The Sun's Financial Diary » Retirement

Financial Tips for College Students

Sun — Tue, 26 Aug 2008 18:29:37 +0000

Original Post on The Sun's Financial Diary

This month, The Money Writers is having its second group writing project. The topic this time is about financial tips for college students, most of them just began their new school year after the long summer break. This is a relatively new area for me, not the financial tips part, but the college part because I didn’t exactly have a college life here in the states. My undergrad years were spent in a college in the northwest China. As you can imagine how much different that experience can be from the college life here nowadays. Back then I didn’t have to pay tuition because it was covered by the government and my parents provided everything else. So basically, the last thing I needed to worry about was money and, therefore, I didn’t develop much financial common sense through my college life, except knowing that money didn’t come easily (maybe that was just enough ).

Though I didn’t went to a college here, I did, however, spent four years in the States to get my graduate degree and experienced a college life, a slightly different one. I still remember the day when I opened my bank account and had my first check book. When I got my first ever credit card, I was really excited. Since then, credit cards have changed the way I approach money and become an indispensable part of my financial life. If there are any financial tips I can offer to college students, the first two come into my mind are:

Earn some money and save some

During the time when I taught at a university, I noticed that lots of my students, while taking five or six courses a semester, worked after classes. Whether you pay your education yourself through a college loan, or, like me, have your parents paid it for you, chances are you may need to work a little bit, on or off campus, to earn some spare cash. It’s always good to have money in your wallet for things you want to do and stuff you want to have. Just don’t spend all the money you earned. So what can you do with your loose changes after you paid all your bills? One of the options is opening an IRA account. You don’t have to make a lot of money to have your own retirement account. As long as you have earned income, you are eligible for an IRA account. An IRA account not only can lower your tax (most likely you will be eligible for making deductible contribution), but also can help you develop the kind of financial discipline you will need after finishing the school.

Get a credit card and use it wisely

You know how important credit worthiness is these days. Without a good credit history, you later will find out it’s going to be difficult to rent an apartment, get a car loan, or sometimes even get the job you want (yes, there are employers check credit history). From my experience, one of the best ways to establish credit history is getting a credit card and use it wisely. Getting a card isn’t really difficult. There are tons of cards designed specially for college students from major issuers such as Citibank, Chase, and American Express. What’s difficult is being responsible with the card. What I mean being responsible is charge your card with care and pay your bill in full every month. Using credit cards can always give people a false sense of ease because there seems to be no money involved, but at the end of the day, you will have to pay the credit card bills. Credit card can be your friend. It can also ruin you if you are not careful with it. The bottom line is, don’t spend more than you earn.

Anything else? Of course, you can always live a frugal college life, as suggested by Jason at Frugal Dad. Meanwhile, check out what other Money Writers are saying:

College Student Money Guide: Financial Tips for Student Success at Money Smart Life
College Student Finance Tips at Brip Blap
How Much Do You Need to Save for College at The Digerati Life
Going Back to School: Here are Some Tips That Helped Me at The Lazy Man and Money

Economic Stimulus Payment Directly Deposited into IRA Accounts?

Sun — Fri, 13 Jun 2008 02:35:10 +0000

Original Post on The Sun's Financial Diary

Economic Stimulus Payment Directly Deposited into IRA Accounts?

Then, are you going to use it?

I didn’t know until yesterday after reading an article on MarketWatch that IRS can actually deposit the economic stimulus payment directly into tax-sheltered accounts such as IRA and Roth IRA (well, we are still waiting for the check to come, which is supposed to be later this month). The article, The do’s and don’ts of withdrawing stimulus payments from an IRA, gives some ideas on what to consider before taking the “found money” out of the retirement account.

From what I read, it seems that most people will use the money, assuming it’s deposited into a bank account, to reduce debt or pay for daily expenses as the cost of living keeps going up. The money indeed helped the economy. A report released today shows that retail sales in May rose an unexpected full percentage point (Bloomberg), fueled tax rebate checks being sent to taxpayers at the end of April. But withdrawing money from an IRA account isn’t as easy as writing a check or hitting the ATM machine. Though IRA has said withdrawing the stimulus payment from an IRA account is free penalty, the extra steps needed should make everybody who selected to deposit the money in retirement accounts think twice unless “you absolutely must or you are sure it makes good financial sense,” says the article.

So what if the money stays in the IRA for its ultimate goal: retirement. I ran a quick calculation on what that $600 (individual) or $1,200 (couple) will look 10, 20, 30 years later if the money isn’t removed now. At a reasonable 8.00% annual return, the stimulus money will become a big pile of cash:

Payment	10 Years	20 Years	30 Years
Individual ($600)	$1,295.35	$2,796.57	$6,037.59
Couple ($1,200)	$2,590.71	$5,593.15	$12,075.19

Even at a moderate 5.00% annual return, the difference is still quite significant:

Payment	10 Years	20 Years	30 Years
Individual ($600)	$977.34	$1,591.98	$2,593.17
Couple ($1,200)	$1,954.67	$3,183.96	$5,186.33

So if the money is already in your IRA account, are you going to take out to help the economy? Or are you going to let it stay there to help your future?

