Financial Futures

Washington Post columnist Martha Hamilton was online Tuesday, Jan. 9 at Noon ET to discuss how to make smart decisions while preparing for retirement.

Her guests were Barbara Fallon-Walsh, who heads Vanguard's retirement plans services and Nancy Philleo, a certified financial planner for Vanguard.

A transcript follows

To read past Financial Futures columns, click here.

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Martha M. Hamilton: Good day to everyone who's joining us--and there are a large number of questions lined up already! We're very fortunate to have two knowlegeable guests with us today, both from Vanguard. Barbara Fallon-Walsh, who heads Vanguard's retirement plans services business,and certified financial planner Nancy Philleo. So, welcome to them and everyone else. Let's get going!

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Baltimore: Does it make sense for a 56-year-old to convert a $30,000 rollover IRA to a Roth IRA and pay the tax bite now, if he's in a relatively low tax bracket this year and won't need the IRA money until he's 76?

Barbara Fallon-Walsh: It's seems like the cost to convert to a Roth is relatively modest vs. the potential benefit of tax diversification and long term tax free growth, given what you have outlined. Haven't heard anyone say that they think tax rates are going to go down in the future!

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Ithaca, N.Y.: I am a 40-year-old woman and my husband is 49. I am thinking about preparing for retirement. I would want to retire when he is of retirement age, which means that I'm considering an early retirement at around age 55. I am wondering how I might begin to prepare.

We both work and we share living expenses. We live way below our means, save a lot, and have no children. I earn more, so I am the one with the greater retirement savings. I work as a college professor; we receive regular raises and especially with respect to promotions. I'll receive a pension upon retirement, and I put as much as I can afford into my 401 k. Do you have any further ideas on how we can maximize our retirement savings?

Barbara Fallon-Walsh: Congratulations on living well within your means - that's an excellent indicator that you and your husband will be able to enjoy a comfortable retirement. You mention that you are one of the lucky ones who will have a pension upon retirement - do you know how early retirement will impact your pension benefit? Retiring early could have a substantial impact. Also, does your pension include a cost of living increase to soften the impacts of inflation? Other thoughts - how will cover health care? You might consider directing current 401(k) savings to a Roth 401(k) if your plan includes that option, or a Roth IRA if you are eligible to diversify your investments with respect to future taxes.

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Greensburg, Pa.: I have been retired for almost 10 years. I'm thinking of paying off a home equity line of credit with a mutual fund I have with Vanguard. My line interest has gone up to more than the fund is paying. What should I be looking at or what questions should I be asking to make sure I would be doing the right thing?

Barbara Fallon-Walsh: Some questions to consider include: if you were to pay off the home equity line, would you still have a cash reserve for emergencies? Is your current level of deb service uncomfortable for you? Is the interest on your home equity line tax deductible?

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Bonifay, Fla.: I'm retired, widowed, in my late 60s and draw Social Security and a pension. I also have an IRA -- 60 percent traditional, 40 percent ROTH, invested in stock mutual funds. My question -- I'm not in dire need, and I see that the Required Minimum Distribution will be somewhere around 4 percent for the first few years. What percent can I withdraw safely to come closer to living in the style I wish to be accustomed to, without ending up at a much lower life style later?

Barbara Fallon-Walsh: Most of our studies show us that investors with an initial withdrawal of approximately 4% of their portfolio (with regular increases to offset inflation) are likely to have savings last throughout their lifetime. You might check out Vanguard's recent podcast on Retirement Spending at vanguard.com.

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Mason, Mich.: I would like to know what resources are available (hopefully locally) to review a household retirement plan for my wife and I?

I would like a second opinion on my plan and its assumptions prior to actually committing to retiring this coming March at age 55.

Martha M. Hamilton: There are a few web-sites where you can find the names of planners in your area. Try www.napfa.org or fpanet.org. And there is good advice about questions to ask financial planners at http://www.sec.gov/investor/brokers.htm.

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Allentown, N.J.: Hi,

Is it better to start saving for retirement while paying down high-interest credit card and personal debt, or is it better to first pay off all of the debt before one begins to save for retirement?

