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Counting Down To AFinancially Secure Retirement

This report is adapted in part from chapters 21-23 of Sound Mind Investing: A Step-by-Step Guide to Managing Your Money

From a Biblical Perspective (5th edition). For a more complete treatment of these topics, review the material in the book in its entirety.

by Austin Pryor

Did you know that today’s generation of retirees (I’ll callthem “prime-timers”) are the wealthiest in U.S. history?

They participated in the postwar economic boom,watched their homes greatly escalate in value during theinflationary 1970s, and paid far less into pension plans andSocial Security than they are now taking out in indexed ben-efits. At the same time, their cash flow needs are past theirpeak—the children are grown and out on their own, mostmortgages are paid off, and work-related expenses are nolonger a drag on the family budget.

According to the most current data available from the U.S.Census Bureau, the majority of Americans 65 and olderwould seem to be living comfortably. They had a median networth of around $130,000 per household, well above themedian for the general population of $59,000. Their medianannual income was $28,300 (including Social Security andother government transfer payments), and more than 80%own their own homes.

The number of those joining the ranks of the retired isincreasing at twice the rate of the overall population. By theyear 2030, the post-WWII “baby boomers” will raise theprime-timer population to 72 million. This translates toabout one out of every five Americans, up from only one inevery eight now. What will retirement be like for us new-comers? (Although I was born a year too early to officiallybe a boomer, I’m taking a little editorial license and includ-ing myself.) Will we have it as good? The trends are notencouraging.

Somewhat paradoxically, the problem has to do with thefact that life expectancy continues to make remarkable gains.This increasing longevity is due mainly to the continuingimprovements in health care; also contributing to longer livesis the American public’s discovery of the benefits of nutri-tion, physical fitness, and healthier lifestyles. About three-fourths of prime-timers consider their health to be good-to-excellent. A significant decline in activities and interestsdoesn’t generally occur until age 85 and later.

It now seems that moving into the 85-plus group has the“elderly” connotation formerly associated with the 65-plusgroup. One expert refers to them as “old-olds” (to distin-guish them from the “young-olds” who are only 65 to 84).The old-olds population is expected to exceed 8.7 million by2030. The Census Bureau projects that one-in-nine babyboomers will live into their late 90s. The number of centenar-ians (100 or older) is expected to grow eight-fold from thecurrent level of about 75,000 to more than 600,000 by 2050!

In short, we’ll all be living longer. And let’s face it: livingcosts money. Of course, the longer the life, the greater thelikelihood that support services will be needed; familiesnow stand a greater chance than ever before of having adisabled elderly relative to support. More than 80% of uswill enjoy reasonably good health, but even so, it’s esti-mated that health care for prime-timers costs three to fourtimes what it costs the rest of the population. Then there arethe other niceties of everyday life, such as food, shelter,clothing, and recreation.

A fundamental fact of retirement life is that you don’twant your money to run out before you do! For a reasonableguess as to how long you’ll live in retirement, let’s considerthe case of 65-year-old males as shown in the table on page 2.On average, a man who lives to age 65 goes on to live an-other 17 years. Roughly half of this age 65 group will livemore than 17 years and half will live less. To be on the safeside, financially speaking, you have to assume you’ll be inthe surviving group. If you make it to age 85, your expectedlife span is increased another six years. That means, in theabsence of health reasons to the contrary, your goal shouldprobably be to have enough money to support yourself (andyour spouse, if married) into your 90s.

So that brings us to the big question: how much is all this

going to cost?

If you’re feeling a sense of urgency about learning theanswer, good! I’ve got your attention. Now you’re ready to

2 A SPECIAL REPORT PREPARED FOR THE SMI FAMILY OF READERS

R E T I R E M E N T C O U N T D O W N

make the effort needed to come upwith a reasonable approximation ofhow much you should be budgeting foryour own prime-time experiences. Mygoal is to help you understand what itwill take to get you “in shape” finan-cially in preparation for your retire-ment years. The process will involvemaking a series of assumptions. As wego along, I will explain the reasoningfor the ones I make, but feel free tochange them to fit your own sense ofwhat is appropriate.

Getting in shape is not a particularlyenjoyable process. It requires us toconsistently sacrifice certain enjoymentsnow in return for uncertain benefits inthe future. That may explain why toomany of us arrive in our 60s ill-pre-pared to get the most from our retire-ment years. You need not let this hap-pen to you and your family.

The remainder of this section isdevoted to a step-by-step process thatwill help you see where you are now inrelation to your long-term retirementneeds. The series of worksheets onpages 3-11 is designed to serve only asa very general tool tohelp you think throughyour personal retirementplanning responsibilities.It is based on a variety ofassumptions concerninginflation and the rates ofreturn you will earn onyour investments. Thecloser you are to retire-ment, the more accurate itis likely to be. It’s a goodidea to run the numbersanew every two years orso to keep them reason-ably on target.

Unless noted, I’ve made no special at-tempt to take one’s normal annual incometax obligations into consideration. All thefinancial goals and standard of living as-sumptions are based on “before tax” dol-lars. My hypothetical couple, the Millers,have a current income of $50,000 beforeincome taxes. The dollars they have re-maining after they pay their income taxesare sufficient to support a certain standardof living. I assume the same will be trueduring their retirement. That is, they will

have to pay their income taxes out of theirprojected retirement income just as theydo their other living expenses. I took thisapproach because it was impossible to ac-commodate all of the various state andfederal income tax rates currently in ef-fect, let alone guess what they might beyears into the future.

Let me warn you ahead of time thatyou might be tempted to feel discour-agement when you complete step 11.That’s the point at which you discover,based on assumptions you will havemade regarding lifestyle costs, infla-tion, and your life expectancy, howmuch money you will need in order tolive comfortably for the rest of your lifeonce you retire. It will be a huge num-ber. But don’t stop there. By the timeyou factor in Social Security and yourother pension and retirement assets,you’ll likely find that the amount youneed to save between now and retire-ment (step 45) is manageable.

Bear in mind that the projections inthe worksheet are based on the as-sumption that you will live to a specificage. If the end of your (earthly) life

comes earlier than youhad assumed, there will bemoney on hand that youwon’t need. It can be leftto your heirs and theLord’s work. If you die“on schedule,” you andyour money will run outat the same time. If youlive longer than you hadexpected, you’ll have aproblem. There are twoways to deal with this“risk.” One is to pick avery long life expectancy

(e.g., 95 or 100). That way, you wouldbe less likely to outlive your money.A second way, assuming you own yourhouse, is to sell it or take out a “reversemortgage” in order to create additionalcash flow. Of course, this brief exerciseis not an adequate substitute for sittingdown with a qualified tax adviser orfinancial planner to develop a morepersonalized strategy.

If all this seems a bit overwhelm-

ing, don’t despair. Before this report iscompleted, you’ll have been given

enough information to enable you toovercome three of the four most com-mon elements of financial failure:

� A failure to inquire. Many areignorant of the serious financial impli-cations of our changing society andhow they will be affected.

� A failure to learn. Once madeaware, they may still lack the know-how needed to begin putting theirfinancial house in order.

� A failure to plan. Even informed,knowledgeable people can let years goby without formulating goals and astrategy for achieving them. But after Iinform you of the seriousness of thesituation, teach you the basics of sur-vival, and lead you through the plan-ning process, there’s still one elementthat only you can overcome:

� A failure to act. Procrastinationcan be the greatest deterrent to reach-ing your financial goals. Commit your-self now to making the sacrificesneeded to put your family’s finances ona solid foundation. �

THE OUTRAGEOUS TRUTH

ABOUT SOCIAL SECURITY

That there has not yet been a popu-

lar uprising against Social Security

can only mean . . .

. . . that most Americans don’t un-derstand what is going on. And that isdue in large part to the fact that theSocial Security system has been misrepre-sented to the American people from thebeginning.

When George Orwell wrote hisclassic novel 1984, he coined the ex-pression “doublethink.” The rulinggovernment (“Big Brother”) useddoublethink to make lies sound truth-ful and to give an appearance of virtuewhere there was none. Our own gov-ernment has proven masterful at this inthe words it has used to promote theSocial Security program.

From the very founding of our coun-try, most Americans believed that car-ing for the elderly was a private matterbetween family members. While Chris-tian charities, churches, and state andlocal governments would often assistthose with special

Age Men Women

30 47 more years 52 more years














LIFE EXPECTANCIES

(continued on page 12)

A SPECIAL REPORT PREPARED FOR THE SMI FAMILY OF READERS 3


Overview Step by Step Millers Yourself

R E T I R E M E N T P L A N N I N G W O R K S H E E T : S E C T I O N 1

How much annual income will you need during prime time?

Note: an online version of these worksheets is available for Sound

Mind Investing website members. Not only are calculations done au-

tomatically, but a copy of the results is saved to your user account, so

you can come back at any time to modify the data. It’s perfect for those

desiring to update information annually. Visit the Retirement page at

www.soundmindinvesting.com and look in the Tools section.

To project the amount of annual income you are likely to need

each year during retirement, we start by considering how your in-

come needs will change as you enter retirement. The good news is

that you can expect to maintain approximately the same standard of

living you have now in spite of the fact you will have a lower income

after you retire. There are several reasons for this:

1. You won’t have work-related expenses such as commuting,

eating away from home, and wardrobe maintenance.

2. You won’t have the children to feed, clothe, transport, and

educate.

3. You won’t have to pay Social Security and other payroll taxes.

4. You won’t be contributing to your personal and employer’s

retirement plans.

5. And, assuming you arrive at retirement debt-free, you won’t

have home mortgage payments, car payments, or credit card pay-

ments to make.

Of course, as I’ve already pointed out, you’ll be facing increased

health care costs, and since you’ll have more free time, you’re also likely

to spend more on recreation. But all in all, most experts say that if your

retirement income is around 80% of what you’re earning now, you’ll

be in good shape; however, they warn that you’re likely to face finan-

cial difficulties if it drops below 50% of what you’re now making.

Let’s see how this works. I’m going to pick a family out of the

mid-range of the census data and assume we are preparing a projec-

tion for them. Let’s call them the Millers. The husband and wife are both

35 years old and have current income (before taxes) of $60,000 per

year. What will their annual income needs be when they retire? To be

on the conservative side, I’m going to use 90% as their “lifestyle main-

tenance” assumption; that is, the Millers’ retirement income needs will

be equal to 90% of their current level of income. By multiplying the

lifestyle maintenance assumption times their current income (90% x

$60,000), we learn that the Millers will need to generate $54,000 per

year in income (before taxes) during their prime-time years.

Of course, that’s in today’s dollars. How can we adjust this num-

ber so that it will have the same buying power during retirement that

is does today? Continue on to the next page.

1. Enter your current before-

tax annual income, or if you

wish to plan for a higher

standard of living than you

now enjoy, enter an amount

that you believe would pro-

vide that standard of living.

2. Enter your lifestyle main-

tenance assumption.

3. Multiply Item 1 by Item 2.

This provides an estimate of

how much annual income

(before taxes) you will need

during retirement to main-

tain your standard of living.

$60,000

x 90%

= $54,000

RATES OF INFLATION / TABLE ONE

YE

AR

S U

NT

IL R

ET

IRE

ME

NT

3.0% 3.5% 4.0% 4.5% 5.0%

5 1.159 1.188 1.217 1.246 1.276

6 1.194 1.229 1.265 1.302 1.340

7 1.230 1.272 1.316 1.361 1.407

8 1.267 1.317 1.369 1.422 1.477

9 1.305 1.363 1.423 1.486 1.551

10 1.344 1.411 1.480 1.553 1.629

11 1.384 1.460 1.539 1.623 1.710

12 1.426 1.511 1.601 1.696 1.796

13 1.469 1.564 1.665 1.772 1.886

14 1.513 1.619 1.732 1.852 1.980

15 1.558 1.675 1.801 1.935 2.079

16 1.605 1.734 1.873 2.022 2.183

17 1.653 1.795 1.948 2.113 2.292

18 1.702 1.857 2.026 2.208 2.407

19 1.754 1.923 2.107 2.308 2.527

20 1.806 1.990 2.191 2.412 2.653

21 1.860 2.059 2.279 2.520 2.786

22 1.916 2.132 2.370 2.634 2.925

23 1.974 2.206 2.465 2.752 3.072

24 2.033 2.283 2.563 2.876 3.225

25 2.094 2.363 2.666 3.005 3.386

30 2.427 2.807 3.243 3.745 4.322

35 2.814 3.334 3.946 4.667 5.516





What about the effects of inflation?

