David McPherson Answers Your Questions About Retirement Planning

July 1, 2008— -- Sharon from Spotswood, N.J., asked: "My husband and I have owned our own business for 26 years. Although we have not saved as we should have, recently we had to refinance to pay business bills. We are both in our fifties. How do we make the money and make up the lost equity from our home that we were counting on?"

McPherson answered: It's difficult to answer this question in detail without knowing more about your business, its profitability and how many people you employ. But assuming the business is profitable, I would suggest you start by making sure you're taking full advantage of the various retirement plan options available to small business owners. These options include SEP IRAs, SIMPLE IRAs and 401(k) plans. The right plan for you and your husband will depend on factors, such as how much money you can set aside each year, and how many employees you have. Regardless of which option you choose, each of these plans provides opportunities to cut your taxes now and allow your investments to grow tax deferred. A small business retirement plan is probably your best opportunity to make up the lost ground. Good luck.

Lisa from Cedartown, Ga., asked: "Should I rollover money from a 401(k) to a Roth IRA? I have this 401(k) from a part-time job. Thanks. What is the best way to start a Roth IRA if eligible?"

McPherson answered: If you continue to work at this part-time job, then you will not be able to rollover this money from the 401(k) plan into a Roth IRA. Generally, such rollovers from an employer-sponsored plan are allowed only after you leave a job. If you have left the job, then, yes, you may rollover directly from the 401(k) to a Roth IRA. This is new as of 2008. In prior years, you first had to rollover into a traditional IRA first and then do a conversion from the traditional into a Roth. If you remain in this job, ask your employer whether they offer a Roth 401(k) option. This may allow you to achieve the same goal without going through the rollover process. Just remember, any money you rollover into a Roth IRA from another retirement plan may be subject to taxes this year. The benefit of tax-free income in retirement very likely may be worth the cost, but it is something you need to factor into your decision.

Judi Schofield from Villa Hills, Ky., asked: "I will be 62 this July. I have a job as a nurse with good health care benefits and salary. I want to retire at 66 but I only have approximately $100,000 in 401(k)s. I owe about $60,000 on my home and I have been putting 17 percent pre-tax money in my account. My question is: Do I drop that amount and pay more on my home? I worry about having a place to live after retirement. I know some say the home loan is a good tax break but I am getting close and don't know what to do. Is my priority over the next four years increase savings or paying down my home? Thank you."

McPherson answered: Without knowing your exact retirement plans, it's tough to say exactly what you should do. But, in general, I would recommend you continue your current course of making substantial 401(k) contributions and paying down your mortgage at the same time. In the meantime, try to figure out what will be left on the mortgage in four years. In the ideal world, we would all retire mortgage-free. But if the balance on your loan will be relatively small in four years, then I would keep stuffing as much as possible into the 401(k). If possible, consider making extra principal payments on your mortgage while continuing to fund the 401(k).

Other factors to consider include whether you plan to remain in your home after retirement (sounds like that's your plan), and whether you might want to work part time in the early years of retirement until you finish paying off the mortgage. You may want to seek out the help of an hourly financial planner to help you assess this issue in more details.

What I like about your plan is that you will be waiting until 66 -- your full retirement age -- before collecting Social Security benefits. This will make a big difference to your retirement income. Too many people begin collecting at age 62 and take a financial hit as a result. Good luck.

Lourdes from Miami, Fla., asked: "I'm a single mom, 55 yrs. old. I was laid off six weeks ago. Now I have to tap into my IRA which isn't that much. What do I do? What stocks do I or should I invest in? My home has been up for sale since November 2007 and nothing yet. We're trying to move to Tampa. My daughter wants to study at USF. Help."

McPherson answered: I have two thoughts on your situation. First, I would try to avoid taking money from your IRA. Doing so would likely trigger a 10 percent penalty, plus ordinary income taxes on the amount withdrawn, and cut substantially into the amount you would receive. I understand the difficult situation, but an IRA withdrawal should be a last resort, not your first.

Second, with respect to investing, I would suggest you first try to stabilize your situation in terms of finding a job. Until then, you probably won't have much to invest. Once employed again, then you definitely want to look at making sure you're investing wisely for retirement. One option may be to look for a target-date mutual fund geared toward the years in which you might retire.

Anonymous from Redding, Calif., asked: "I'm putting 20% of my earnings in a 403 account at work. It is tax deferred. Would it be wise to take the 20% and put it in the bank instead of leaving it in the 403 account? I'm worried that if I leave it in the account, in 10 years I will have less in the account than I put in it. If I save it in the bank, at least I know it is safe, even though it doesn't grow much. I am 52 years old and single."