Thank you!

Martha M. Hamilton: I'll let the experts follow up, but my instinct would be to do both, perhaps putting more money toward paying off the debt initially. And once the debt is paid off, increase the amount of savings for retirement by what you have been spending on debt repayment.

Barbara Fallon-Walsh: We concur! With a good strategy in place to pay down debt, it seldom makes sense to defer retirement savings because of the value of compounding. Perhaps consider increasing your retirement savings by 1%-2% per year, tied to the timing of your annual merit increases.

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Round Rock, Tex.: How best would one approaching 60 prepare for his long-term care? If long-term care insurance would constitute a part of this preparation, how does one select a good policy?

Thanks

Martha M. Hamilton: Hi, Round Rock. I wrote a whole column on this issue which we'll provide a link to.

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Atlanta: If one has maxed out his or her 401k, cannot contribute to a Roth IRA, should the next step in retirement savings be to invest in taxable mutual funds or make a non-deductible contribution to a traditional IRA?

Barbara Fallon-Walsh: Couple of options: Does your employer offer a Roth 401(k) option? You give up current deductions, but get tax diversification, tax avoidance on the gains in your plan. Second, balances in a traditional IRA can be converted to a Roth IRA regardless of income in 2010 (I think that's the date). So, today's contribution would offer a Roth option even if you don't get it today. Finally, there are tax efficient options among taxable mutual funds that you might consider.

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State College, Pa.: America's CEOs are taking care of THEIR retirement, i.e. Home Depot's nice little package for their loser CEO who is "retiring." And they are providing these dollars out of the pockets of the rest of us, who count on our mutual fund retirement plans. What can be done to change the system to work for the average worker instead of the elite as we try to "fund our own" retirements?

Martha M. Hamilton: A number of organizations including state pension funds and labor unions are working at making good corporate governance a reality which includes getting rid of the excesses of executive compensation. One statistic I saw is that independent directors now hold 81 percent of board slots at companies on the Standard & Poor's 500-stock index, up from 77 percent in 2001.

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Arlington, Va.: For the past few years, I've worked on balancing and re-balancing my retirement investments. Now I see a lot of age-based or target-date life cycle funds being offered. Is it a good idea to put all of my retirement savings into one or two of these funds and let someone else do the re-balancing?

Barbara Fallon-Walsh: Target date retirement funds work great, especially for someone who wants to put the burden of rebalancing on someone else's shoulders. These funds gradually become mroe conservative over time as you get closer to retirement. On the other hand, some funds (i.e., Vanguard's Life Strategy funds) maintain a consistent asset allocation. Your choice - however, generally it doesn't make sense to choose more than one of these types of funds.

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Anchorage, Alaska: Is it possible to remove some of my current employers 401k/TSP and convert it to a Roth IRA (through a rollover IRA)? I'm in a low tax-bracket now and expect it to rise.

Barbara Fallon-Walsh: You cannot take a distribution until you leave your employer.

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Millbrae, Calif.: I constantly read that it is "safe" to withdraw approx 4 percent of my retirement nest egg per year so that the money will not run out within my lifetime (e.g. $40,000 per year for each $1 million saved).

Is this too conservative? Would it be better to buy an annuity?

Barbara Fallon-Walsh: We concur. An initial rate of 4% with subsequent increases to keep up with inflation is a realistic strategy for most people. This assumes a reasonable mix of stocks and bonds, with the former providing some protection from inflation. If you invest only in bonds/bond funds/certificates of deposit, your withdrawal will need to be less. On the otherhand, the more stocks in a portfolio, the more volatility. Am immediate annuity can provide some peace of mind that you will have income that lasts throughout your life, however, they often carry higher costs and you do give up any control.

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Waldorf, Md.: My wife and I are trying to maximize our retirement savings, but, this year, we will come close (or go over) the income limits to contribute to a Roth IRA. Will contributions to our employer 401k and 403b plans reduce our effective income and possibly allow us to fully contribute to our Roth IRAs? Currently we both contribute enough at work to get the maximum employer match but we could contribute more before reaching the government limit of $15,500. Thanks

Barbara Fallon-Walsh: Your contributions to your retiremnt plans will lower your AGI, which may make you eligible. Can you do a Roth 401(k)? Another option.