3. From page 3.

4. Enter the rate of inflation

assumption which you are

making for planning pur-

poses.

5. Enter the number of years

remaining until you retire.

6. Using the table on page 3,

enter the inflation adjust-

ment factor which reflects

your assumption con-

cerning the rate of future

inflation and the years re-

maining until you retire.


This is an estimate of the

amount of income you will

need during your first year

of retirement to sustain your

desired standard of living.

$54,000

4% inflation

30 years

x 3.243

= $175,122

The Millers’ $54,000 will not always buy for them what it can

buy today. We must take the $54,000 per year we projected as the

amount of annual income the Millers will need during retirement and

translate that to a higher number to allow for the fact that the value

of the dollar shrinks a little every year.

To do that, we refer to the inflation chart on page 3. For the

Millers, I’m assuming that long-term inflation will average 4% per year.

That’s close to what it was for the final two decades of the 20th cen-

tury. You’re free to change the inflation assumption if you wish. Be-

cause your family’s spending pattern is unique, your personal inflation

experience will be different from any theoretical number computed for

the “typical” American family. Choosing a higher rate, for example, is

for the extra cautious person who wants to be doubly careful to arrive

at retirement with a sufficient nest egg built up. Choosing a lower rate

is for those who think I’m being too pessimistic—after all, inflation av-

eraged just 2.6% annually for the 10 years ending in 2007.

Since the Millers have 30 years to go before they retire at age

65, we look down the left-hand column until we come to the num-

ber “30.” Then, we go over three columns to find the number listed

under the 4% heading.

The number we find is 3.243. Now, here comes the scary part.

We multiply $54,000 times 3.243 to learn what the Millers’ income

will need to be when they retire in 30 years in order to maintain the

standard of living they enjoy today. The answer is $175,122 per year!

Sort of overwhelming, isn’t it? It’s difficult to imagine that the day will

come when a family would need that much money every year just to

maintain a modest lifestyle.





Will you have enough to sustain you through a normal life expectancy?

7. From page 4.

8. Using the life expectancy

table shown on page 2 as

a guide, enter the number

of years of life after retire-

ment that you have de-

cided to use for financial

planning purposes.

9. Enter the inflation assump-

tion that you are making for

planning purposes. It can be

the same assumption you

used in Item 4, or you can

raise or lower it if you have

a different outlook for the

more distant years.

10. Using the table at left, enter

the inflation adjustment fac-

tor that reflects your inflation

assumption as well as the

years of life expectancy af-

ter retirement.


This is the approximate to-

tal spending you anticipate

during all of your retirement

years. Let’s call it your

“prime time wealth.” In the

Millers’ case, this would be

the total expected spending

for the 25 years following

retirement.

$175,122

25 years

4% inflation

x 43.31

$7,584,534

An essential part of your planning is to come up with a reasonable

estimate of how long you (and, if married, your spouse) will live. The table

of life expectancies on page 2 is a good starting point. You can make ad-

justments based on your current state of health and family history.

We use this information to project how much income you’ll need

during the whole of your retirement years. This is a function of your stan-

dard of living, life expectancy, and the rate of inflation after you retire.

The table below has been designed to do the math for you. In the

Millers’ situation, I’m being cautious and assuming they will live to be 90.

This means their life expectancies after retirement at age 65 are another

25 years. Continuing to assume inflation of 4%, the table gives us a factor

of 43.31.

Years 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%

1 1.03 1.04 1.04 1.05 1.05 1.06 1.06

2 2.09 2.11 2.12 2.14 2.15 2.17 2.18

3 3.18 3.21 3.25 3.28 3.31 3.34 3.37

4 4.31 4.36 4.42 4.47 4.53 4.58 4.64

5 5.47 5.55 5.63 5.72 5.80 5.89 5.98

6 6.66 6.78 6.90 7.02 7.14 7.27 7.39

7 7.89 8.05 8.21 8.38 8.55 8.72 8.90

8 9.16 9.37 9.58 9.80 10.03 10.26 10.49

9 10.46 10.73 11.01 11.29 11.58 11.88 12.18

10 11.81 12.14 12.49 12.84 13.21 13.58 13.97

11 13.19 13.60 14.03 14.46 14.92 15.39 15.87

12 14.62 15.11 15.63 16.16 16.71 17.29 17.88

13 16.09 16.68 17.29 17.93 18.60 19.29 20.02

14 17.60 18.30 19.02 19.78 20.58 21.41 22.28

15 19.16 19.97 20.82 21.72 22.66 23.64 24.67

16 20.76 21.71 22.70 23.74 24.84 26.00 27.21

17 22.41 23.50 24.65 25.86 27.13 28.48 29.91

18 24.12 25.36 26.67 28.06 29.54 31.10 32.76

19 25.87 27.28 28.78 30.37 32.07 33.87 35.79

20 27.68 29.27 30.97 32.78 34.72 36.79 38.99

21 29.54 31.33 33.25 35.30 37.51 39.86 42.39

22 31.45 33.46 35.62 37.94 40.43 43.11 46.00

23 33.43 35.67 38.08 40.69 43.50 46.54 49.82

24 35.46 37.95 40.65 43.57 46.73 50.15 53.86

25 37.55 40.31 43.31 46.57 50.11 53.97 58.16

26 39.71 42.76 46.08 49.71 53.67 57.99 62.71

27 41.93 45.29 48.97 52.99 57.40 62.23 67.53

28 44.22 47.91 51.97 56.42 61.32 66.71 72.64

29 46.58 50.62 55.08 60.01 65.44 71.44 78.06

30 49.00 53.43 58.33 63.75 69.76 76.42 83.80

RATES OF INFLATION / TABLE TWO

LIFE

EX

PE

CT

AN

CY

AFT

ER

RE

TIR

EM

EN

T





How much of your “prime time wealth” will Social Security provide?

12. Enter the amount of your

combined annual Social

Security benefits as pro-

jected in your current So-

cial Security Statements

(in today’s dollars).

13. Enter the inflation adjust-

ment factor used in Item 6.

14. Multiply Item 12 by Item

13. This is the approximate

amount of your Social Se-

curity benefit during your

first year of retirement.

15. Enter Social Security’s annual

cost-of-living increase. You

might assume an increase

less than the inflation as-

sumption (made in Item 9)

in order to reflect the possi-

bility of benefit cutbacks.

16. Using Table Two on page

5, enter the inflation ad-

justment factor that re-

flects the inflation as-

sumption in Item 15 as

well as the years of life ex-

pectancy shown in Item 8.


This is the approximate total

amount of Social Security

you can anticipate receiving


years.

His:$15,696+ Hers:$7,848

= $23,544

x 3.243

$76,353

3%annual

increases

x 37.55

$2,867,062

For years, workers have been paying much more in Social Secu-

rity taxes than was needed to fund the current level of benefits. That’s

because a surplus was needed in order to take care of the baby boomers

when they retire beginning around 2010. Projections made at the time

of the 1983 “reforms” predicted the surplus would peak at a huge

$16 trillion before the baby boomer drawdown began.

Eleven years later the projected surplus had almost vanished.

Critics of the 1983 changes said at the time that the surplus was based

on several unrealistic assumptions having to do with birth rates, life ex-

pectancies, and economic growth. They were proven correct, and the

reality is that the benefits will have to be substantially scaled back.

Once a year, an updated Social Security Statement is mailed auto-

matically to workers age 25 or older who are not yet getting Social Se-

curity benefits. Your Statement provides you with a record of the contri-

butions credited to your account (be sure to check it for accuracy) and

an estimate of what your retirement benefit will be. If you will be retiring

in the next ten years, it will likely be fairly accurate. The further you go

beyond ten years, however, the more you might want to adjust the esti-

mate downward to allow for economic and political realities.

You should get your Statement a few months before your birth-

day. If you’d rather not wait, you can request a Statement at any time.

Call (800) 772-1213 or visit www.ssa.gov to get the ball rolling.

While you’re there, you can check out the “Benefit Calculators” at

www.ssa.gov/planners/calculators.htm which will give you an imme-

diate online estimate of what your Statement will show.





How much of your prime time wealth will your company’s pension provide?


annual pension benefit. See

your most recent employee

benefit statement.

19. If your benefit is “indexed for

inflation,” enter the factor

used in Item 16. Or, if your

benefit is not “indexed for in-

flation,” enter the factor used

in Item 8.



total amount of pension in-

come you can anticipate

receiving during all of your

retirement years.


spouse’s annual pension

benefit from his or her

employee benefit state-

ment.

22. If your spouse’s benefit is “in-

dexed for inflation,” enter the

factor used in Item 16. Or, if

your spouse’s benefit is not

“indexed for inflation,” enter

the factor used in Item 8.


This is the approximate total

amount of pension income

your spouse can anticipate

receiving during all of his or

her retirement years.

There are two different varieties of pension plans (which we’ll

review in a later section). One kind is called a “defined-benefit” plan

because the focus is on the lifetime benefit you’ll ultimately receive.

These plans promise to pay you, when you retire, a certain dollar amount

every month for as long as you live. If you participate in a defined-ben-

efit plan, your employer is required by law to offer you a summary of

the plan that’s written in layman’s terms. This is called a “summary

plan description,” and should be readily available from your personnel

department. Many companies also provide a personalized employee

benefit statement once a year that provides an estimate of how much

your monthly retirement check will be.

Plans in the other major category of employer-sponsored retire-

ment plans are called “defined-contribution” plans because they place

their emphasis on how much the employer will put into the plan for you

each year. They should not be included in the worksheet at this point—

we’ll get to those on the next page.)

When you reach retirement and the time comes for your monthly

pension benefit to be paid, you have several choices as to how you wish

it to be calculated. See page 23. If you are currently a participant in a

defined-benefit plan, make an appointment with the appropriate person

at your company to get your specific questions answered.

If you have participated in such a plan in the past at another com-

pany, you may have earned vested benefits there as well. Be sure to in-

clude them here also unless you have already moved them into a rollover

IRA. In that case, enter the value of that account in step 31.

$3,312

25

$82,800

none

N/A

none



Years 6% 7% 8% 9% 10%

5 0.8368 0.8126 0.7891 0.7665 0.7445

10 0.7157 0.6764 0.6392 0.6039 0.5704

15 0.6080 0.5579 0.5115 0.4687 0.4292

20 0.5129 0.4559 0.4047 0.3587 0.3175

25 0.4299 0.3694 0.3166 0.2708 0.2311

30 0.3580 0.2968 0.2452 0.2019 0.1658

35 0.2963 0.2366 0.1881 0.1489 0.1174

40 0.2438 0.1873 0.1430 0.1086 0.0822



How much of your prime time wealth must you provide?

24. Enter the amount from Item

11. I’ve been calling this your

prime time wealth.



total amount of Social Secu-

rity you anticipate receiving


years.

26. Enter the sum of Items 20

and 23. This is the approxi-

mate total amount of pen-

sion income you anticipate

receiving during all of your

retirement years.

27. Subtract Items 25 and 26

from Item 24. This is the total

amount of your prime time

wealth that you must provide.

28. Enter the average annual rate

of return you are assuming

your investments will earn

during retirement.

29. Enter the factor from Table

Four that reflects the life

expectancy during retire-

ment (Item 8) and the ex-

pected return on invest-

ments (Item 28).


This is the amount of capital

you should have on hand as

you enter retirement.

$7,584,534

$2,867,062

$82,800

$4,634,672

7% rateof return

x .3694

$1,712,048

In step 27, we learn the amount that you must supply from your

own retirement investment strategy. Of course, you don’t need to have

all your prime time wealth available on your first day of retirement. After all,

it’s going to take the rest of your life to spend it all. The question is: How

much of your prime time wealth do you need to have at the outset (know-

ing that your investments will continue to earn a respectable rate of return

after you retire)?

Table Three, shown below, will help you ascertain that amount. It

assumes not only that your retirement capital earns a return (see head-

ings which range from 6% to 10%), but also that withdrawals are made

from your investment accounts each month to meet current spending

needs. The withdrawals are designed to exhaust the investment account

by the end of your life expectancy. For example, when you have a re-

maining life expectancy of 25 years, you can withdraw 4.00% of the ac-

count value during that year (1 divided by 25). The next year, when you

have 24 years of life expectancy, you can withdraw 4.17% of the ac-

count value (1 divided by 24). And so on. In the Millers’ example, I as-

sumed a 7% long-term return during retirement. This is lower than the

9% expected return prior to retirement because they should be taking

less risk at this stage of life.