McPherson answered: It would not be wise to remove the money from your 403(b) account and put it in the bank. That would trigger a 10 percent early withdrawals penalty plus ordinary income taxes on the amount withdrawn. A better idea would be to review the investment options available in your 403(b) plan. More than likely, there are probably some conservative options that may be appealing to you. However, you don't want to dump everything into a money market or stable value fund within the 403(b) plan. At 52, your retirement funds need an opportunity to grow, and a cash account won't provide that opportunity. Ten years from now, the current market turmoil will be a distant memory.

Louise from Hood River, Ore., asked: "We're already retired. How do we handle our investments (ira's, etc.)? Do we sell out of the mutual funds and stocks at this point to stop the losses?"

McPherson answered: As a general rule, retirees should keep some portion of their money in stocks or stock mutual funds to help their portfolio keep pace with inflation. The key question: What is the right mix? In some cases, it might be just 30 or 40 percent stocks and the rest in cash and bonds. For others, it might be a stock mix as high as 60 or 65 percent.

Despite the recent market turmoil, I'd suggest avoiding the urge to panic and dump all your stock-based investments. Rather, I'd suggest you do some research on an appropriate asset allocation for someone in your circumstances. Also, consider what your cash needs are going to be over the next couple years and set aside that amount in conservative investments such as CDs or short-term bonds.

Tom from Clayton, Calif., asked: "One of the biggest disagreements my wife and I have about our pending retirement is how to estimate the future returns from our savings. These estimates dramatically affect our finances in retirement. What approach should we use to get a reasonably conservative estimate of future returns?"

McPherson answered: The general consensus within the financial planning community is that future rates of return are likely to be lower than they have been in the past, particularly if inflation remains at historically low levels. Many planners use an average of return in the neighborhood of 7.5 percent when making projections.

The financial planning software I use projects a 9.5 percent future rate of return for a 100 percent stock portfolio diversified across large caps, small caps, international developed markets and emerging markets. But most investors, particularly those near retirement, don't own 100 percent stock portfolios. They also own cash and bonds that help reduce risk, but also lower rates of return. For planning purposes, I'd suggest using a conservative estimate for projection purposes. Better to be surprised on the high side than on the low side.

Linda Woodson from Helotes, Texas, asked: "I will be eligible for Social Security benefits at 66, but have read on their Web site that my benefits will be reduced for each $3 I make over $36,120. My annual salary is approximately $92,000. Will that be a significant reduction and will the reduction in benefits continue after I do retire?"

McPherson answered: You would be subject to this reduction only in the months before you reach your full retirement age if you begin collecting benefits before reaching 66. Once you reach the month you turn 66, your Social Security benefits are not subject to any reduction, no matter how much you earn.

If your plan is to continue working until at least age 66, then I'd suggest you not begin collecting until at least then. If your annual salary is $92,000, you might want to consider holding off on your Social Security benefits until at least then. You might also want to consider waiting even longer if your plan is to continue working past age 66, as it sounds you might. Up until age 70, each month you wait to collect, the higher your retirement benefit.

John Davis from Elkins Park, Pa., asked: "I am a 22-year-old. I am a college student and have been saving ever since I have been working at age 14. I have 20k saved in online savings. Also, I have an IRA, which I have done for several years at max. I also have some stock but not much. What should I do to make sure when I get older, that I can retire and not worry? If I am able to retire when I want to? Also, about how much do you think that I will need to retire when I retire?"

McPherson answered: Congratulations on getting such an early start on saving for retirement. I wish I had been wise enough to open an IRA account at that age. If you continue on your current path of contributing the maximum amount to your IRA and invest the funds wisely, you should be able to enjoy a very comfortable retirement.

Consider these numbers: $5,000 annual contributions for the next 43 years (until you reach 65) could grow to $1.4 million, assuming a 7.5 percent average annual rate of return. Raise that contribution amount as IRA limits increase, and that savings figure may go even higher.

My one suggestion to you is that you direct your savings to a Roth IRA, rather than a traditional IRA, if you're not already doing so. Given your age, you should be able to reap huge future tax savings by investing in a Roth.

Kenneth from Brownfield, Maine, asked: "My wife died during our 10th year of marriage when I was 54. I'm now 57 and retired, but won't be able to stay retired with the current economic conditions. Is there a widower benefit I can claim, and if so, at what age?"

McPherson answered: You would be eligible for a widower's benefit at age 60, but that would be at a reduced rate, compared to waiting until your full retirement age of 66. You may be eligible to receive benefits earlier if you are disabled, or if you're caring for a child of your late wife, who is under age 16, or who is disabled and receives benefits based on your wife's earnings record. You may also be eligible to collect a small special death benefit if you did not file for it at the time of your wife's death. The current lump sum benefit is $255. You should contact your local Social Security to see if you qualify for this lump sum payment.

I'd also suggest you visit the Social Security Web site: www.socialsecurity.gov. At the top of the home page, you will find a link for survivors. You also may want to download a publication called "How Social Security Can Help You When a Family Member Dies."