Withdraw the money unless “you absolutely must.”

You Don’t Have to Know Everything to Have an IRA Account

Sun — Tue, 10 Jun 2008 14:06:03 +0000

Original Post on The Sun's Financial Diary

You Don’t Have to Know Everything to Have an IRA Account

My answer is: No, nobody needs to be an expert in order to open and invest in an IRA account.

The biggest obstacle from I can see is not whether you know investing or not, but whether you are determined to save for your own retirement. If you make tons of money, you probably don’t need that $5,000 a year (2008 IRA contribution limit) stacked away for your future. But if you are in the working class like me facing an uncertain future of the social security and with no pension to rely on, then you probably will have to take care of your retirement life yourself. One way of achieving that is investing in an IRA account.

Where to get an account?

Once you decide to have an retirement account, the next thing is to find a custodian to open an account. Setting up an IRA account is simple. As long as you have taxable earned income, you are eligible for making contributions to an IRA account. But there are hundreds of places you can open an IRA account, which one to chose?

A general rule I have for investing, not just in IRA accounts but also taxable accounts, is to keep cost low to get the maximum return. For an IRA account, you can get an account either from a broker or from a mutual fund company, depending no what you want to invest. If you want to buy stocks in your IRA account, then look for discount brokers such as Zecco ($0 commission), TradeKing ($4.95 commission), Firstrade ($6.95 commission), and Scottrade ($7 commission). Since trading stocks usually involves commissions, the lower the commission, the more you get to keep with your money. And before getting account, make sure the broker you choose offers No Fee IRA!

Personally, I don’t buy individual stocks in my IRA account because individual stocks are usually volatile. Plus, I want my IRA investment in the set-and-forget mode. What I have are mutual funds. Though brokers like those mentioned above (the so-called mutual fund supermarkets) also offer thousands of mutual funds, buying funds from them will add unnecessary cost because they charge fees, usually much higher than commissions for trading stocks, for buying and selling mutual funds. Discount brokers have funds in their no-transaction fee category, but it’s likely that the fund you want to buy is not included, meaning you have to pay fees to buy the fund you like.

On the other hand, no mutual fund company charges extra fees to buy funds they offer (you do have to pay for the fund’s own fee though, which is the case no matter where you buy it) . So investing directly with the fund company makes sense in the long-term. The only drawback I can think of for this method is that if you buy several funds, all from different companies, you will have multiple IRA accounts to manage instead of just one. If you plan to buy only a couple of funds, then it’s manageable. With fund supermarkets, you have only one account, but that convenience comes with a price.

If you want to have an IRA account, but don’t know much on how to select a fund company, a good place to start are reputable companies such as Vanguard, Fidelity, and T. R. Price, etc. With them, you can find a full line of products at relatively low costs.

What to invest?

Getting an IRA account is simple. Investing in it is not much complex either. In fact, you don’t have to know everything about stocks, mutual funds to start to invest for your retirement. Even if you know absolutely nothing, there are simple choices to let you start right away: just buy two funds while you are educating yourself about investing:

A total stock market fund
A total bond fund

at a 80/20 ratio. Quite simple, right? Indeed, as John Bogel, founder of Vanguard, advised investors that the the long-term winning strategy in investing is “simply buy all the stocks in the U.S. stock market and hold them forever”, which means that you don’t really have to know a lot about investing to just get started. The best thing about this investment strategy is that by owning the entire stock market, you are exposed to all asset classes. Though the mix of each asset class in a total stock market fund may not give you the return you are looking for, it’s a simple and safe strategy . To make your life easier, those fund companies also offer lifecycle funds, a single fund consisting of both stocks and bonds that is managed by professionals who will determine the right mix of the two based on your time frame!

Once you know enough about stocks, mutual funds, ETFs, Treasury bills and bonds and investing and no longer satisfy with the two-fund portfolio, you can start to add other elements into your investments bases on, for example, asset allocations suggested by model portfolios when you feel confident about making your own choices on what to buy (more about asset allocation and why it’s important).

So, do you have an IRA account? If you don’t, then what prevents you from having one?

Promotions at Brokers for New IRA Accounts before Tax Deadline

Sun — Fri, 11 Apr 2008 02:43:26 +0000

Original Post on The Sun's Financial Diary

Promotions at Brokers for New IRA Accounts before Tax Deadline

There are only four days left before the April 15 tax deadline, but it isn’t too late to make 2007 IRA contribution which has a limit of $4,000 ($5,000 if 50+ years old). At this time, some brokers are offering incentives to encourage people to open IRA accounts with them. For example:

Scottrade: 1-year subscription of Smart Money magazine;
Commissions: Stock: $7; Mutual fund: $17 for transaction-fee funds;

optionsXpress: Get 3 free trades;
Commissions: Stock: $14.95; Mutual fund: $14.95;

E-Trade: 50 commission free trades;
Commissions: Stock: $12.99 for assets less then $50,000; Mutual fund: $19.99 for transaction-fee funds;

Fidelity: One-year commission free trades for rollover IRA only;
Commissions: Stock: $19.95 (lower commission available); Mutual fund: $75 for transaction-fee funds;