You should understand that this provides only a rough blueprint

of what each year’s cash flow will be like. The 7% return is an average

over a 25-year period. You might start off with a 15% return the first

year, or a loss. If a given year’s scheduled withdrawal is insufficient to

cover that year’s needs, you might have to “borrow” from next year

and wait for your investment returns to catch up.

RATES OF RETURN DURING RETIREMENT

TABLE THREE

LIFE

EX

PE

CT

AN

CY





How much will your current tax-deferred portfolio be worth when you retire?

31. Enter the current values of

any tax-deferred investment

accounts you and your

spouse have:

a. IRAs / Roth IRAs1

b. 401(k)

c. 403(b)

d. Variable annuity

e. Other

f. Other

32. Enter the sum of all the ac-

counts listed in Item 31.

This is the total amount of

tax-deferred capital that

you and your spouse cur-

rently have working for you.

33. Enter the average annual rate

of return you are assuming

your investments will earn

between now and the year

you retire.


the rate of return factor that

reflects your assumption

concerning the future annual

rate of growth of your long-

term capital (Item 33) over

the period of time between

now and retirement (Item 5).


34. This is an estimate of

the value of your current

tax-deferred capital when

you reach retirement.

Now that we know your prime-time wealth goal, let’s see how far

along you are toward achieving it. In this section, we project the current

values in any tax-deferred accounts you may have into the future. For

the Millers, I’m assuming a 10% average annual rate of return. If you’d

like to use a different assumption, see the table below. Using a lower per-

centage assumption implies a more cautious view, and may require a

higher level of savings between now and retirement.

$24,552$42,460

$67,012

10% rateof return

x 17.45

$1,169,359

RATES OF RETURN / TABLE FOUR

YE

AR

S U

NT

IL R

ET

IRE

ME

NT

Years 6% 7% 8% 9% 10% 11% 12%

5 1.34 1.40 1.47 1.54 1.61 1.69 1.76

6 1.42 1.50 1.59 1.68 1.77 1.87 1.97

7 1.50 1.61 1.71 1.83 1.95 2.08 2.21

8 1.59 1.72 1.85 1.99 2.14 2.30 2.48

9 1.69 1.84 2.00 2.17 2.36 2.56 2.77

10 1.79 1.97 2.16 2.37 2.59 2.84 3.11

11 1.90 2.10 2.33 2.58 2.85 3.15 3.48

12 2.01 2.25 2.52 2.81 3.14 3.50 3.90

13 2.13 2.41 2.72 3.07 3.45 3.88 4.36

14 2.26 2.58 2.94 3.34 3.80 4.31 4.89

15 2.40 2.76 3.17 3.64 4.18 4.78 5.47

16 2.54 2.95 3.43 3.97 4.59 5.31 6.13

17 2.69 3.16 3.70 4.33 5.05 5.90 6.87

18 2.85 3.38 4.00 4.72 5.56 6.54 7.69

19 3.03 3.62 4.32 5.14 6.12 7.26 8.61

20 3.21 3.87 4.66 5.60 6.73 8.06 9.65

21 3.40 4.14 5.03 6.11 7.40 8.95 10.80

22 3.60 4.43 5.44 6.66 8.14 9.93 12.10

23 3.82 4.74 5.87 7.26 8.95 11.03 13.55

24 4.05 5.07 6.34 7.91 9.85 12.24 15.18

25 4.29 5.43 6.85 8.62 10.83 13.59 17.00

26 4.55 5.81 7.40 9.40 11.92 15.08 19.04

27 4.82 6.21 7.99 10.25 13.11 16.74 21.32

28 5.11 6.65 8.63 11.17 14.42 18.58 23.88

29 5.42 7.11 9.32 12.17 15.86 20.62 26.75

30 5.74 7.61 10.06 13.27 17.45 22.89 29.96

31 6.09 8.15 10.87 14.46 19.19 25.41 33.56

32 6.45 8.72 11.74 15.76 21.11 28.21 37.58

33 6.84 9.33 12.68 17.18 23.23 31.31 42.09

34 7.25 9.98 13.69 18.73 25.55 34.75 47.14

35 7.69 10.68 14.79 20.41 28.10 38.57 52.80

36 8.15 11.42 15.97 22.25 30.91 42.82 59.14

37 8.64 12.22 17.25 24.25 34.00 47.53 66.23

38 9.15 13.08 18.63 26.44 37.40 52.76 74.18

39 9.70 13.99 20.12 28.82 41.14 58.56 83.08

40 10.29 14.97 21.72 31.41 45.26 65.00 93.05

1 Note that Roth IRA distributions will not require taxes to be paid. This means that any shortfall in Item 43 will be lessened to some degree.

We suggest ignoring this factor and using this advantage as a margin of safety in your calculations.





How much will your current taxable holdings be worth when you retire?

36. Enter the current values of

any taxable investment ac-

counts that you and your

spouse may have that are

not part of your contin-

gency fund or set aside for

a special purpose like col-

lege or house purchase:

a. Bank savings/CDs

b. Money market funds

c. Mutual funds

d. Brokerage accounts

e. Other

f. Other

37. Enter the sum of all the ac-

counts listed in Item 36.

This is the total amount of

taxable investments that

you and your spouse cur-

rently have working for you.


the rate of return factor that

reflects your assumption

concerning the future annual

rate of growth of your long-

term capital (Item 33) over

the period of time between

now and retirement (Item 5).


38. This is an estimate of

the value of your current

taxable holdings when

you reach retirement.

Now, we calculate the current value in your taxable holdings and

estimate their value at the time of your retirement. We will take into ac-

count the taxes due on your gains under the assumption they will be paid

with funds from these accounts. For the Millers, I’ll use the same estimated

rate of return of 10% as before. You can use the table below to select an-

other one if you wish. This table differs from the one on page 9 in that it

assumes a 34% combined state/federal income tax rate.

$ 3,188

$ 8,524

$ 11,712

x 6.80

$79,642

RATES OF RETURN / TABLE FIVE

YE

AR

S U

NT

IL R

ET

IRE

ME

NT

Years 6% 7% 8% 9% 10% 11% 12%

5 1.21 1.25 1.29 1.33 1.38 1.42 1.46

6 1.26 1.31 1.36 1.41 1.47 1.52 1.58

7 1.31 1.37 1.43 1.50 1.56 1.63 1.70

8 1.36 1.44 1.51 1.59 1.67 1.75 1.84

9 1.42 1.50 1.59 1.68 1.78 1.88 1.99

10 1.47 1.57 1.67 1.78 1.89 2.02 2.14

11 1.53 1.64 1.76 1.89 2.02 2.16 2.31

12 1.59 1.72 1.85 2.00 2.15 2.32 2.50

13 1.66 1.80 1.95 2.12 2.30 2.49 2.69

14 1.72 1.88 2.06 2.24 2.45 2.67 2.91

15 1.79 1.97 2.16 2.38 2.61 2.86 3.14

16 1.86 2.06 2.28 2.52 2.78 3.07 3.39

17 1.94 2.16 2.40 2.67 2.96 3.29 3.65

18 2.01 2.25 2.52 2.83 3.16 3.53 3.94

19 2.09 2.36 2.66 2.99 3.37 3.79 4.26

20 2.17 2.47 2.80 3.17 3.59 4.06 4.59

21 2.26 2.58 2.95 3.36 3.83 4.36 4.96

22 2.35 2.70 3.10 3.56 4.08 4.67 5.35

23 2.44 2.83 3.27 3.77 4.35 5.01 5.77

24 2.54 2.96 3.44 3.99 4.64 5.38 6.23

25 2.64 3.09 3.62 4.23 4.94 5.77 6.72

26 2.74 3.24 3.81 4.48 5.27 6.19 7.26

27 2.85 3.39 4.01 4.75 5.62 6.63 7.83

28 2.97 3.54 4.22 5.03 5.99 7.12 8.45

29 3.08 3.71 4.45 5.33 6.38 7.63 9.12

30 3.21 3.88 4.68 5.65 6.80 8.19 9.84

31 3.33 4.06 4.93 5.98 7.25 8.78 10.62

32 3.47 4.24 5.19 6.34 7.73 9.42 11.46

33 3.60 4.44 5.46 6.71 8.24 10.10 12.37

34 3.75 4.64 5.75 7.11 8.79 10.84 13.35

35 3.89 4.86 6.05 7.54 9.36 11.62 14.41

36 4.05 5.08 6.37 7.98 9.98 12.47 15.55

37 4.21 5.32 6.71 8.46 10.64 13.37 16.78

38 4.37 5.56 7.07 8.96 11.34 14.34 18.11

39 4.55 5.82 7.44 9.49 12.09 15.38 19.54

40 4.73 6.09 7.83 10.06 12.89 16.50 21.09



Years 6% 7% 8% 9% 10% 11% 12%

5 17.22% 16.80% 16.39% 15.99% 15.60% 15.22% 14.85%

6 13.92% 13.51% 13.11% 12.72% 12.34% 11.98% 11.63%

7 11.57% 11.16% 10.78% 10.40% 10.04% 9.69% 9.35%

8 9.81% 9.42% 9.04% 8.68% 8.33% 7.99% 7.67%

9 8.45% 8.07% 7.70% 7.35% 7.01% 6.69% 6.38%

10 7.37% 6.99% 6.64% 6.30% 5.98% 5.67% 5.38%

11 6.48% 6.12% 5.78% 5.45% 5.14% 4.85% 4.57%

12 5.76% 5.40% 5.07% 4.75% 4.45% 4.17% 3.91%

13 5.14% 4.80% 4.47% 4.17% 3.88% 3.62% 3.37%

14 4.62% 4.28% 3.97% 3.68% 3.40% 3.15% 2.91%

15 4.17% 3.84% 3.54% 3.26% 3.00% 2.75% 2.53%

16 3.78% 3.46% 3.17% 2.90% 2.65% 2.42% 2.21%

17 3.44% 3.13% 2.85% 2.59% 2.35% 2.13% 1.93%

18 3.14% 2.84% 2.57% 2.32% 2.09% 1.88% 1.69%

19 2.88% 2.58% 2.32% 2.08% 1.86% 1.66% 1.49%

20 2.64% 2.36% 2.10% 1.87% 1.66% 1.48% 1.31%

21 2.43% 2.15% 1.91% 1.69% 1.49% 1.31% 1.15%

22 2.24% 1.97% 1.73% 1.52% 1.33% 1.17% 1.02%

23 2.07% 1.81% 1.58% 1.38% 1.20% 1.04% 0.90%

24 1.91% 1.66% 1.44% 1.25% 1.08% 0.93% 0.80%

25 1.77% 1.53% 1.32% 1.13% 0.97% 0.83% 0.71%

26 1.64% 1.41% 1.20% 1.03% 0.87% 0.74% 0.63%

27 1.52% 1.30% 1.10% 0.93% 0.79% 0.66% 0.56%

28 1.42% 1.20% 1.01% 0.85% 0.71% 0.59% 0.49%

29 1.32% 1.11% 0.92% 0.77% 0.64% 0.53% 0.44%

30 1.23% 1.02% 0.85% 0.70% 0.58% 0.48% 0.39%

31 1.14% 0.95% 0.78% 0.64% 0.52% 0.43% 0.35%

32 1.07% 0.88% 0.72% 0.58% 0.47% 0.38% 0.31%

33 1.00% 0.81% 0.66% 0.53% 0.43% 0.34% 0.28%

34 0.93% 0.75% 0.61% 0.49% 0.39% 0.31% 0.25%

35 0.87% 0.70% 0.56% 0.44% 0.35% 0.28% 0.22%

36 0.82% 0.65% 0.51% 0.41% 0.32% 0.25% 0.19%

37 0.76% 0.60% 0.47% 0.37% 0.29% 0.22% 0.17%

38 0.71% 0.56% 0.44% 0.34% 0.26% 0.20% 0.15%

39 0.67% 0.52% 0.40% 0.31% 0.24% 0.18% 0.14%

40 0.63% 0.48% 0.37% 0.28% 0.22% 0.16% 0.12%



How much should you save each year to meet your retirement goal?