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Minneapolis: How do I decide which of my IRA funds should be in my ROTH account? Presently I hold these Vanguard IRAs -- VIPSX, VTRIX, VGTSX and VISVX. If there's only room for one fund which one would you suggest belongs in the ROTH and why?

Barbara Fallon-Walsh: Your Roth investment should be part of your overall asset allocation strategy. That said, it often makes the most sense to put your growth equity funds in a Roth.

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Baltimore: A friend told me it's a mistake to keep IRAs at more than one financial institution because you wind up paying double fees. Is that true? I have IRA rollovers at three different companies, each charging no annual fee, only expense ratios on individual investments. And I figured those fees weren't redundant. Advice?

Barbara Fallon-Walsh: Low balance IRAs often do incur annual fees, which can erode or offset growth in an account, so it's great that you are paying attention to this. Since you aren't paying account maintenance fees, it doesn't appear to apply in your situation. However, please be sure to keep an eye on the expense ratios of your investments, since a high expense ratio could have an even greater impact on your long term investment success.

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washingtonpost.com: Should You Secure Your Health Care? (Post, Oct. 15, 2006)

Martha M. Hamilton: Here's the long-term care column I referenced in an earlier answer.

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Knoxville, Tenn.: What do you consider an appropriate retirement fund allocation (stocks/bonds) for someone retiring in 2012?

Barbara Fallon-Walsh: Our Target Retirement Fund for 2010 has a 55% allocation to equities, 2015 has a allocation of about 65%. Seems like a good place to start.

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Harpers Ferry, W.V.: Imagine an investor in a given year contributes the maximum amount to his/her Roth IRA, but has more to save. Would you recommend investing the extra funds through the Roth or a traditional IRA (given equal expected returns)? Does it matter?

Thanks very much.

Barbara Fallon-Walsh: The maximum allowable contribution ($4,000, plus $1,000 if you are over age 50) applies across all IRAs - traditional, Roth or a combination of both. Consider tax efficient investments if you have maximized other tax-advantaged savings opportunities.

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Washington, D.C.: Hello, thank you for taking my question. I will soon have around $125K, which I will use to pay off my student and credit card debts and then put 30-percent toward a down payment for a home. Do you think that is a wise decision? With around $60K left over, I don't know where to put it to make it grow. I do have 401K, an IRA, and a savings accounts. I'm 31-years-old and I do want to retire in comfort. Again, thank you for taking my question.

Martha M. Hamilton: It sounds like you're doing extremely well. Assuming you have about three months worth of expenses in your savings account, you probably want to add to your 401(k) or IRA. If you're not already earning any matching funds available through your 401(k), I'd do that first.

Martha M. Hamilton: Here's what Barbara Fallon-Walsh added: This person is great shape for someone 31 years old - off to a stellar start. I think it makes sense to invest in real estate. Question the 30% down - is that to get to a level of debt that feels comfortable? Interest rates are still close to historical lows so could go with a lower down payment to maintain flexibility. Maximizing 401(k) and IRA contributions? If so, next I'd look to tax efficient funds, and don't forget to maintain a strong emergency reserve - home ownership can bring a lot of surprises.

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Roth fixation: Why do you folks keep pushing Roths?

1. It is highly unlikely you will have a higher income in retirement than actively working. More likely you will be in lower bracket.

2. Does anyone really believe you will get this money "tax free"? By the time the primary savers, Gen X comes due to take out their Roths, the Boomers will likely be draining Social Security to death while personally broke (given present retirement saving trends).

Boomers have not been above demanding govt. subsidies for their personal mistakes in the same way the oceans are not above the moon. Their kids show no signs of being willing to pony up.

Now along come the X'ers with their nice, large tax-free retirement Roths. You honestly think Congress won't cave and hit a tax on that to fund the Boomers?

