have to be included when determining your eligibility to make a Roth contribution.

What to do with extra cash when an auto loan is paid off

February 25, 2013 By Liz Weston

Dear Liz: I’ll be done paying off my car in a couple of months. What’s a good strategy for redirecting that money once it’s paid off? Should I use the whole amount each month to start saving for my next car, or would I be better off splitting it up and putting it into several savings “buckets” such as retirement, emergency and my next car? I’m 35, have an emergency fund equal to four months’ living expenses and only one other debt, a very low-interest student loan.

Answer: If you aren’t already contributing to a retirement plan, you should be. If you aren’t contributing enough, that should be your priority even before you pay off your debt.

Market researcher and Yale University professor Roger Ibbotson has found that people who start saving for retirement after age 35 have an extremely difficult time “catching up.” They’ve lost a crucial decade or more, and often can’t set aside enough to offset their late start.

If you are on track for retirement and are comfortable with your emergency fund, saving to pay cash for your next car is a reasonable course.

No 401(k)? Set up transfers to IRA

January 21, 2013 By Liz Weston

Dear Liz: I started a new job, but unfortunately it does not offer a 401(k). I have an IRA but don’t contribute to it. What is the best way to contribute so I can discipline myself in saving for retirement? I am 47.

Answer: The best way to save for retirement is to leave the issue of discipline out of it. If you have to discipline yourself to make the right choice every paycheck, you’ll wind up spending the money rather than saving it.

Instead, put your savings on automatic. You can contribute $5,500 year to your IRA. Divide $5,500 by the number of paychecks you get in a year and set up an automatic transfer of that amount. If you’re paid every other week, for example, you would divide $5,500 by 26 paychecks to get $211.54, which is the amount you should have transferred into your IRA every two weeks.

If you can save more, then open a regular brokerage account and set up automatic transfers into that. You won’t get a tax break for your contributions, but if you hold your investments for at least one year you’ll qualify for long-term capital gains rates that are lower than regular income tax rates.

Once you’ve set up these transfers you need to keep your hands off the money. Don’t treat your retirement funds as emergency cash or tap into them for any other reason. You’re getting a late start and you’ll need every dollar you can save if you want a comfortable retirement.