Your final step is to calculate how much you need to save in the

future in order to arrive at retirement day with the amount of capital

needed. If the amount computed in step 43 is a positive number, you’re

already in great shape. Unfortunately, most of us need to continue add-

ing to our retirement savings. Table Six will help you determine the an-

nual amount which you need to add each year to a tax-deferred account

(it assumes no taxes are paid on the returns earned).

RATES OF RETURN / TABLE SIX

YE

AR

S U

NT

IL R

ET

IRE

ME

NT


35. This is the estimated

value of your current tax-de-

ferred investments when

you reach retirement.1


39. This is the estimated

value of your current tax-

able investments when you

reach retirement.


30. This is the amount of your

prime-time wealth that you

must provide from your retire-

ment investment strategy.

43. Add Items 40 and 41 and

subtract Item 42. This is

your estimated shortfall if

you do not continue adding

to your retirement savings

in future years.


the annual savings growth

factor that reflects your as-

sumption concerning the

future rate of growth of your

capital (Item 33) over the

period of time between now

and retirement (Item 5).


This is an estimate of the

amount of new savings you

need to add to your tax-de-

ferred accounts each year.

$1,169,359

$79,642

$1,712,048

– $463,047

x .0058

$2,686

1 See footnote on page 9.



needs, the basic responsibility remainedwith the individual. This all changedwith the passing of the Social SecurityAct of 1935. For the first time, it becamemorally acceptable for the government totake money from one group of citizensfor the sole purpose of giving it away toanother group of citizens. Responsibilityfor the elderly was being transferred from theindividual/family to society. In order tooverturn our 150-year tradition of self-reliance, double-think wording was usedto make this transition more acceptableto the American people.

Doublethink Example #1: We’re

told we’re buying “insurance.”

To disguise the fact that Social Secu-rity is actually a wealth-transfer pro-gram, the government named it “OldAge and Survivors Insurance.” After all,buying insurance is a prudent financialstep every family should take, isn’t it?But insurance involves making pay-ments proportionate to the risk involved.That’s why insurance companies hireactuaries—to help them set premiumsbased on reasonable life expectancies.Social Security isn’t like insurance at all;your payments have little direct correla-tion to your ultimate benefits.

This immediately became obviouswith the case of Ida Fuller. Before retir-ing in 1939, she had paid a mere $22into Social Security. In her first month,she recouped all that she had ever paidin! By the time she left this life 34 yearslater at the age of 100, she had collectedmore than $20,000—almost 1,000 timesmore than she had put in!

In Beyond Our Means, Alfred Malabreshares a different, but equally compel-ling, scenario:

Consider a worker who began payinginto the system in 1937, when it waslaunched, and worked until 1982. If he hadpaid the maximum in Social Security taxeseach of the 45 working years, his paymentswould have totaled $12,828. His benefitswould have begun at $734 a month.If he were married, his wife would collecthalf of his benefit, or an additional $367monthly, bringing their total first-yearbenefit to $13,217, or more than he had paidin the 45 years of employment.

Malabre goes on to show that if the

couple live out normal life expectan-cies, their lifetime benefits wouldamount to some $375,000! You maywonder how all this lavish generosityis possible. We’ll take that up shortly.


told we’re “entitled” to benefits.

We’re led to believe that, upon retire-ment, our years of payments give usspecific entitlement rights. That is, thegovernment is obligated to honor itscommitments. Unfortunately, that’s notthe case. The fact is that the governmentcan change the rules anytime it wants.For example, it used to be that youcould retire at age 65 with “full ben-efits.” In 1983, as part of a Social Secu-rity bailout plan, Congress decided toraise the age requirements on a gradu-ated basis. Now, people (like me) whowere born between 1943-1954 have towork until age 66 to get full benefits.That involves not merely waiting anadditional year to collect, but also anadditional year of paying in. So, what Ihad been promised for half of my work-ing life was suddenly changed at thestroke of a pen. Congress giveth andCongress taketh away.

Is that fair? No less an authoritythan the U.S. Supreme Court has ruledthat Congress can do whatever it wantswith Social Security: “The Social Securityprogram is in no sense a federally-adminis-tered insurance program under which eachworker pays premiums over the years andacquires at retirement an indefeasible[guaranteed] right to receive for life a fixedmonthly benefit irrespective of the condi-tions which Congress has chosen to imposefrom time to time.”

Justice Hugo Black dissented: “Icannot believe that any private insurancecompany in America would be permitted torepudiate its matured contracts with itspolicyholders who have regularly paid alltheir premiums in reliance upon the goodfaith of the company.”

But Justice Black lost because SocialSecurity is a tax, not insurance as it hasbeen called.


told we’re making “contributions”

that “earn” us protection.

Money is automatically taken out of

our paychecks and called a “contribu-tion.” But unlike voluntary paymentsinto a private pension plan, there’snothing voluntary about these so-calledcontributions. Try to get the govern-ment to stop the withholding and seewhat happens. The simple fact is thatSocial Security is a tax.

Many working Americans now paymore in Social Security withholdings thanthey do in federal income taxes. Whatstarted out as a 1% payroll tax with a$30 per year maximum per person hadgrown by 2009 to a 12.4% tax with anannual maximum of $13,324 (of whichyou pay $6,662 directly out of yourpaycheck, and $6,662 is paid on yourbehalf by your employer).

For many years, Social Securitydistributed a booklet that containedthis statement: “Nine out of ten work-ing people are earning protection forthemselves and their families under thesocial security program.” The truth isthat the individual worker is not “earn-ing” anything in the same sense as onewho invests in an IRA or other privatepension plan. Rather, as we have seen,what nine out of ten working peopleare actually doing is paying taxes,which are then given to persons whoare not working.

Now, I might not consider this to beall that bad if I thought my own turnwould come—if, like hypotheticalworker in Alfred Malabre’s book, Iwould get back all that I had paid induring my very first year of retirement,and that I would eventually reap life-time benefits that were almost thirtytimes more than the total taxes I paid.But, alas, I harbor no such illusions; Iknow the awful truth about the so-called trust fund.


told our money goes into a “trust

fund.”

For most of us, the expression “trustfund” means that a sum of money isbeing accumulated, invested safely, andis growing daily as it awaits the timewhen it will be needed. It sounds secure.So it would be understandable if youthought in those terms when you hearthat your money is going into the Social



Security trust fund. That’s what you’resupposed to think. Unfortunately, nothingcould be further from the truth. TheSocial Security program has not set asideany trust money for our future use, andnever has. Actually the program is morelike the world’s largest chain letter.

Remember the examples I gave youearlier about the people receiving hugesums in relation to what they put in?Since their withholdings couldn’t pos-sibly have grown that much purelyfrom investments, how was it possible?Here’s how they did it. From the mil-lions of dollars of “contributions” com-ing into Social Security each morningfrom the younger workers, Social Secu-rity took what they needed in order topay the generous “benefits” in theafternoon to the older retired workers.What did they do with the rest? They“invested” it in Treasury bonds. Inother words, Social Security lent theTreasury Department what was left sothe federal government could spend iton whatever it wanted. That money islong gone; only the IOUs remain.

No one can tell you with certaintywhere the government will get themoney to pay Social Security for theseIOUs. Need I remind you of the size ofour national debt? The federal govern-ment is very good at borrowing; it isvery bad when it comes to paying back.It is so bad, in fact, that America hasnow become the world’s largest debtornation. Where will the governmentcome up with the money when SocialSecurity comes knocking at its doorwith trillions of dollars of governmentIOUs in hand? In the great doublethinktradition, what Congress likes to call atrust fund is actually a gigantic futureliability!


told that Social Security is running a

“surplus.”

You will hear that the Social Security“trust fund” is running a surplus. Ac-cording to government figures, it was$2,024 billion (that is, over $2 trillion) atthe end of 2007. This is supposed to bereassuringly good news, but it’s not. Thesurplus is a drop in the bucket com-pared to the level of benefits already

promised. Here’s the coming scenarioaccording to the 2008 Annual Report ofthe Board of Trustees of the Federal Old-Ageand Survivors Insurance Fund.

• From now through 2016. At thepresent time, the taxes being paid intothe system by current workers are morethan enough to pay the promised ben-efits to retirees. The money not neededfor paying current benefits gets carriedover to future years, increasing thesurplus. Think of it as a family that isable to live within its income and savefor the future.

• From 2017 through 2026. Mattersare projected to continue in this wayuntil 2017, at which time the moneygoing out (to an ever-larger number ofretirees) will exceed the money comingin (from an ever-smaller number ofworkers). At that point, Social Securitywill have to use some of the interestincome it receives from its TreasuryIOUs to make up the difference. Ourfamily is now spending all its income,and needs to use part of its interestincome to support its standard of living.

• From 2027 until 2040. In 2027, theinterest income is no longer sufficient tomake up the difference. To continuemaking payments, Social Security willneed to draw on the surplus. This hastwo important implications: (1) theTreasury will need to begin paying offits IOUs, and (2) as the IOUs are paid offand the money distributed to retirees,there are fewer IOUs to earn interest forthe coming years. Our family is nowbeginning to spend the capital that hasbeen providing the essential interestincome. A downward spiral has begun.

• 2041 and later. The surplus isgone; the trust fund is empty. All theIOUs have all been paid (don’t ask mewhere the Treasury got the money) andthe money spent. There is no interestincome. And the tax money coming incovers only about three-fourths of theneed. Our spendthrift family is broke.

Sounds pretty hopeless, doesn’t it?

Just how hopeless depends on . . .

. . . how close you personally are tothe day you switch teams—leaving theranks of the people paying in and join-ing those in that happy state of grace

where you receive monthly income forlife far in excess of your earlier contri-butions. If you are planning to retire inthe next 10 years, you’re in pretty goodshape. There may be minor adjust-ments to your benefits along the way,but congressional hypocrisy and cow-ardice is probably good for anotherdecade of failure to face up to SocialSecurity’s monumental problems.

The rest of us are probably going tobe pretty unhappy about whatever“fix” Congress finally comes up with,and the younger we are now, the moreunhappy we’re likely to be. In the past,each generation of workers was askedto support the benefits for the previousgeneration. But it is falling to the baby-boomer generation to pay for the retire-ment of not only the previous genera-tion (the workers who supported IdaFuller so generously) but also to pro-vide trillions in additional taxes fortheir own retirement as well.

Today’s workers carry the tripleburden of (1) paying far more in SocialSecurity taxes than any previous gen-eration, (2) waiting longer to collectthan any previous generation, and (3)retiring with lower after-tax benefitsthan any previous generation. As un-fair as this is, tomorrow’s workers, ourchildren, might have to pay even more,wait even longer, and receive even less.And that’s why the truth about SocialSecurity is indeed outrageous.

In light of the uncertainties sur-rounding the level of Social Securitybenefits after 2016, receiving significantsupport from the private retirementplans sponsored by your employer isall the more critical. A basic under-standing of their strengths and weak-nesses is essential if you are to planrealistically. We begin our look at suchplans in the next section. �

YOUR PENSION

AT WORK

Although the government can

change its rules anytime it wants and

arbitrarily reduce . . .

. . . the Social Security benefits you’vebeen “contributing” to for a workinglifetime, it won’t let your employer do



that to you. After all, that wouldn’t befair. So let’s look at employer-sponsoredpension plans to see what help you canexpect from your company. First, youshould understand that there are twodifferent kinds of pension plans. Onekind promises only to put a certainamount aside for you each year andmakes no projections as to the amountof your ultimate monthly benefit. Thiskind is called a “defined-contribution”plan, and it comes in a bewilderingarray of alphabet-like names such asSEP-IRA, 401(k), and 403(b). We’ll lookat these plans later in this section.

For now, let’s concentrate on theother type of pension plan, the kind thathas historically covered the greatestnumber of employees. According toU.S. government numbers, they coverabout 44 million American workers andretirees.

These plans promise to pay you,

when you retire, a certain dollar

amount every month for as long as

you live . .

. . . however, they promise nothingabout how much money your companywill put aside each year to accomplishthis (other than to observe certain mini-mum federal requirements). These plansare called “defined benefit” plans be-cause the focus is on the lifetime monthlybenefit you’ll ultimately receive. Underthis arrangement, the employer carriesthe burden of where the money for thecontributions comes from as well ashow well the investments do betweennow and your retirement.

The first barrier standing between youand your monthly pension check is meet-ing the eligibility requirements. Justbecause you’ve been hired doesn’t meanyou immediately qualify for a company’sretirement plan. Usually they require (1)that you’ve reached a certain age, and (2)that you have been with the company fora certain period of time before youqualify to join the plan. It is customarythat an employee must be at least twenty-one years old and have been with thecompany at least one year.