Firstrade: Six-month commission free trades for rollover IRA of $25,000 or more;
Commissions: Stock: $6.95; Mutual fund: $9.95 for transaction-fee funds;

TD Ameritrade: 30-day commission free trades;
Commissions: Stock: $9.99; Mutual fund: $49.99 for transaction-fee funds;

While it’s nice to receive incentives when opening an account with the broker at your choice, the bonus shouldn’t affect one’s decision on which broker to use. In fact, when I look at these brokerage firms, it’s quite clear that some, like Fidelity and Ameritrade, charge ridiculously high commission for mutual funds that are either not their own or not in their respective no-transaction-fee fund category. The no-transation-fee fund list could have hundreds of funds, but popular funds are usually excluded, meaning that if an investor wants to buy a Vanguard fund from TD Ameritrade, a $49.99 commission will be imposed. That doesn’t make too much financial sense for an IRA account with an annual contribution of $4,000. The commission could eat up a big chunk of the investment right at the beginning.

I always identify the fund that I want to invest first, then find the right broker to buy it for less. Not the other way around.

Social Security Exhaustion Date, USPS Free Recycling Through Mail, and First Ever Actively Managed ETF

Sun — Wed, 26 Mar 2008 02:53:44 +0000

Original Post on The Sun's Financial Diary

Social Security Exhaustion Date, USPS Free Recycling Through Mail, and First Ever Actively Managed ETF

The government today updated its outlook on Social Security and Medicare and there’s no good news for folks who will retire in 10 years from now. According to the annual trustee reports released by The Department of Treasury, the Social Security Trust Fund will run into negative cash inflow in 2017 and exhaust its assets in 2041. The Medicare Hospital Insurance Trust Fund, on the other hand, is projected to run out of money in 2019. With 78 million baby boomers expected to retire in the next few years, the financial strain on the two programs will increase, which could force the government and congress to increase taxes or reduce benefits, or both.

Time to save for our own retirement

Have old PDAs, MP3 players that you no longer use, but don’t want to just threw them away? You can recycle them through USPS mail!

The U.S. Postal Service announced early last week that it has started a pilot program to allow customers recycle small electronics, such as inkjet cartridges, PDAs, Blackberries, digital cameras, iPods, and MP3 players, for free. Currently the program is only available in 10 areas, including Washington, D.C., Chicago, Los Angeles and San Diego. But it could nationwide if the pilot is successful. Envelopes used in the recycle program can be found at 1,500 post offices in these areas and postages for shipping back the recycled items will be paid by Clover Technologies Group.

Finally, the wait is over!

Bear Stearns Asset Management, whose parent company has dominated the headlines of financial news lately, launched the first ever actively managed exchange-traded fund (ETF), the Bear Stearns Current Yield Fund (YYY) today. Triple-Y is a fixed income ETF that invests in “a variety of short-term fixed income instruments.” The fund has an expense ratio of 0.35%.

Since YYY is an actively managed ETF, it doesn’t follow any index. That’s different from all other ETFs previously being offered, which all track some kind of index. The actively managed equity ETFs from PowerShares are expected to hit market next month.

Will you invest in actively managed ETFs?

*Photo from Coxandforkum.com

Finally, I Set up a 401(k) Account

Sun — Tue, 26 Feb 2008 15:45:28 +0000

Original Post on The Sun's Financial Diary

Finally, I Set up a 401(k) Account

I know, setting up a 401(k) account should be one of the first things to do after changing employer, but I waited for more than half a year to finally get it done

When I started my current job last July, I didn’t have the chance of making contributions to the retirement plan as the new employer has a rule which allows contributing to 401(k) plan only after the first three months of service. At that time, I was also actively trying to find a new job (yeah, I just got a new one, but it wasn’t the job I would like to do). So the time constrain didn’t bother that much. However, my effort didn’t have any positive outcome and I stuck with this job for nearly eight months already. As no change in my employment situation is expected any time, I thought it would be better to set up a 401(k) and start to make contributions, though my employer didn’t offer any match.

I finally got my act together and opened a 401(k) account at the end of January. The plan was managed by Sovereign Bank and investment options are less attractive. Not just that, they are quite expensive actually. Of the 30 funds offered, the highest expense ratio (ER) is 2.39%, while the lowest is 0.72%, which is the only equity fund with below 1.0% ER. Since I don’t know how long I am going to be with my current employer, I want to make my investments as simple and low cost as possible. After going the options, I settled with three funds:

American Funds EuroPacific Growth Fund (RERCX): 40%
American Funds AMCAP Fund (RAFCX): 40%
T. Rowe Price Growth Stock Fund (RRGSX): 20%

with an average ER of 1.08% according to Morningstar. To makeup the missed contribution of the first month of 2008, I set my payroll deduction to 20%. When I checked my account last night, I am up 3.90% since making first investment early this month Actually, I am glad I delayed one month when the market tumbled. If I started in January, the year-to-date return could be very negative.

photo credit: _e.t

Considering Rollover My 401(k)

Sun — Wed, 05 Sep 2007 13:52:22 +0000

Original Post on The Sun's Financial Diary

Considering Rollover My 401(k)

Last week, when my previous employer informed me that the company match for the first 6 months has been credited to my 401(k) account at Fidelity, I was also told that my account status will be changed to “Terminated” on August 31st. That means I can move the money to other accounts starting September 1st. The first option came to my mind was to roll it over to Vanguard where I have a Roth IRA account. There are three factors I considered in my decision making:

Investment choices
Expenses
Taxes

No, performance isn’t really one of my concerns.