Martha M. Hamilton: If your premise #2 is accurate, it could mean higher tax brackets even for retirees. I think a Roth IRA is attractive to people for different reasons. If you're a new entrant to the workforce, you may be paying lower taxes now than in the future when saving money tax deferred will make more sense. And many folks like the idea of having money in an account from which they don't have to take minimum distributions.

Barbara Fallon-Walsh: Nancy points out that a combination of Roth and traditional gives the investor the benefits of tax diversification and many people will experience a high marginal tax bracket even in retirement, especially when RMDs kick in. Re the future of Roth, perhaps more likely that the opportunity to direct future investments to Roth will disappear before current Roth owners are taxed.

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Philadelphia: My husband and I just turned 50. We put the maximum away into our 401K accounts. We feel we have the college tuition payments under control, adequate life, health and disability coverage and a comfortable emergency fund to cover nine months of expenses should an emergency arise. My question is this: What should we do with the additional money that we have? We are debating whether to pay off the mortgage or invest it into a taxable mutual fund. What is your advice? If you recommend investing, what are the best type of accounts to invest in (35-percent tax bracket)? Thanks.

Barbara Fallon-Walsh: Congratulations- sounds like you have done an excellent job of planning and managing your finances. Re the mortgage: are you still getting a tax deduction, or are you paying primarily principal? What is your mortgage rate, fairly low or high. (I can't imagine that would not have refinanced some time in the recent past!) Best accounts for someone in the 35% marginal tax bracket - first maximize formal retirement plan savings, IRAs, etc., and then look to tax efficient mutual funds.

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Cash Savings: My husband and I both worked at a large company and recently left (relocated). I am currently not working and he took a job with another company. We are 34 and 35 and live below our means (which is good since I am not working right now!). We have about 65K unallocated sitting in a checking account making 5.06 APY for us. Do you recommend investing it -- setting up an IRA?? We both have 401ks. I just don't know what to do with the money in the bank. We might start a company BUT in the meantime -- I think we are too young to just have attractive interest payments.

Martha M. Hamilton: Maybe now would be a good time to open a Roth IRA if you qualify. Your taxes should be lower by virtue of not having a job right now.

Barbara Fallon-Walsh: Another benefit of a Roth - you can always take your contributions out without penalty or tax. However, the investment you chose within the Roth should reflect your time horizon. If you think you might start a company, it's important to stay flexible. Equity investments are great for the LONG term. 5% in a checking account might make sense if you think you will tap this money soon to invest in your business.

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Baltimore: Question about Target Retirement funds: The major ones are Vanguard, Price and Fidelity. Does it make sense, from a diversification standpoint, to be in two funds, from two different companies, with the same target date, or do the portfolios and underlying funds tend to mirror one another? Thanks.

Barbara Fallon-Walsh: Pick one fund family and one fund. There is little to be gained from duplicating similar investments among three reputable firms. Check the expense ratio and look at how the fund allocation changes over time and chose the one you are most comfortable with.

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Virginia: When you are advising couples, do you look at retirement savings as a whole, or do you analyze for each member of the couple (in case they don't stay together)? What about when one earns significantly more than the other, because the other has stopped working to care for children -- what do you advise then?

Barbara Fallon-Walsh: I turned to Nancy for this one - she said that we look at the couple, not the individual. Even when the couple does not stay together, marital assets are generally divided between the two, and so should be considered as one portfolio during the marriage and planning process. This helps avoid duplication and excess cost.

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Steamboat Springs, Colo.: For long term retirement savings -- do you recommend indexing funds or trying to find the best-managed funds?

Barbara Fallon-Walsh: You would be disappointed if we didn't point out that costs really do matter, and index funds do the best job of controlling costs. In addition, they are also generally quite tax efficient. It's proven tough to beat the indexes over the long term.

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Atlanta: Thank you all!!!

Martha M. Hamilton: why, thank you, Atlanta. How nice of you to say.

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Martha M. Hamilton: Lots of great questions today. Many thanks to all of you who joined us and to Barbara and Nancy. If we weren't able to get to your question, I hope you'll try again. And if you have suggestions for future columns, please e-mail me at hamiltonm@washpost.com.

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