Once you’re eligible, what you

really want to know is . . .

. . . how much is my monthly benefitgoing to be when I retire? That dependson several factors. Each is fairly simple;let’s take them one at a time.

• Salary formula. The goal of amonthly pension check is to help re-place the earnings lost when you retire.That means your benefit is based pri-marily on the amount of your annualearnings while you were still working.Some formulas take an average of yourearnings from all the years you workedfor the company. Presumably, the ear-lier years were not as well paying, sothis is not as favorable to you as a planthat uses a formula based on your finalyear(s) of service.

• Years of service. People whospend their entire career with the samecompany receive more than those whocome along later. Your benefit is af-fected by the number of years youwork for your employer. But howmany hours are needed to constitute a“year of service”? Some plans mayrequire 500 hours in a twelve-consecu-tive-month period, whereas othersrequire 1,000 hours. Or what if youworked for twenty years, left for twoyears, and returned for another eigh-teen years? Do you get credit for thirty-eight years or just the last eighteenyears? And does it matter why you leftfor those two years? There are count-less variations on this theme that canaffect your benefit.

• Vesting requirements. When canyou know for sure that you’re guaran-teed to receive at least some pensionbenefit from your employer? The dayyou start to work? The year you qualifyto join the plan? After three years withthe company? That’s where the conceptof “vesting” comes in. It means youhave an absolute right to receive somemoney from a retirement plan, even ifyou resign or are fired. You’re entitledto it no matter what.

Some plans call for “graded vest-ing,” where you receive a right to apension gradually (for example, 20%after three years, 40% after four years,and so on). Others provide for what iscalled “cliff vesting,” an all-or-nothingapproach where, for example, youcould become 100% vested after three

years but be entitled to nothing if youleave before then. The most favorable is“vesting upon entry” where you mustwait for two years before qualifying toparticipate in the plan, but are immedi-ately 100% vested upon entry. This isespecially helpful to working womenwho, on average, change jobs morefrequently than men.

• Normal retirement age. Mostplans use formulas that consider 65 asthe normal retirement age. If youchoose to work past 65 (federal lawprohibits age discrimination rules thatwould require you to retire before age70), will your plan give you credit forthe additional years worked? Or whatif you wanted to take early retire-ment—how much will that reduce yourmonthly pension check? The rulesgoverning these matters vary from planto plan.

• Social Security considerations.

So-called “integrated plans” deduct aportion of your monthly Social Securitycheck from your monthly benefit check.Remember that your employer hasalready paid hefty Social Security taxes.From his point of view, it seems rea-sonable that the company retirementplan formula recognize that you arereceiving Social Security benefits towhich the company has already con-tributed.

• Survivors’ benefits. As an alterna-tive to the basic “monthly check forlife” benefit, federal law requires mostplans to offer you another approach: ajoint and survivor annuity. If this isselected, the monthly benefit checkdoesn’t stop coming when you die; itgoes instead to your spouse (or who-ever you have named in the annuity).The trade-off is that your pension willbe 10%–20% lower than it otherwisewould be—after all, it has to last fortwo lifetimes now instead of just one—and the amount of the monthly check iscut in half when you pass on. Even so,it’s good to know that your spouse willstill be provided for at some level.

Armed with this information, you

might now be wondering how the

plan at your company . . .

. . . measures up in these various



areas. If you aren’t sure, it’s time tofind out! And don’t worry about howyou’ll ever get your thoughts togetherin order to ask the right questions.Your employer is required by law tooffer every participant a summary ofthe plan that’s written in layman’sterms. This is called a “summary plandescription” and should be readilyavailable from your personnel depart-ment. Ask for one. It will explain all ofthe above and lots more.

Many companies also provide apersonalized “employee benefit state-ment” once a year that explains theamount of benefits you’ve earned todate and provides an estimate of howmuch your monthly retirement checkwill be. Other items that you’re entitledto receive upon request include: the“summary annual report” (your plan’sbalance sheet), the Form 5500 (yourplan’s tax return and an excellentsource of information concerning itsfinancial health), and the retirementplan document itself (in case you hap-pen to enjoy digging through page afterpage of mind-numbing legalese).

So far, we’ve looked at retirementplans that promise to pay, upon retire-ment, a certain dollar amount everymonth for as long as you live. Under thatarrangement, the employer makes all thecontributions into the plan plus carriesthe burden of how well the investmentsperform until your retirement.

There is another major category of

employer-sponsored retirement plans.

They are called “defined-contribu-

tion” plans because . . .

. . . they place their emphasis onhow much (if any) the employer willput into the plan for you each year. Nopromises are made with respect to howmuch your account will be worth whenyou retire. In this respect, they are likeIRAs. The advantage to employers ofthis approach is that you bear the in-vestment risk between now and retire-ment rather than your company. If theinvestments do great, you’ll have ahealthy amount in the plan at retire-ment; if they perform poorly, you mustmake do with a lesser amount. Thisshift of the investment risk from the

employer to you is significant; you nolonger can “count on” having a specificmonthly income. You should look at itas an opportunity! Here is another areathat is now under your control whereyour Sound Mind strategy can helpshape a balanced long-term portfoliothat will be personalized to your spe-cific goals and risk tolerance.

Over the years, Congress has createdseveral varieties ofdefined contributionplans (see next page).Many companieshave more than oneof these plans inplace in order to helpyou take the fullestadvantage of the tax-sheltering possibili-ties. The table willprovide a generalidea of the kinds ofplans your employermay offer. I suggestyou make an ap-pointment with theappropriate personat your company toget your specificquestions answered.

By far the most

popular of these is

the 401(k) plan.

About 75% of com-panies with 100 ormore employees spon-sor a 401k plan. Insuch a plan, employ-ees can elect to contrib-ute (via payroll with-holding) a portion oftheir paycheck to a tax-deferred investment ac-count set up in their name.

Here are the primary features oftraditional 401(k) plans (features of“Roth 401(k)” plans are different; theywill be explained shortly):

•Contributions are tax-deductible inthe year they’re made.

However, there are limits imposedthat affect the maximum amount youcan contribute. According to IRS guide-lines for 2009, the most a 401(k) plan

can permit you to contribute is $16,500,plus an extra $5,500 “catch-up” contri-bution if you’re at least 50 years old.(Your employer can elect to apply morestringent limitations than those setforth by the IRS.)

• Employees control how theirmoney is invested.

However, they usually must choosefrom among a lineup of stock, bond,

and money marketfunds selected by the employer. Thislimits the flexibility of the employee toinvest in the funds or securities of hisor her choice. To offset this drawback,many plans are beginning to offer a“self-directed” option which allowsyou to enter buying and selling instruc-tions through a broker, thus openingup a vast range of investment choices.

• All investment income and capital

GOOD QUESTIONS TO ASK YOUR

COMPANY ABOUT YOUR BENEFITS

� What do I have to do to participate in the plan?

� Do I contribute money, and if so, does the company

match my contributions?

� How quickly is my contribution deposited in my

account?

� Is the plan federally insured by the Pension Benefit

Guaranty Corporation?

� When will I be fully vested?

� What are the investments in the plan?

� Do I get to decide how the investments in my ac-count are allocated?

� Can I borrow or withdraw money before I retire?

� Does the plan include death or disability benefits?

� What happens if I take early retirement?

� What happens if I work past the normal

retirement age?



gains in the account grow tax-deferred.However, withdrawals are taxed at

ordinary income tax rates in the yearthey’re made. Thus, capital gains ulti-mately lose their advantageous tax statuswhen occurring within a 401(k) account.

• Payroll deduction provides adisciplined, consistent approach tosaving for retirement.

However, once you put the money in,you normally can’t get it out before age59½ without paying a 10% early with-drawal penalty (plus the customaryincome taxes due on plan withdrawalsas mentioned above). Most plans, how-ever, do allow employees to borrowfrom their 401(k) accounts.

• Most employers (more than 90%)match their employee’s contributionsto some degree. For example, a com-pany might contribute 50 cents forevery $1 the employee puts in. This isthe feature that makes 401(k)s so at-tractive; the employer match providesan automatic and immediate profit onyour contribution.

However, employers who offermatching programs put a ceiling on theamount they will match, say up to 6%of the employee’s income. Thus, moneycontributed above the ceiling will notbe matched. Furthermore, many plansrequire employees to remain with theemployer for a certain number of yearsbefore the matching contributions vest,that is, become the property of theemployee. They do this to discourageemployee turnover.

The 401(k) is becoming the bedrockof our private pension system. In 2006,an estimated 50 million Americanworkers had investments worth $2.7trillion in their 401(k) accounts. Basedon those numbers, the average 401(k)account was worth about $54,500. Ac-cording to a study by the Profit Shar-ing/401(k) Council of America, nearly78% of those eligible to participate in a401(k) do so. Yet, it’s been estimatedthat 91% of those who participate in a401(k) plan contribute less than theyare allowed.

If possible, I encourage you to par-ticipate in your company’s 401(k) planat least to the point where you take fulladvantage of any employer-matching

funds. If you’re still working on gettingyour consumer debt paid off (SMI’sLevel 1) or building your emergencyfund (SMI’s Level 2), that may not bepossible immediately, but it should beone of your intermediate-term financialgoals. If your 401(k) plan doesn’t offer amatching feature, or if you can afford tocontribute beyond the maximum match-ing percentage, then you will want toweigh the remaining advantages of401(k)s versus the pros and cons of IRAsbefore deciding which should have thepriority in your retirement planning.

The Roth 401(k), a retirement-plan

option introduced in 2006, differs . . .

. . . from the “traditional” 401(k) in avery important aspect. The tax benefitof investing in a traditional 401(k) isimmediate. You’re allowed to reduceyour taxable income by an amountequal to what you invest. (You pay theincome tax when you withdraw moneyfrom your account in retirement.) TheRoth 401(k) works the other wayaround. There’s no tax break up front,but later you can withdraw your contri-butions, plus all the earnings accumu-lated over the years, tax-free. Thismakes the Roth 401(k) an especiallyattractive option for young investorswho have many years to accumulateearnings.

As with traditional 401(k)s, employ-ers may offer to match worker contri-butions. But with the Roth 401(k),matching money is treated differentlyunder tax law than employee contribu-tions. Employer-matching amounts aremade with pre-tax dollars, whichmeans any matching contributions willbe subject to income tax when with-drawals are made (in other words, notall distributions from a Roth accountmay actually be tax-free).

Roth 401(k) withdrawals can beginat age 591/2 (earlier if you become dis-abled), as long as the account has beenactive for at least five years. Withdraw-als must begin by age 701/2. Mandatorydistributions can be avoided, however,by rolling a Roth 401(k) into a “RothIRA.” (Because employee contributionsand employer contributions face differ-ent tax treatment, consult a tax adviser

before making this kind of rollover.)Federal workers participate in a

retirement plan . . .

. . . similar to a traditional 401(k)arrangement—the Thrift Savings Plan.Those hired after 1983 are covered bythe Federal Employees RetirementSystem (FERS), which means, amongother things, that the government willmatch employees’ contributions to theThrift plan in a very generous way.

First, the government automaticallycontributes an amount equal to 1% ofsalary. Second, for every dollar em-ployees contribute up to 3% of theirsalary, the government matches it witha dollar. Third, for every dollar em-ployees contribute above 3% of salary(up to 5%), the government puts in 50cents. By contributing 5%, therefore,employees have doubled their moneyjust by virtue of the government’smatching funds.

Finally, employees can contributebeyond the 5%—up to a dollar limit of$16,500, or $22,000 for those age 50 orolder (2009 limits). Although amountsbeyond 5% are not matched by thegovernment, they do provide addi-tional immediate tax benefits plus long-term tax-deferred compounding ofinvestment returns.

According to government figures,13% of FERS participants don’t contrib-ute to the Thrift Plan. In light of thegenerous matching provisions, this issurprisingly shortsighted behavior.Their goal should be to contribute 3%of salary at a minimum, and 5% if at allpossible. Federal workers hired in 1983and earlier fall under the Civil ServiceRetirement System (CSRS). While CSRSworkers are not eligible for matchingfunds, they can make contributions tothe Thrift Savings Plan and enjoy tax-deferred compounding.