Investment choices and costs

One of the disadvantages of employer sponsored retirement plans is the selection of investments. Since my previous employer uses Fidelity to manage the company’s 401(k) plan, I could only choose from a number of Fidelity mutual funds to make my contribution. In addition to the limited selections, the costs for those funds are not ideal either. For the four funds I own in my account, the expense ratio (ER) of FFTHX is 0.8%, FCPVX 1.06%, FRESX 0.82%, and FDGFX 0.59%. Obviously, if I want to hold the funds for something like 30 years, I can use some less expensive choices. In that sense, nobody beats Vanguard. The ERs of the four Vanguard funds in my Roth IRA account are: VGTSX 0.32%, VIPSX 0.20%, VGTSX 0.32%, and VWELX 0.30%. The decision doesn’t seem to be too difficult to make.

Taxes

My main concern is tax consequences of the rollover and whether I want to pay taxes now or in the future. Since 401(k) contributions are made before taxes and Roth IRA takes after-tax money, I will have to pay taxes for the contributions made in my 401(k) if I choose to convert from Traditional to Roth after the rollover. Last year, we lost the eligibility to contribute to Roth IRAs as our annual income exceeded the threshold and had to withdraw almost all the $4,000 contributed last year (converted from Roth to Traditional). This year, it could happen again. If that’s the case, I may choose to postpone the conversion till 2010 when the income limitation is lifted to do the conversion all at once. The problem for this option, however, is I may have to pay more federal income taxes if I am in a higher tax bracket at that time. If I choose to do the conversion in 2010, the tax bill can be split two years (2011 and 2012) instead of paying it in a single year if a conversion occurs in 2007.

The procedure

I contacted Vanguard yesterday to inquiry the rollover procedure. In order to move the money from Fidelity to Vanguard, I will need to open an Roll over IRA account first, which is essentially a Traditional IRA account, as there is no direct transfer from 401(k) to Roth IRA. Once the account is opened, I can instruct Vanguard to initiate the roll over process without having to deal with Fidelity myself. After the completion of the roll over, I can immediately convert the Traditional IRA into a Roth.

Or I could wait three more months to directly roll 401(k) over to Roth in 2008 to make the process a little easier, according to the new tax law.

Compare Your Savings Rate against National Savings Rate Guidelines

Sun — Wed, 25 Apr 2007 15:33:46 +0000

Original Post on The Sun's Financial Diary

Compare Your Savings Rate against National Savings Rate Guidelines

So are you saving enough (or too much) for your retirement? Given your age and income, do you know how much you should set aside every month now so you can have enough fund to cover your daily expenses when you are at age 65?

In the April issue of Journal of Financial Planning, a group of scholars and financial professionals published a report on individual’s savings rate in preparation of retirement. The report, National Savings Rate Guidelines for Individuals, provides the “savings guidelines for typical individuals with different ages, income levels, and initial accumulated wealth” such that we can use the guideline to assess our saving plans and see how much we need to save for retirement. The motivation of the study is the increasing dependence on personal savings via defined-contribution plans such as 401(k) plans to pay for retirement for future retirees. The study also aimed to help people to determine the total assets needed to fund their retirements.

According to the report

To calculate the savings rates, we calculate income needed in retirement based on retirement income as a percent of net pre-retirement income, which we define as gross income less the amount saved for retirement each year during pre-retirement. Basing retirement costs on pre-retirement net income rather than gross income, as done with other studies, significantly reduces the amount that must be saved.

From the description, I am not sure if this “pre-retirement net income” concept is unique, though it’s closer to reality. The last time when I used Fidelity’s myPlan retirement calculator to get an idea on how much we need for retirement, I was also asked for current monthly saving amount, though it’s unclear how that information is used in the calculation. The reason for using net income than gross income is, as the report argues, that using gross income

forces an individual to save more and to make a more radical reduction in current lifestyle, resulting in excess capital that can generate an increase in lifestyle upon retirement. In short, the amount saved could theoretically be too much and provide a higher standard of living in retirement than while working.

That sounds a whole lot like what has been argued in the “Are we saving too much?“debate. In addition, the study also made the following assumption when calculating retirement cash flow:

A 2.5% annual inflation rate
A 2.5% annual income growth rate (equivalent to inflation rate)

With these assumptions, the study comes up with savings rate guidelines for individuals at different ages (from 25 to 60) and with different income levels (from $20K to $120K a year). The guidelines have two parts. The first part assumes that one needs to replace 80% pre-retirement gross income at age 65 when retirement begins. The savings rates are shown in the plot below (click to enlarge).

