Rule Number One: Be Sure to Save Enough

Q:

I feel that I've lost track of my 401(k) savings. I am 43 years old, earn $115,000 annually, and usually receive a pay increase of about 4 percent annually, with contributions to a modest company stock plan. At present, I put $8,400 annually into the 401(k) and hope to add future pay increases each year to my contributions until I reach the legal limit. I have $220,000 in home equity and owe about $275,000, with a mortgage rate of 4.8 percent.

I have $65,000 for each of my two children in the Vanguard Total Stock Market Index fund in irrevocable UGMA accounts. One child starts college in three years and the other in five. I have the following in 401(k) investments: Vanguard Health Care fund, $11,300; Vanguard Total Bond Market Index fund, $10,200; Vanguard Total Stock Market Index fund, $15,350; Fidelity Contrafund, $16,800, and Fidelity Growth Company fund, $5,900. In less than 10 years, I will have about $400,000 from a trust fund. However, I sure could use some guidance for the mutual fund selections I have made.

A:

You are too young -- probably 20 years or more away from retirement -- to have a significant part of your retirement money in the slow lane represented by bond investments. Also, I remain bearish on the bond market, reasoning that a trend of higher interest rates will cause erosion of principal in these accounts.

And Vanguard Total Bond Market Index fund is pretty much incapable of taking defensive measures when the bond markets go sour. It must hold a portfolio representing all sectors of the bond market -- short, intermediate, and long -- and thus cannot significantly shorten duration when rates are expected to rise.

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If you feel you must hold a bond fund, you would be better off with Vanguard GNMA fund, which normally has an intermediate-term portfolio but can batten down its hatches by reducing portfolio maturities.

The bigger question is simply whether you are saving enough money. I realize that you clearly have put a lot of your savings into establishing those two admirable college savings accounts, but perhaps you should focus some more on yourself. I ran some projections of where you might be in 20 years if you follow the current course. With contributions at current levels and with investment returns of 9 percent, after 20 years your 401(k) balance would grow to $825,135.

Assuming you got the funds from the family trust and managed to invest them in a tax-deferred investment vehicle (such as a variable annuity account) for 10 years with investment returns of 9 percent, that account would grow to $980,480. That $1,805,615 pool sounds tidy.

But if you were to reinvest it for retirement, with a more conservative portfolio delivering only 7 percent, you could make inflation-adjusted withdrawals, escalating by 3.5 percent annually over a 35-year period, beginning at the $85,875 level. You should bear in mind that the inflation of the 20 years before retirement would make serious inroads into the buying power of that money, reducing it by half. You would be moving from your current $115,000 income level to about $43,000 spending power, which is a very serious step down.

Of course, the picture won't be that bleak. If you escalate your 401(k) contributions to reflect any raises you get during the next 20 years, you would be that much better off.

If you escalate your savings after your years of college tuition bills are past, again, so much the better. Also, however modest, your employer's stock plan might over two decades amount to a tidy sum. And as another boost, it's likely that some shards of Social Security will be around in 20 years or so, so that would further brighten the picture.

But in the end, you are currently saving only 7.3 percent of your income for retirement, and to my thinking that's just not enough. I suggest you try to rework your budget to allow you to save the maximum allowed each year in the 401(k) account, which would make a dramatic difference when retirement time comes.

The time to move your children's college money out of the stock index fund is now. With tuition bills scheduled to come in three- and five-year time frames, this has become short-term money. It would be best consigned to short-term investment vehicles. I suggest you look to CDs or the money markets as safe havens for that tuition money.

As you probably know by now, putting the children's college savings in the UGMA accounts was a mistake; officials weighing their eligibility for financial aid will assume that almost all of it will be put toward their education expenses before considering their eligibility for assistance. But what is done is done.

I suggest that you immediately stop contributing to those accounts and put any additional money that you want to earmark for their education in your own name. Only a small percentage of those funds would be deemed ''available" for educational expenses, and accordingly, their eligibility for assistance will be that much greater.

Consolidate accounts and prepay mortgage

Q:

I just turned 65 and my wife is 63. I retired from my full-time job at age 56 and worked part time until the year 2000. My wife retired from full-time work in 1999 and now is working 15 hours a week to pay her health insurance. I had insurance from my early retirement, but it ended last month when I turned 65. I have $182,000 in an annuity with Sunlife Financial, which pays me 5.8 percent yearly, or $850 each month. I also have $97,000 with TIAA-CREF, earning 3.5 percent. I am not drawing upon it as yet. I also have pension income of $721 monthly, plus $1,089 from Social Security. I also have $10,000 in an AARP investment. My wife has close to $100,000 in TIAA-CREF. Upon full retirement in two years, she will have $14,500 a year income from pension and Social Security. She now makes about $12,000 in her part-time job. We will be paying around $400 a month in health insurance when she retires. We have about $80,000 in checking and savings accounts. We have an $80,000 mortgage with a monthly payment of $454. The house is worth approximately $350,000. We are wondering if we should take some money and pay off the mortgage to have some additional income every month, or would you suggest changing our accounts for future income gains? We would have a large income tax bill if we took money from one of the TIAA-CREF accounts, I believe.

A:

You don't specify what interest rate you are getting from the various bank accounts but it's almost certain that it is considerably less than what you are paying on your mortgage. It seems to me that you probably have considerably more in these accounts than you need, and that a good deal of this money could be used to prepay the mortgage.

What you need to do is sit down with your wife and decide what level of emergency savings you will need to feel comfortable, and then to use whatever is left against the mortgage. You aren't specific about the $10,000 account you have with AARP, but perhaps you could also shake that loose without devastating tax effects.

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Let's suppose that these moves would allow you to pay off $60,000 or more of the mortgage balance. That would take care of the lion's share of it. At that stage, you could then explore whether you could embark upon an aggressive prepayment campaign, designed to bring the mortgage balance to nothing by about the time your wife fully retires.

Thus, at that stage, you would have the money that you have been spending on the mortgage to meet the new insurance bills.

A second approach would be to make that $60,000 or so prepayment, and then ask your bank to refinance over a fairly long time period -- perhaps 10 years.

That would likely cut your monthly mortgage payment by half and would provide cash to help meet the insurance bills.

And after she retires, your wife will get enough of a ''raise" from her current part-time income to her combined pension and Social Security benefits to meet more than half of the insurance costs.

It doesn't make much difference which of these strategies you pursue; either way, you would work the mortgage balance down to a fairly insignificant level.

Between the pension and Social Security income streams for yourself and your wife, plus the income from the largest annuity account, you will have enough to maintain your current life style.

And I like the approach of leaving the considerable balances in the two TIAA-CREF accounts untouched for as long as you can.

Not only will that eliminate sudden and large tax bills, but it will leave you with a nice buffer to protect you against the inflation of the later years of your retirement.

Source: The Boston Globe 09-12-2004

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