Other points of interest concerningthe Thrift plan: You can borrow fromyour account for purposes of buying ahouse, paying education or medicalexpenses, or alleviating a temporaryfinancial hardship. When you leaveyour job with the government, you canroll your Thrift account assets intoyour personal IRA.

If you want to change the way your



AN OVERVIEW OF THE MAJOR KINDSOF DEFINED-CONTRIBUTION PLANS

Your company may offer one or more of the following defined-contribution pension plans. These are the most

common types; however, there are many variations depending on the way your company’s plan was initially

structured. This is a highly technical area, and this table is merely intended to provide an overview. For more

information on your specific rights and benefits, contact your company’s Human Resources department.

ProfitSharing

Your companyannually contributes aportion of its profits, ifany, into a fund foremployees. Can beeither a corporate planor, if employer is notincorporated, can bea Keogh plan.

You don’t contribute.

25% of employee’sW-2 compensation.Your contribution plusemployer’s can’texceed $49,000 or25% of your salary(this limit includes yourcontribution), which-ever is less.

No. The amountcontributed canchange fromyear to year.

Typically 3-6 years.

Some plans allowborrowing at theemployer’s discretion.

SEPIRA

Simplified EmployeePensions use a form ofemployee IRAs ratherthan set up a separatecompany plan.Primarily funded byyour employer, theseaccounts are highlyportable if you changejobs.

You don’t contribute.

25% of employee’sW-2 compensationor $49,000.

See sidebar on page261 for mention of asecond kind of IRA thathas salary reductionfeatures similar to a401(k).


Immediately.

No.

401(k)Plan

A salary reductionplan where you decidehow much of yoursalary to put in (up to amaximum level that israised annually forinflation).The amountyou contribute is notcounted as taxableincome.

$16,500 + $5,500“catch-up” contributionif 50+ years old.

Can match a percent-age of your salarydeferral. Your contribu-tion plus employer’scan’t exceed $49,000or 25% of your salary(after deducting yourcontribution), which-ever is less.

No. The amountcontributed can changefrom year to year.

Immediately on yourcontributions, but atthe employer’sdiscretion on anymatching amounts.

At the employer’sdiscretion, butgenerally yes.

403(b)Plan

Similar to the 401(k)plan, but limited toemployees of publicschools, governmentagencies, hospitals,religious organizations,and other nonprofitinstitutions.

$16,500 + $5,500“catch-up” contribu-tion if 50+ years old.

Can match a percent-age of your salarydeferral up to 100%.Your contribution plusemployer’s can’texceed $49,000 or25% of your salary(after deducting yourcontribution),whichever is less.


Immediately on yourcontributions, but atthe employer’sdiscretion on anymatching amounts.

At theemployer’sdiscretion.

Type ofPlan

Brief summary

What is the mostyou can put in

each year? *

What is the mostyour employercan put in each

year? *

Are annualcontributions

fixed at a certainamount?

When do youreceive owner-

ship rights toyour pension?

Can you borrowfrom youraccount?

* Note: The amounts reflect year 2009 limits.

Roth 401(k)or 403(b)

Similar to traditional401(k) and 403(b)plans, except youreceive no tax deductionon the money you put in.No taxes are assessedupon withdrawal ifyou’re over 591/2 andhave had the Roth for atleast five years.

Same as traditional401(k) and 403(b)plans.

Same as traditional401(k) and 403(b)plans. Note: Matchingcontributions are on apre tax basis; they willbe taxed when youbegin taking moneyout.

No. The amountcontributed can changefrom year to year.

Same as traditional401(k) and 403(b)plans.

At theemployer’sdiscretion.



money is currently allocated, you canauthorize transfers at www.tsp.gov, orby calling (877) 968-3778. To make sureyou’re getting the most from yourThrift Plan opportunities, you mightwant to purchase a copy of Your ThriftSavings Plan, a privately publishedguide (i.e. not an official governmentpublication) that’s available via PDFdownload as well as in print. You canorder a copy at www.fedtools.com.

All retirement plans have one thing

in common: at some point, you’re

going to want to take your money out!

Your decision as to how to do thiswill be one of the most important andfar-reaching ones of your financial life.You shouldn’t make it hurriedly; infact, you should begin thinking about ityears ahead of time. Make sure youunderstand the laws (which Congresshas succeeded in making complicatedand confusing by changing them fromtime to time) and how they affect yourrange of options. Some of the factorsthat will influence your decision in-clude your age at retirement, birth year,health and life expectancy, income taxbracket, other sources of retirementincome, inflationary expectations, de-sire for certainty versus desire forgreater potential future income, and thelist goes on.

Basically, you have three choices:take all your money out in one largepayment; take it in the form of monthlypayments spread over the remainder ofyour life; or transfer your account valueto an IRA rollover where you can con-tinue to invest it on a tax-deferredbasis.

Here are guidelines to consider asyou go about making your decision.After finding out from your employerthe amounts of both your lump-sumbenefit and your monthly income ben-efit, ask yourself these questions:

• How long do I expect to live? Obvi-ously, you can only make a guess basedon your health at the time and yourfamily history. The reason this comesinto play is that the monthly paymentoption is usually computed based on alife expectancy of age 80. The longeryou live past 80, the greater the value

of your total monthly pension and thebetter off you are versus taking thelump-sum.

• How dependent are my spouse or heirson my estate? If your spouse is depen-dent on you, you might prefer the “jointand survivor” pension. It provides amonthly payment to you for life (about10%–20% lower than it would otherwisebe), with an ongoing monthly payment(reduced by half) to your spouse afteryour death. If providing for your spouseis a primary consideration, these andother options should be explored fullywith your pension administrator. Ifproviding for heirs is the most impor-tant consideration, then go with thelump-sum option.

• How do I feel about inflation? Unlessyour monthly benefit provides foradequate cost-of-living increases, youmay find it difficult keeping up withinflation over the longer term. Thelump-sum approach burdens you withthe responsibility and risk of investing,but following our Sound Mind portfo-lio recommendations should keep youahead of inflation.

• What other sources of income will Ihave? Both the lump-sum and themonthly payment options have theirrisks: the lump-sum carries the risk thatcomes with doing your own investing,and the monthly payment has the riskof keeping ahead of inflation. Youshould also consider what additionalhelp you can expect from Social Secu-rity and your investments.

The table on page 23 summarizesthe tax implications and other impor-tant features of the three alternatives(lump-sum, monthly payments,rollover). For additional help weighingthe options, I encourage you to contactsome of the leading no-load fund orga-nizations. They’ve developed user-friendly explanatory material (Schwab,Fidelity, Price, and Vanguard have doneespecially good jobs), that will walk youthrough the technical aspects.

Of course, the no-load fund organiza-tions offer their help free because they’rehoping to win you over as a long-termcustomer during your retirement years.Just remember that you’re under noobligation to give them your business. �

THE INS AND OUTS OF IRAS

A rather limited Individual Retire-

ment Account first appeared on the

financial scene in the 1970s . . .

. . . but the IRA didn’t really grow toprominence until 1981. That’s whenCongress voted to allow all wage earn-ers under age 701/2 to put away up to$2,000 a year for retirement and deductit on their federal income tax return.Not only did workers enjoy immediatetax-savings, but they also were excusedfrom paying any income taxes on theinvestment profits they made. Untilthey began withdrawing the moneyupon retirement, they had the pleasureof watching their money grow tax-deferred. After the deductibility ofhome mortgage interest, it was the besttax break available to the middle class.

Congress soon decided it had beentoo generous in allowing taxpayers tokeep so much of their own income. Inpassing the 1986 Tax Reform Act, thelaw was changed to limit the deduct-ibility of IRA contributions to thosefolks who were not participating inretirement plans at work unless theirincome fell below certain levels.

The IRA landscape grew even more

complicated in 1997 when Congress

gave us the “Roth IRA.”

Named for Sen. William Roth, aconsistent supporter of IRAs, this newoption was an effort to reinvigorate theIRA concept and encourage middle-income folks to save more for theirretirement. (Sen. Roth’s name alsoadorns the Roth 401(k) mentionedearlier.) The Roth IRA differs from theDeductible IRA primarily in the waytaxes are handled—do you want to paythem now or pay them later? In a De-ductible IRA, you receive a tax deduc-tion for the amount you contribute(save on taxes now) and eventually payincome tax on all contributions andgains when money is taken out downthe road (pay taxes later). With a RothIRA, your current contributions are notdeductible at all (no tax savings now)but all of your future withdrawals,even your investment gains, are tax-free (no taxes to pay later, ever).



Along with the Roth came new regu-lations that govern who qualifies forone—not everyone does. But assumingyou qualify, is a Roth a better bet than atraditional IRA? You have a decision tomake because your total IRA contribu-tions are limited to $5,000 for tax year 2009.(Contribution limits are indexed toinflation, so they typically rise fromyear to year.) The big question is whichkind of IRA will give you the best long-term result. It can be a confusing analy-sis to make. The outcome will vary de-pending on the assumptions you make.

Let’s pretend we’re in IRA school . . .

. . . and, as teacher, I’m going to leadyou through some general principlesthat will help guide your decision as tothe best place to invest your retirementmoney. The first is this: If you partici-pate in a 401(k) where your contribu-

tions are matched, and you’re currentlynot contributing up to the full amountthat would be matched by your em-ployer, you don’t even need to considerIRAs at this point. If this describes you,your homework assignment is to chan-nel your efforts into taking full advan-tage of the employer matching oppor-tunity in your 401(k). Meanwhile,you’re dismissed for the rest of thissection. You can stay if you want, but

I’m going to be giving all my attentionto the other students.

Now, I want to divide the rest of youinto five groups according to your an-nual income. But not necessarily yourgross income, rather, you need to usewhat Congress calls “modified adjustedgross income” (MAGI). Groan! The goodnews is that these two numbers are thesame for most people. But if you’re closeto the income limits listed below, you’dbe wise to find out exactly what goes intothe MAGI calculation. So, with MAGI inmind, look on the blackboard to seewhich of the five groups you belong to.Be sure to read the small print, especiallyFootnote 2. Now consider the followinggeneral guidelines:

• Group 1: You have the greatestflexibility. You can choose to makeeither a fully deductible contribution toa traditional IRA or a non-deductible

contribution to aRoth IRA. Later we’ll have a “Deduct-ible versus Roth” discussion that willbe helpful in making your decision.

• Group 2: You’re in the “phase-outrange” where the government beginstaking away your tax deduction forcontributing to a traditional IRA. Becauseyour family income is more than $89,000but less than $110,000, only a portion ofyour contribution is tax-deductible.(Single taxpayers have a lower threshold

at each step along the way as can be seenon the board.) You’ll also want to payattention during the “Deductible versusRoth” discussion.

One quick note—mixing deductibleand non-deductible contributions in thesame IRA can greatly complicate yourtax situation when you finally with-draw the money. If possible, set upseparate IRAs to keep these differenttypes of contributions separate.

• Group 3: You’re over the limit.Because your MAGI is $110,000 ormore, you receive no deduction unlessyou’re a Footnote 2 person. You couldmake a non-deductible contribution toa traditional IRA, but why do that withthe Roth option available? You’re Rothmaterial all the way.

• Group 4: Like Group 3, Roths areyour best option. But you’re in the“phase-out range” where the govern-ment begins taking away your right tomake a full Roth contribution. Still,take what you can get.

• Group 5: What can I say? You’vebeen too successful and Congress fig-ures you don’t need any tax incentivesto save for retirement. Thankfully, arecent rule change has left the door ajar.Starting in 2010, the restriction on con-versions from a traditional to a Roth IRAfor taxpayers with income over $100,000will be lifted. This means you can makenon-deductible contributions to a tradi-tional IRA now and then convert theminto a Roth IRA in 2010. You’ll owe taxonly on any gains earned between nowand then.

Now, all you Footnote 2 folks whoaren’t covered by a retirement plan atwork, pay attention. You’re theexception to the rule. No matter whatgroup you’re in and no matter what Ijust said, you are entitled to a full taxdeduction for any contributions youmake to a Deductible IRA. And unlessyou’re in Group 5, a Roth IRA is also anoption.

Okay, that covers the basic “whoqualifies for what?” question.

Now let’s look at three questions

that will help you decide what’s best

when choosing between a Roth and a

Deductible IRA.

YOUR INCOME LEVEL DETERMINES YOUR BEST IRA OPTION

Your Modified Adjusted Modified Adjusted Deduction for Eligible forIncome Gross Income for Gross Income for Contribution to ContributionGroup Single Taxpayers Married Taxpayers1 Traditional IRA?2 to Roth IRA?