While there’s no surprise that the older you are and the more you make, the more you need to save, what seems to be extraordinary from the report is that if you are 60 now and make $60K a year or more, you will have to have a savings rate greater than 150% in order to reach your retirement goal. 150%? Is it possible to save more than what you earn? These numbers could be theoretically true, but not really realistic. On the other hand, it could also suggest that if you start to save very late, you can’t hope too much in replacing most of you pre-retirement incomes.

For many people, a lot of current obligations such as mortgage and college expenses will disappear when they are 65, thus a 80% pre-retirement income may not be necessary. If this’s the case, the report also provides savings rates with 60% replacement income as shown above (click to enlarge the picture). Again, for people who are already 60 and making $80K or more, a 100+% savings rate is needed.

With these savings rates and expected replacement income level, the report offers a table with assets needed at age 65 to fund retirement with adequate cash flow. The studay assumes that to generate the retirement cash flow, assets “would be invested in inflation-indexed lifetime fixed-payout annuities.” For example, if you make $80K a year at the time when you retire at age 65 and have a net income (gross minus annual savings) of $66,880, then a 80% replacement income in retirement will be $53,504. If you receive the full benefit of social security which will give you an annual income of $25,252 and with no pensions, then you will need generate the rest of $28,252 from your own savings and the assets you need at that time is $512,821.

To reach the assets, and thus the cash flow, needed to pay for your retirement, the money should be invested through the accumulation stage. The report then outlines some rough strategies in the allocations of stocks and bonds based on the maturity targets, as shown in the following plot.

The asset allocations are quite similar to some typical asset allocations of lifecycle funds. For example, if a person is 30 years old (35 years to retirement), then the average asset allocation is 91% in stocks and 9% in bonds. Five years late, the allocation chages to 86% stocks and 14% bonds. The average asset allocation of lifecycle funds from Vanguard, Fidelity, and T. R. Price for 2040 target date is 86.8% stocks and 9.6% bonds.

Correct Excess Contribution in Roth IRA Accounts

Sun — Sun, 22 Apr 2007 13:48:46 +0000

Original Post on The Sun's Financial Diary

Correct Excess Contribution in Roth IRA Accounts

We realized last weekend after we were done with our income taxes that we, my wife and I, had made excess contributions in our Roth IRA accounts. Based on our income numbers, TurboTax said we were only eligible for $200 Roth IRA contributions in 2006, instead of the maximum $4,000 we made throughout the year. As a result, we will have to withdraw the excess contributions. Among the three options we have, we decided to make the money into a non-deductible traditional IRA as it appears to be the best choice. We can also choose to leave the fund in the account and keep paying 6% tax every year, or get the contributions plus any earnings back in cash, but neither gives us the maximum benefit of tax deferred growth of earnings.

The first step to fix the problem is to choose which fund to unload. For my wife’s account, the choice is quite obvious. She has more than $4,000 in American Century Equite Income Fund (TWEIX), the fund that will soon become a load fund. We never invested in a load fund and will never invest in such a fund, thus it’s an easy decision to sell TWEIX. In fact, I already sold all her TWEIX shares last week and she’s in the process of opening a traditional IRA account and transfer the proceeds to the new account. Part of my wife’s Roth IRA holdings are with Scottrade and the procedure of withdrawing excess Roth contribution at Scottrade is:

Open a transitional account
Complete a Roth distribution request
Remove the excess contribution from the Roth account to the traditional account

As for me, the decision is not easy to make. After transferring most of my IRA assets from Scottrade to Vanguard, I only have one fund (BRSIX) at Scottrade, which has less than $4,000 market value. Besides, BRSIX is also the fund I want to keep. Thus, selling assets in Vanguard account becomes the only choice for me. I currently have four Vanguard funds in my Roth account:

Vanguard Total International Stock Index (VGTSX)
Vanguard Inflation-Protected Securities (VIPSX)
Vanguard Total Stock Market Index (VTSMX)
Vanguard Wellington (VWELX)

Though there are overlaps between VTSMX and VWELX, I really like VWELX a lot and since it now needs a minimum $10,000 (when I got in, it was $3,000), I think I will keep it for now. What I could do is to sell some of VTSMX shares, move the money to the traditional account, and buy VTSMX again. However, with this approach, I will have to pay $10 annual fee since the account will have less than $5,000 in asset by the time I make the withdrawal. To be cost-efficient, I think I will have to go with Vanguard funds (Vanguard charges hefty fees for non-Vanguard products), but which one to invest?

Key Differences between Traditional and Roth IRA

Sun — Tue, 10 Apr 2007 15:29:40 +0000

Original Post on The Sun's Financial Diary

Key Differences between Traditional and Roth IRA

Last week I got an email from a reader about the difference between Traditional and Roth IRA. The question is more on the withdraw side than contribution side. After giving a quick answer, I feel I can expand it a little bit with more information on this topic. But tax rules are always complex, so this by no means is complete. Instead, it focuses on the major differences.

First of all, what is Traditional IRA and what is Roth IRA? According to IRS definitions (Publication 590), a Traditional IRA is “any IRA that is not a Roth IRA or a SIMPLE IRA,” and a Roth IRA is “an individual retirement plan that is subject to the rules that apply to a traditional IRA.” Are these definitions clear? Not at all. Therefore, a better way to understand them is by examining the key differences between these two.

Eligibility

Everyone has earned income can participate in IRA (when the income is greater than the contribution), however

Traditional: Only eligible for age under 70.5 with no maximum income limitation;
Roth: Only eligible when earned income is less than $114,000 for single, or $166,000 for married filing jointly, with no age limit;

Deductibility

Traditional: If you or your spouse is not covered by employer-sponsored retirement plan such as 401(K), your contributions is deductible; Your deduction starts to decline if you (or spouse) participates in a retirement plan through employment and adjusted gross income hits certain level [for 2007, the phase-out limits are $50,000 - $60,000 (single) and $80,000 - $100,000 (joint)];
Roth: Contributions can’t be deducted;

Tax advantages

Traditional: Earnings grow tax-deferred, but are taxable at withdrawal;
Roth: Both principal and earnings are tax-free if you take the distributions after age 59.5 and have established your IRA for five years or more;

Withdrawal

Traditional: Must start to withdraw at age 70.5;
Roth: No age limit;

Contribution limits

Traditional: $4,000 ($5,000 for age 50 or above) in 2007 and $5,000 ($6,000 for age 50 or above) in 2008 and 2009;
Roth: $4,000 ($5,000 for age 50 or above) in 2007 and $5,000 ($6,000 for age 50 or above) in 2008 and 2009;

From what we can see, Roth IRA offers much more flexibilities than Traditional IRA on withdrawals and long-term tax advantages (you may not pay taxes at all on earnings), though it has no immediate tax benefit at the time you make the contribution. If you are considering an IRA account, but haven’t opened one yet, you have until April 17, 2007 to set up your account and make 2006 contributions.

For more information on IRAs, check out IRS Publication 590. Fool.com also has a nice (and complete) coverage on this topic.

The Best Investments in IRA Accounts

Sun — Thu, 22 Mar 2007 18:47:06 +0000

Original Post on The Sun's Financial Diary

The Best Investments in IRA Accounts

So you still have about three weeks to file your 2006 income tax (this year’s deadline is April 17, 2007) if you haven’t done so already, what else can you do to save instantly on taxes? If you meet certain income conditions (see 2006 IRA deductibility limit at Investopedia), you can open a traditional IRA account before the tax deadline, make $4,000 contribution for 2006, and deduct part or the full amount of your contribution. The deadline to open an IRA account and make 2006 contribution is April 17 this year instead of the last day of the calendar year. Therefore, there is still time to make the last tax-saving move.

While setting up an IRA account (traditional or Roth) is simple and can be done at almost every brokerage firm or mutual fund company, making the right investment choices so your hard earned money can grow quickly and steadily is by no means trivial. In fact, it’s the second most important part (the first one being opening an account) in retirement account planning. For tax sheltered accounts such as IRAs, a general rule is that securities that generate high incomes (interests, dividends, or capital gains) should be held in these accounts first. But there are much more to be considered when selecting what to invest. I came across an article on Morningstar.com yesterday which offers some advices how to invest in IRA accounts. The article, The Best Investments for Your IRA, by Christopher Davis, declares that for IRAs, “not all options are created equal.” So exactly what kind of investments should be held in an IRA account?

Stocks or bonds

Since stocks historically produce much higher return than bonds, it makes more sense to put stocks in an IRA account if you have a long time to go to retirement. On the other hand, if you want to hold bonds after all in retirement savings accounts (taxable or tax-protected), then they should go to a tax-protected account first due to the taxable incomes bonds generate. However, if you are close to retirement, the best strategy is to invest more in bonds to preserve your assets.

Not all stock investments are equal

Index funds usually generate less taxable incomes due to the passive nature of the funds. If you have your favorite actively managed funds that distribute lots of capital gains (funds with high turn-over ratio will generate more capital gains) and consider them for retirement purpose, these funds should be held in tax-sheltered IRA accounts to take advantage of the hefty distributions. The fund price usually drops after the distribution and if you set up dividend/capital gain reinvestment, the distribution will net you more shares.

Think the big picture

While we should always keep taxes in our mind when making investment decisions in retirement accounts, the only goal is to build a solid portfolio with the right asset allocation that meets your investment objective. As the article says

How you split your portfolio between stocks and bonds should be based on your risk tolerance and time horizon, not what makes sense from a tax perspective. Your primary goal should be to find superior investments and then think about whether they fit best in a taxable account or an IRA.

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Buy that Big Screen TV You Want and You’ll Still be Fine When You Retire

Sun — Thu, 08 Mar 2007 18:55:12 +0000

Original Post on The Sun's Financial Diary

Buy that Big Screen TV You Want and You’ll Still be Fine When You Retire

Go ahead and buy that big-screen TV. Enjoy your daily latte. Book your dream vacation. When it’s time to retire, you’ll be just fine.

Though this is not exactly what came out of my mouth, it pretty much represents my opinion when it comes to enjoy the life today and live comfortably 30 years later.