Group 1 $55,000 or less $89,000 or less Yes Yes

Group 2 $55,000 to $66,000 $89,000 to $110,000 Partial Yes

Group 3 $66,000 to $108,000 $110,000 to $166,000 No Yes

Group 4 $108,000 to $121,000 $166,000 to $176,000 No Partial

Group 5 More than $121,000 More than $176,000 No No

These income levels are adjusted each year. 1When filing jointly. 2If you are not covered by a work-related retirement plan, contributions to traditional IRAs are fully deductible regardless of yourincome level.



The first question to consider is: Doyou expect to be in a lower tax bracketwhen you retire than you are now? Ifso, choose a Deductible IRA. You get atax benefit now while your rates arehigher, and pay tax later when they’relower. Conversely, if you anticipate ahigher bracket in retirement, take yourtax lumps now and put the money in aRoth. It’ll sure feel good coming outtax-free in the future.

Having said that, this question isprobably useful only if you anticipateretiring and beginning IRA withdrawalswithin 10-15 years. Beyond that it’s toohard to predict what might happen to taxrates, not to mention personal circum-stances. Plus, the longer your time hori-zon, the greater the tax-free advantagesof the Roth become. In short, if you can’treasonably predict whether your tax ratewill be higher or lower in the future thanat present, favor the Roth.

The second question is: Would youlike to postpone withdrawals beyondage 70½, or possibly leave the IRAintact for your beneficiaries? If so, optfor the Roth, which has no mandatorywithdrawal requirements.

The final question is: Can you affordto contribute the maximum allowableamount into a Roth? Remember, thoseare after-tax dollars. Assuming you’rein the 25% tax bracket, you’d have toactually set aside $6,667—$5,000 foryour Roth and $1,667 for federal taxes.If you can do that, you’ll get a betterdeal with the Roth.

To sum up, unless retirement will bearriving shortly and with it the expecta-tion that you’ll be in a lower taxbracket, the Roth IRA is the superiorchoice for most retirement savers.

If you’re still considering a Deduct-

ible IRA, be sure you take these draw-

backs into consideration.

It’s easy to become so impressedwith the power of tax-deferred com-pounding that we can overlook a fewof the disadvantages of the traditionalIRA. One is that it turns lower-taxedcapital gains into higher-taxed ordi-nary income. That’s because, undercurrent law, when you begin takingyour money back out, it all gets taxed

the same way—as ordinary income—even though a sizeable portion ofyour growth came in the form of capi-tal gains.

Another drawback are the rulesgoverning how much you must takeout each year. If you run afoul of them,the penalties are unbelievable.

And third are the estate tax implica-tions. These are the taxes we Americanspay for the privilege of dying and leav-ing what wealth we may have attainedto our loved ones. (The first $3.5 millionis exempt in 2009. The estate tax wasscheduled for repeal 2010, but that nowseems unlikely to happen.) This tax hasalways struck me as outrageous becausethe estate that we leave behind is com-prised of wealth that, by and large, hasalready been taxed at the local, state,and federal level. It seems criminal forthe government to come back for more.

Roth IRAs are better in regard to allthree of the above concerns: (1) all mon-ies taken out of a Roth are tax-free; (2)there are no mandatory distributionrequirements; and (3) estate taxes stillapply but no income taxes or penaltiescome into play.

Roth’s offer more flexibility than

traditional IRAs if you face a cash

crunch.

With a Roth, you always have accessto the principal you’ve contributedwithout income taxes or penalties. Inaddition, earnings can generally bewithdrawn early without penalty if thedistributions are for death or disability,high medical expenses, qualified highereducation expenses for you, a spouse,child or grandchild, or first time homebuyer expenses. Naturally there aremany details to each of these exceptions,so you’ll have to do some research tofind out more specifics, but generallyyou can get away with just paying in-come taxes and no penalties in thesecases. With traditional IRAs, if youtouch any of it early, you pay dearly.

It can be a challenge managing

multiple retirement accounts.

Today’s worker will likely holdseveral different jobs in the course oftheir career. That often means people

find themselves inadvertently “collect-ing” retirement accounts. There’s yourold 401(k) from Glad-I-Left Corp., theTraditional IRA you opened with your1999 bonus check, your currentcompany’s retirement plan account,and the new Roth IRA you opened lastyear. Plus your spouse’s assortment ofaccounts. What to do with them all?

Generally speaking, it makes senseto roll over old work accounts intoIRAs. Your investment choices areusually going to be much better ratherthan being limited to the handful offund options offered in most 401(k)s.This means you’ll be able to followSMI’s proven Upgrading strategy.Some experts say it’s smart to keep old401(k) money in one IRA, separate fromany IRAs funded with regular contri-butions. The thinking is that eventuallyyou could roll your rollover IRA backinto a 401(k). The main reason for do-ing that would be so you could borrowfrom the 401(k), which we discourage.So for simplicity’s sake, we’d be in-clined to consolidate IRA accounts intoas few as possible. But it’s up to youwhether that slight loss of flexibility isworth keeping multiple IRAs open.

How do you go about rolling overan IRA? First, recognize that there arereally two types of rollovers. In one, themoney you’re putting into your newIRA comes from a qualified employerplan like a 401(k). In the other, themoney you’re putting into your newIRA comes from another IRA. In thissecond kind of rollover, you must com-plete the transaction within 60 days ofreceiving the check (although complet-ing it within 60 days of the date on thecheck is safer because you can proveyou complied with the time limit). Ifyou miss the 60-day deadline, youmight be assessed income tax and earlywithdrawal penalties on the fullamount of the check.

There’s another way to move yourIRA—have the trustee/custodian ofyour new IRA do it for you. A transferof funds at your request from your oldIRA directly to your new one is not onlysimpler but it avoids any potentialproblems associated with missing the60-day deadline.



If you have more than one IRA ac-count, consider combining them intoone. It’s not unusual for people to havemany different IRAs spread aroundvarious places that were offering the“best deal” at the time their contributionwas made. By combining them into oneaccount, you’ll save on annual accountfees and cut your paperwork. Moreimportant, you’ll have a much easiertime managing your investments andtracking their performance. As always,there’s an exception: be sure to keepIRAs of different types separate. Puttingan IRA with non-deductible contribu-tions together with one containing de-ductible contributions is not only con-fusing, it can cost you down the road ifyou can’t distinguish which withdraw-als should and should not be taxed.

Whether or not to convert a Tradi-tional IRA to a Roth is another ques-tion that deserves considerablethought. First things first—are youeligible to convert? Until 2010, yourmodified AGI (not including the con-verted IRA income) needs to be$100,000 or less, and you can’t be us-ing the “married filing separately”status. If you meet those criteria, someof the questions are the same as theones we looked at earlier: How doesyour current tax bracket compare withyour anticipated tax bracket in retire-ment? Is postponing withdrawalsand/or being able to pass the accountto your heirs important to you?

There are two additional factors toconsider. If you convert your IRA, youwill have to pay income tax on anygains in the account, plus any deduct-ible contributions you’ve made over theyears. Unless you’ve made non-deduct-ible contributions at some point, thatusually means the full amount you’reconverting will be taxed as regularincome on this year’s tax return, whichcan add a sizeable sum to your tax bill.If you have the resources to pay thoseextra taxes without having to use any ofthe IRA balance to do so, it may beworth converting. But if you’ll have topull money out of the account just topay the tax bill, converting is probablynot a good move. Not only will you loseout on future appreciation on these

funds, but you’ll pay a stiff early with-drawal penalty if you’re under age 59½.

If you have the cash on hand to paythe tax bill, and converting looks goodto you, a final question to consider ishow far off is your retirement? At a bareminimum, you should have at least fiveyears before you’ll need to tap the con-verted IRA. That’s because you’ll faceearly withdrawal penalties if the Roth isnot established for five years beforewithdrawals begin. A five year horizonis a minimum, not an automatic signalto proceed. The Roth’s advantages buildwith time, so the longer the Roth will beintact, the better your chances that theconversion will be worthwhile.

The longer you wait before with-

drawing money from your IRA,

the longer it can continue to grow

tax-deferred.

Since it’s your money, you mightthink that it’s up to you to decide whento start tapping your IRA account andhow much to withdraw each year.Naturally, because the federal govern-ment is involved, it’s not that simple.

The IRS imposes very strict rules thatdictate how long you can postpone mak-ing withdrawals from your IRA, as wellas the minimum amount you must with-draw each year. (They want you to starttaking your money out so you will beginpaying some of those long deferredincome taxes.) The minimum withdrawalamounts are called “required minimumdistributions,” and the latest you canwait to begin making them is April 1 ofthe year after you reach age 70½. If youviolate the IRS guidelines, there are somehorrendous penalties awaiting you. Hereare the basics.

• Up to age 59½—Take it and pay a

penalty. The general rule is that IRAwithdrawals are taxed as ordinaryincome in the year you receive them. Ifyou withdraw money before reachingage 59½, you are also hit with a 10%penalty that is in addition to any in-come tax you owe. The penalty doesnot apply if you have a disability, or ifyou begin a series of scheduled annuitypayments based on your life expect-ancy (see next page).

Things get slightly more compli-

cated if you’ve made nondeductiblecontributions, because they’ve alreadybeen taxed. In that case, only part ofyour withdrawal is taxed and part of itis treated simply as a return of yournondeductible contribution. The 10%penalty is applied to the taxableamount of your withdrawal. This istrue of both Deductible and Roth IRAs.

• Age 59½ to age 70½—Take it or

leave it. You have the greatest flexibilityin your sixties. You can take out asmuch as you like, or nothing at all. Theamounts you withdraw are no longersubject to the 10% penalty tax. Ofcourse, normal income taxes apply. Ifthey can afford it, most people are in-clined to make no withdrawals duringthis period in order to make the most ofthe benefits of tax-deferred growth.

• Age 70½ and over—Leave it and

pay a penalty, unless you’ve got a

Roth. You’ve gotten the most from thetax deferral, and the IRS now insistsyou make a withdrawal whether youneed the money or not. Listen carefully:The law says that you must take yourfirst minimum annual distribution nolater than April 1 of the year after theyear you reach 70½. The IRS calls thisyour “required beginning date.” Fur-thermore, you must take additionalminimum annual distributions no laterthan December 31 of each year afteryou attain age 70½.

For example, if you were born onMarch 15, 1950, you’ll turn 70½ on Sep-tember 15, 2020. You must make yourfirst minimum withdrawal on or beforeApril 1, 2021. Then you must make yoursecond minimum withdrawal by Decem-ber 31, 2021. These deadlines are forpeople who have resisted taking theirdistributions. You don’t have to wait thislong. In fact, most people would benefitfrom taking their first required distribu-tion three months early to avoid havingtheir first two distributions occur in thesame tax year.

If you wish, you can begin makingpenalty-free withdrawals as soon as youturn 59½. Remember that when youbegin withdrawing IRA funds, you’llpay taxes at that time. Being tax-deferredis not the same as being tax-free. Don’tthink of a traditional IRA in the same



category as a truly tax-free investmentlike municipal bonds or a Roth IRA.

How is the minimum annual

withdrawal calculated?

We’ve been discussing the conceptof “required minimum distributions,”but don’t let that give you the impres-sion that you are restricted to takingsmall amounts out of your IRA. You’refree to empty the entire account any-time you want (of course, the penaltytax applies before age 59½, and the

income tax applies re-gardless of your age).But assuming you wantto minimize your with-drawals, how is therequired minimum cal-culated?

Regulations issued bythe IRS in 2002 havegreatly simplified thistask. Now, IRA ownersand retirement planparticipants will gener-ally all use the same newuniform life expectancytable. Only taxpayerswith a spousal benefi-ciary more than 10 yearsyounger can use a differ-ent method; they havethe option to use theiractual joint life expect-ancy.

The minimumamount that must bewithdrawn annually iscalculated by dividingyour account balance (asof December 31 of theprevious year) by theapplicable life expect-ancy. The table on the

left shows the value to use. For ex-ample, a 70-year-old person with ayear-end IRA value of $250,000 wouldbe required to withdraw at least $9,124the following year (250,000 divided by27.4).

What if you fail to withdraw theminimum? That’s where the “horren-dous” penalty I referred to previouslycomes in—a 50% nondeductible excisetax is assessed on the shortfall, that is,

on the difference between what youshould have withdrawn and what youactually withdrew. If the 70-year-oldretiree in the above example withdrew$6,000 the following year, the excise taxwould amount to $1,562 (50% of thedifference between $9,124 and $6,000).And the excise tax would not be deduct-ible on that year’s income tax return.

The moral of this is that it’s reallyimportant to pay close attention to thedetails when you’re planning how youwant to use your IRA during retirement.The rules can be complicated, especiallythose that relate to what’s best in termsof naming a beneficiary. While the newregulations now allow you to changebeneficiaries after your “required begin-ning date,” it is still a decision withextremely important long-term implica-tions. When determining your benefi-ciary choices, make sure you have ad-equate tax planning counsel and plentyof time to make your decisions. The2002 regulations make some of the con-ventional wisdom regarding estate taxplanning obsolete, so review your ben-eficiary choices if you haven’t looked atthem recently.

All the major banking, brokerage,

and mutual fund institutions offer

self-directed IRA accounts.

Self-directed means you decide howto invest the money you put in theaccount. The competition for your IRAbusiness is fierce, as can be seen by thewillingness of firms to waive theirannual fees for IRA accounts. Manydiscount brokers (such as Firstrade)charge no annual fees for IRAs. Theyoften offer huge numbers of mutualfunds, many as no-transaction-fee op-tions. As long as you aren’t tempted bythe easy access to trade more within youraccount, they can be a good deal worthinvestigating. The “deals” being offeredchange frequently, so check with theleading no-load fund organizations fortheir current policies.

Investors are fee-sensitive, as evi-denced by the fact that financial organi-zations give such great emphasis totheir low fees in their advertising.However, I would suggest that yougive greater weight to having a large

number of investment alternatives fromwhich you can choose. After all, whatgood are low fees if you have only afew average-performing funds to selectfrom? �

YOUR INVESTMENTS IN

RETIREMENT

Throughout my advisory career I’veseen people suffer financially becausethey look to the forecasts and opinionsof gurus and experts to guide theirdecisions. It’s very important we learnto admit, “I don’t know what the futureholds. The financial commentators inthe media don’t know. Investmentexperts don’t know. Nobody knows.So, I must face the fact that I can neverknow in advance which investmentalternatives will make the most money,lose the most money, or do little at all.”

This uncertainty makes it difficult toknow how much to cut back our invest-ment risk—and the potential gainswe’re hoping for—as we enter retire-ment. In our Jumpstart report (page 5), Ioffer my opinion on how this mightbest be done. The risk matrix balancesthe two competing influences in yourinvestment planning—your fear of lossand your need for growth. On the onehand, I believe that you should “beyourself” as you make investing deci-sions. The quiz I designed (Jumpstart,page 7) helps you select the investingtemperament best suited to your per-sonality by probing the intensity ofyour fear of losing money (an ever-present possibility in the markets). It’simportant that you be emotionallycomfortable with your strategy. Other-wise, it’s questionable if you’ll developthe confidence and discipline needed tohang in there when the periodic stormsof market turbulence blow through.

On the other hand, your investingstrategy must face the realities of yourpresent stage of life—how much timeremains before you reach retirement,and what financial goals do you hopeto achieve by that time? If you structureyour portfolio too conservatively, yourinvestment capital may not grow by theneeded amount. But if you take toogreat a risk, you could suffer a large

LIFE

EXPECTANCIES

FROM IRS

TABLES

Age Expectancy

70 27.4

71 26.5

72 25.6

73 24.7

74 23.8

75 22.9

76 22.0

77 21.2

78 20.3

79 19.5

80 18.7

81 17.9

82 17.1

83 16.3

84 15.5

85 14.8

86 14.1

87 13.4

88 12.7

89 12.0

90 11.4

91 10.8

92 10.2

93 9.6

94 9.1

95 8.6

96 8.1

97 7.6

98 7.1

99 6.7



loss just before you need to withdrawcapital for living expenses.

In the matrix, I offer suggestions onhow much to invest-by-owning (typi-cally in stocks and stock funds) versushow much to invest-by-lending (insavings accounts, bonds and bondfunds, and other fixed income holdings).As I pointed out at the time, however,“This matrix reflects my personal senseof risk. Other investment advisers mightfeel more comfortable with less restric-tive guidelines.” In fact, most do.

After reviewing several of the booksin my library on the subject of how tobest adjust your stock-to-bond portfoliomix as you grow older, it’s clear thatthe guidelines I offer are on the conser-vative side.

For example, if you’re 65 years old(in what I call your “early retirementyears”), the matrix indicates that thestock portion of your holdings notexceed 60% in stocks. Recommenda-tions of other advisers called for portfo-lios with stock allocations ranging from40% to as high as 75%. Their argumentfor higher stock holdings is that, al-though stocks are subject to occasionalmajor setbacks, they are needed to keepahead of inflation. The response to thatargument is that, while it’s true thatstocks have always recovered fromprevious bear markets, older investorsmay have a need to withdraw theirmoney before stocks have time to re-bound. Interest income from bonds iscertain; good returns from stocks in theshort run are not. A guiding principleshould be that you take as little risk aspossible in attaining your income goals.For example, if a 20% stocks, 80%bonds mix will generate adequate in-vestment income, then a 65-year oldshould move in that direction even ifthey have a temperament that wouldsuggest a higher stocks allocation. So,it’s a matter of balance. For more oninvesting during retirement, see mybook, The Sound Mind Investing Handbook,chapter 24.

Once you reach retirement and begindrawing from that storehouse of wealthyou’ve worked so hard to accumulate,the question naturally arises: Whichasset accounts should you withdraw

from first? This is an often overlookedquestion, since most banks, mutual fundcompanies and brokers are more fo-cused on how to solicit and where toinvest your money. (Thanks to EricReinhold, CFP and President of Acad-emy Planning Group in Orlando, for hiscontributions to this final section.)

Let’s look at four ofthe most commonretirement vehicles:traditional tax-de-ductible IRAs, RothIRAs, tax-deferredannuities and taxableinvestments. Forpurposes of thisdiscussion, I’ll as-sume that any pen-sion plan assets fromyour place of em-ployment have beenrolled over into atraditional IRA atretirement. The start-ing point is to an-swer this question:“Are my intentionsto pass a significantportion of these as-sets to my family, orwill I be utilizingthem for myself?”

• To favor your

heirs, withdraw from

your annuity and

traditional IRAs first.

Let’s suppose thatyour desire is to maxi-mize what you canpass along to yourfamily at the time ofyour death. This meansyou want to minimize the tax conse-quences to your heirs even though itwould cost you a little more in incometaxes in the meanwhile. With this inmind, you’ll not want to generate in-come by selling assets that receive a“step-up in basis” at your death. Forexample, if you purchased Micro Inc. at$5.00 a share (your “basis”), and Microis priced at $50.00 a share on the date ofyour death, $50.00 a share becomes thenew tax basis enjoyed by your heirs(and the capital gains tax on the $45.00

per share profits is completelyavoided).1

Even better than the “stepped-upbasis” deal is the treatment of RothIRAs. These are passed to your children

with their tax-freeadvantages intact,

meaning the account can continue togrow tax-free over the beneficiary’s lifeexpectancy if they elect to make onlythe minimum required withdrawalseach year. Over time, this can be anincredible benefit.

For passing on wealth, it is to your ad-vantage, then, to first draw from your an-nuities or traditional IRAs where there isno step-up in basis at your death. In thecase of an annuity, a portion will be tax-able upon withdrawal (the amount abovewhat you invested), and in the case of a

THE THREE PRIMARY CHOICES FOR

RECEIVING YOUR RETIREMENT BENEFITS

How doyou receive

yourmoney?

What taxeswill you

pay?

What otherfactors

come intoplay?

Your employersends your entireretirement benefitdirectly to your newIRA account.

None until you beginmaking withdrawals(which will be taxedas income the yearthey are received).

You lose the optionof reducing your taxburden by incomeaveraging over aten-year period.

Your investmentscontinue to growtax-deferred andare under yourdirect supervision.

Your employerpays your retire-ment benefit to youall at one time.

The entire amountis taxed at ordinaryincome rates in theyear it is received.

A special taxformula that canreduce your taxesmay apply. Depend-ing on your birthyear, incomeaveraging over aten-year periodmay be permitted.

Early withdrawalpenalty could applyif you are under age591/2.

You choose thecombination ofamount and durationof guaranteedmonthly payments.

The money youreceive will be taxedas income the year itis received.

Early withdrawalpenalty could applyif you are under age591/2 and do notchoose the lifetimeincome option.

If your employerprovides yourmonthly paymentsby buying an annuityfor you, a financiallystrong insurancecompany is of greatimportance.

Take yourmoney in onelarge payment

Transfer yourmoney to an IRArollover account

Take yourmoney in monthlypayments

1The "step-up in basis" is scheduled to expire beginning in 2010, the same year the estate

tax is supposed to be repealed. If you’re considering this strategy, check with your

financial planner or accountant to determine your best course between now and 2010.



NECESSARY CAUTIONS: It shall not be assumed that the investment recommendations herein will necessarily be profitable. The informationpublished in SMI is carefully compiled from sources believed to be correct, but no warranty as to accuracy is made. SMI is not responsiblefor any errors or omissions. The counsel given in this publication is not a substitute for personalized legal, tax, or financial planning advice.NO CONFLICTS OF INTEREST: Nothing in this report constitutes an offer to sell any investment. Investments should be made only after acareful consideration of the fund prospectus. SMI receives absolutely no financial benefits, payments, or incentives from any financialorganization recommended in the SMI newsletter or this report. SOURCE & COPYRIGHT: This report is an adaptation of material that hasappeared previously in the Sound Mind Investing monthly newsletter or The Sound Mind Investing Handbook, A Step-by-Step Guide to ManagingYour Money from a Biblical Perspective. Copyright © 2009 by Austin Pryor. All rights are reserved. No part of this report may be reproducedin any fashion without the prior written consent of Sound Mind Investing. 04/2009

I M P O R T A N T R E M I N D E R S

traditional IRA, all of the withdrawal willbe taxable. If left to your heirs, however,these assets would be subject to incometax on your basis. If they are in the highesttax bracket, this would be almost 40%. Inaddition, estate taxes can take as much as50% of what’s left. When all is said anddone, your children may only be inherit-ing 30 cents on the dollar from your tax-deferred retirement accounts.

• To increase your giving. If yourtax bracket situation is such thatyour heirs might receive only 30cents on the dollar from your annu-ity and IRA retirement accounts, youmight want to consider leaving aportion of them to charity. One ofthe simplest ways to do this is bymaking your spouse the first benefi-ciary and a church and/or charitiesyour secondary beneficiary. Yourspouse is taken care of, but uponhis/her death, the charity would get100% of the remainder. The govern-ment would not receive its custom-ary 70%, and your children’s inherit-ance would only be reduced by 30%

1www.soundmindinvesting.com

of that value. Since annuities andIRAs pass outside of probate, you donot have to change your will or trusts.You simply have to ask for a “changeof beneficiary form” from the com-pany at which you have your invest-ment and update it to reflect yourdesires. Over the course of time, ifthe Lord leads you to pass this moneyalong to different organizations, youcan easily update your beneficiaryform again.

• To maximize your lifetime in-

come, withdraw from your taxable

investments first. If your priority is notmaximizing inheritance but rathermaximizing your retirement income,then you would want to first withdrawfrom your taxable investments in orderto prolong the tax-deferral aspects ofyour annuity and IRAs for as long aspossible. The compounding of tax-deferred dollars is hard to beat. For atraditional IRA, you can postponemaking withdrawals until age 70½; inthe case of an annuity, it will vary fromcompany to company. To postpone

your withdrawals even further, youmight want to consider a Roth IRAwhich requires no minimum distribu-tions ever. Upon your death, the assetsprovide tax-free income to your chil-dren when annuitized over their life-times, as mentioned previously.

Depending upon your desires, anideal strategy may be to combine bothconcepts. Let your tax-deferred invest-ments continue to grow and designateyour spouse as the first beneficiary andchurch/charities as the secondary ben-eficiary while utilizing your taxableinvestments as a source of income.Meanwhile, you could make annualgifts to family members so they are ableto enjoy the benefit in their youngeryears when it is most often needed. �

FOR UPDATED

INFORMATION

For our most recent articles and listof resources related to financial plan-ning for retirement, 401(k)s, IRAs, andgiving, visit the SMI website.1 �

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