In an article yesterday published on USA Today (title Are you saving too much for retirement?), the topic of whether we are saving too much for our retirements again surfaced. While the article, similar to the one appeared on NY Times in late January, used the data from the Employee Benefit Research Institute 2006 Retirement Confidence Survey to show that “more than half of U.S. workers have saved less than $25,000 for retirement,” it also brought up the notion that families who have already put a decent amount of their incomes into retirement accounts for years are “delaying a lot of gratification because of the fear they’re blowing their retirement, maybe that anxiety is misplaced.”

However, the article acknowledged that as retirees enter into an age of uncertainty, there are plenty of reasons for people to save more, not less, including:

Increased longevity
Family obligations
Health care

And these uncertainties will present a big financial challenge to aging baby boomers who are making their retirement plans. And if you are wondering if you have saved enough for your retirement, the article offered a piece of advice from Prof. Olivia Mitchel at the Wharton School of the University of Pennsylvania:

“When in doubt, work longer and keep saving.”

Are We Saving Too Much?

Sun — Sun, 28 Jan 2007 20:17:28 +0000

Original Post on The Sun's Financial Diary

Are We Saving Too Much?

Yesterday, I read an article on New York Times with the title "A Contrarian View: Save Less, Retire With Enough" [Registration required]. Without reading the article, the message seemed to be very clear: maybe we are saving more than necessary.

If you visit any of the big mutual fund firms' website, such as Vanguard, Fidelity, or T. R. Price, you will find that they all offer a tool (or a calculator) to estimate how much you will need for retirement, based on, for example, your age, current income level, current retirement assets, annual contribution to retirement accounts, expected returns, and life expectations, etc. Once you provide all these information, the calculator will tell you the estimated number you are going to need for a comfortable retirement. For me, I tried Fidelity's myPlan a couple of moths ago, and the number I got was a shocking $6M. Vanguard's calculator gave a slight lowered number, but still at more than $4M (Super Saver has a review of T. R. Price retirement calculator). If I believe what the numbers are telling me, then the prospect of my golden years won't be pretty.

While the accuracy of these calculators is questionable, they all seem to use one common assumption: your expected income level in retirement relative to your income right before retiring, a number that varies from 70% to 110% in Vanguard's calculator, 80% in myPlan, and a default of 75% at T. R. Price. Of course, the higher the percentage, the higher the estimated number. So how do they come up with the default percentage? As T. R. Price stated:

A general rule of thumb is that you will need between 60% and 90% of your preretirement income to maintain your lifestyle. A general rule of thumb is that you will need 50% of your pre-retirement income from your investments in the first year of retirement to maintain your lifestyle. We assume that you will increase the inflation withdrawal amount to maintain your purchasing power through retirement.

Again, the explanation seems reasonable. And, in order to reach your retirement goals that these calculators suggest, the only option you have is to save more. Not just save, but invest your savings. And invest your savings with them.

So is it possible that these financial firms all paint a gloomy picture for your retirement just to get you save more and, hopefully, invest your money with them?

The NY Times article says that a small group of economists from universities, research institutions and the government concluded that

the financial industry, with its ostensibly objective online calculators, overstates how much money someone will need in retirement. Some, in fact, contend that financial firms have a pointed interest in persuading people to save much more than they need because the companies earn fees on managing that money.

For the financial industry, the paper says, the rule of thumb in determining how much one will need for retirement is:

The replacement rate: The annual income for a person in retirement should equal to 75% to 86% of preretirement income;
The withdraw rate: A retiree should spend no more than about 4% of his/her assets each year to make them last.

With these rules, you will find you have to save more, a lot more. And "the financial planning industry prefers to characterize itself as cautious."

Finally, the paper has this example to show why the numbers you get may not make sense at all:

Fidelity’s Retirement Quick Check calculator says that a 50-year-old person making $100,000 a year with $700,000 stashed in retirement accounts, saving $15,000 a year, would still fall short of the $2.8 million goal that would provide the necessary monthly retirement income of $7,408 that it sets. Its calculations do not include Social Security payments. Fidelity actually recommends saving about $1,000 a month more. It also encourages this person to save more even when more than enough has been saved. It recommends putting away up to $9,749 a month on top of the $15,000 a year already being saved, an impossibility since that would more than consume the person’s entire gross income.

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IRA Transfer from Scottrade to Vanguard: The Horrible Experience Continues

Sun — Tue, 16 Jan 2007 18:36:40 +0000

Original Post on The Sun's Financial Diary

IRA Transfer from Scottrade to Vanguard: The Horrible Experience Continues

The first thing I did when I came to work this morning was giving Vanguard a call, again.

When I filled out the IRA asset transfer form to move all Vanguard funds in my IRA account I had with Scottrade to Vanguard, I provided a blank check and instructed Vanguard to automatically invest $200 into each of the four funds every quarter, starting February (that's the only option available on the form for quarterly automatically investment). Last night, I logged into my account to check if my automatic investment plan has been correctly set up before the investment date of February 5th. There was nothing!No bank information on record and, of course, no automatic investment plan.

When I called Vanguard and asked for an explanation why there's no bank information even when I attached a blank check, the story the CSR told me was that since there are two names on the check (mine and my wife's since it's a joint account), they can't use that information to fund my IRA account because the IRA account only has my name on it!

That's simply ridiculous!

I don't know how many accounts I have opened so far, joint or individual, and this is the first time I heard that an joint bank account can't be used to fund an IRA (which is an individual account) unless with a signature guarantee from the other party.

My angry isn't really about whether this is right or wrong, but that they found something that's not right (according to their rules) and they just let it go without informing me. If I don't check my account and don't call, this probably will never be corrected. When I asked the CSR the same question, he said they don't think this is a problem.

I transferred my IRA account from Scottrade to Vanguard, I wrote clearly on the application form I want to establish automatic investment plan, I provided a bank check with all the necessary information, and they found they can't do what I want to do for me but don't think that's a problem! Then what all these are about? Just to have fun so I can kill some time? If it's not a problem, then what is it?

After putting me on hold for nearly 20 minutes, the CSR came back and told me they actually use the bank information to set up the automatic investment plan and said sorry about the mistakes.

Please, no more!

At one point I asked the CSR to check how many phone calls I had made in the past three months and he told me maybe about 20 times.

I don't call you 20 times because everything is fine. For a simple account transfer, which itself took two and half months, how many mistakes have you made, Vanguard? How many mistakes you allow yourself to make? Infinite? Or as long as you keep making them?

Finally, My IRA Transfer is Completed

Sun — Thu, 14 Dec 2006 16:26:57 +0000

Original Post on The Sun's Financial Diary

Finally, My IRA Transfer is Completed

I can't believe it took more than two months to transfer my IRA assets from Scottrade to Vanguard.

Last night, I finally received the confirmation letter from Vanguard, saying that the transfer is now completed and my Vanguard account is ready. The assets were moved to Vanguard on December 8th, two months and eight days after I mailed out the transfer form. Initially, I thought this is a very simple and straightforward process as Vanguard must have done lots of them. Yet, the whole process was full of troubles, from the beginning to the end. The way they handled my case shows the lack of professionalism, though they run some great funds.

And they didn't forget to make one more error of my account. Since Vanguard charges account maintenance fees for funds with less than $5,000 of market value, I re-distributed the total assets among the four funds I transferred to avoid the fees. For example, I have more than $13,000 in VTSMX but only $3,500 in VGTSX. So on the application form, I gave the new percentage for each fund of the total transferred value. However, on the confirmation letter, the value of each fund is exactly the same as when they were with Scottrade. Nothing changed. Though I think I can easily move money among these funds, I am bothered again by the fact that they have the options on their application form to allow me change the size of each fund and I gave them the instructions on how I want the changes to be made, but they just ignored them!

I have talked a lot about my terrible experience with Vanguard in the past two months and I am glad that the seemingly endless trouble is finally behind me. However, there's no word on the status of my wife's IRA transfer, which was filed on the same date.

myPlan, Fidelity’s Retirement Calculator, Said We Need $6 Million for Retirement

Sun — Mon, 04 Dec 2006 17:38:56 +0000

Original Post on The Sun's Financial Diary

myPlan, Fidelity’s Retirement Calculator, Said We Need $6 Million for Retirement

Fidelity’s myPlan is a simple retirement calculator which estimates the retirement assets based on your current age, annual income, and monthly saving rate. There are five simple questions to begin the asset projection:

How old are you?
How much do you make per year?
How much do you save so far, including everything you saved for retirement such as 401(k) and IRA, etc?
What’s your monthly savings, including contributions to 401(k) and IRA every month?
What’s your investment style?

At the last step, Fidelity provides several asset allocation styles to choose from:

Short-term: 0% stocks, 0% bonds, 100% cash;
Conservative: 20% stocks, 50% bonds, 30% short-term;
Balanced: 50% stocks, 40% bonds, 10% short-term;
Growth: 70% stocks, 25% bonds, 5% short-term;
Aggressive growth: 85% stocks, 15% bonds, 0% short-term;
Most aggressive: 100% stocks, 0% bonds, 0% short-term.

At the end, Fidelity gives the projected assets based on the inputs:

The goal at retirement, according to Fidelity, is generated based on replacing 80% of our pre-retirement income (the numbers I provided are our joint incomes and savings). Though I think 80% of pre-retirement income in retirement is a little bit high, what really shocked me is the target: almost 6 million!!! What’s even worst is that using the current model (no. 4, 70% stocks, 25% bonds and 5% short-term), we won’t hit the target at the age of 65 whether the market performs poorly or on average (which is more likely).

I never really thought how much we are going to need for retirement, the most I guessed was 2 million after reading some articles early suggesting a moderate number of one million for each to maintain the life style. The Fidelity target, however, seems somewhat excessive and I don’t think we will ever reach it. Of course, the estimate assumes everything (income sand savings) remains the same for the next three decades, except inflation adjustments.

Well, this is just one (probably the most challenging one) of many scenarios we could face for our retirement and the picture isn’t pretty. In any case, there’s still a long way to go for us. Go to myPlan check how much you are going to need for a comfortable retirement.

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