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Financial Futures

Martha M. Hamilton
Washington Post Columnist
Tuesday, May 1, 2007 12:00 PM

Washington Post columnist Martha M. Hamilton was online Tuesday, May 1 at Noon ET to discuss what twentysomethings should do now to plan for their retirement.

She was joined by Anthony Webb, a Research Economist at the Center for Retirement Research.

A transcript follows.

To read past Financial Futures columns, click here.

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Martha M. Hamilton: Good day, and welcome to our chat. I'm happy that Tony Webb will be joining us today. He gave great advice to the 20-somethings we wrote about on Sunday. We'll try to get to as many questions as we can today.

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Jefferson City, Mo.: Thanks for taking my question. I am about to turn 27 and have saved very little towards my retirement. I would like to get involved in starting a Roth IRA for my wife and I, but don't know where to start. Everything seems a bit overwhelming. Any suggestions would be greatly appreciated. Thanks.

Martha M. Hamilton: I think Roth IRAs generally are good savings vehicles for younger savers. Your tax bracket is likely to grow as you earn more money, so why not pay taxes now at a lower level? You could talk to banks, investment firms and mutual fund companies about starting a Roth to find the one with the lowest fees. And then, you probably want to invest in a broadbased mutual fund.

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Washington, D.C.: Do you suggest that people in their early 20s see a financial planner before they begin attempting to pay of loans and credit cards while also trying to save for retirement? Will we all basically get the same general advice...save, save, save?

Martha M. Hamilton: Frankly, I'd rather you use the money you might spend on a planner for debt repayment or savings. The first thing you need to do is pay off debt, starting with the highest interest rates. Then, take the amount of money you have been using to pay the credit card bills and start saving it. I would split the amount between and emergency fund (most people advise having about three months worth of expenses) and longer term savings. The emergency fund is designed to help keep you from getting into det again if you run into an emergency. Take a look at the couple of sites that I mentioned Sunday which are designed to help beginners understand their finances.

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Atlanta, Ga.: Hello. My wife and I are in our 20s and 30s. With our work experiences, we have three 401(K) accounts between us. One account has nearly $40,000, while the other two has maybe $3,000 combined. What would you suggest to consolidate them? What are a few of the options?

Thanks.---Drew

Anthony Webb: One option would be to roll over 401(k)balances from past employments into an IRA. Any financial services company can help you with the paperwork.

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Washington, D.C.: Hi Martha:

My husband and I enjoy your column each Sunday. Any chance you may cover the financial challenges and goals of groups other than twenty somethings and boomers? Those of us in our thirties (and I suspect forties) would like to read some solid advice/analysis about our situations.

Thanks,

Alison

washingtonpost.com: Martha wrote about thirtysomethings in this colum: 30 and Counting-- and for more here's her column archive.

Martha M. Hamilton: My very first column dealth with those in their 30s. I haven't gotten to the 40-year-olds yet.

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Monroe, N.C.: I am 52. My wife, also 52, is temporarily out of the workforce while attending college full-time to earn her Bachelor's degree. I am maxing out my 401(k) and Catch-Up account to the obvious benefit of my retirement savings but to the detriment of my budget (we frequently borrow against a credit card to pay a bill). Should we scale down the 401(k) and Catch-Up for now in order to follow the traditional model, i.e., consumer debt eliminated and six months of salary saved? Thanks for the help!

Anthony Webb: The danger, of course, with your plan is that you cut your 401(k) contributions but don't manage to repay the credit card debt. I assume that you have no other investments to draw on, other than an emergency fund. If you think that you can stick to your plan, then you are probably better off cutting back on your 401(k) contributions and repaying the debt - you are unlikely to earn a higher return on the 401(k) than the credit card interest. The only exception to this rule is where cutting back on your 401(k) contributions would result in you losing an employer match.

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Southern Maryland: What are the eligibility requirements for opening a Roth IRA? Can a teenager with a job open a Roth IRA?

Martha M. Hamilton: You need to have earned income, so a teenager with a job would be eligible and would probably not be bumping up against the income limits either. If you're single you can make a full contribtion of $4,000 (this year) if your modified adjusted gross income is $95,000 or under. If you have (or are) a teenager who is thinking about doing this, I'd love to talk to you. So would you please e-mail me at hamiltonm@washpost.com. Thanks. I'm going to be talking to someone who urges teens to do this.

Anthony Webb: The only comment I would add is the contribution cannot exceed the contributor's income.

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Bowie, Md.: What kind of trade off should you make between saving for retirement (usually stocks in a tax-preferred account but not accessible) and for a house (usually liquid cash)?

Anthony Webb: I assume that you are asking whether you should make 401(k) savings or the purchase of a house your first priority. This is a difficult question to which there is no easy answer. If your employer is offering a 401(k) match, I would be very reluctant to cut my 401(k) contributions to such a level that I was losing that match. Other than that, personal preferences and circumstances have to play a large part in the decision - how long do you expect to stay in the house?, how important is pride of ownership to you?, how stable is your job?

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Washington, D.C.: I am an independent consultant but my income has been steady for more than a year. I bring in about $10k/month before taxes. While freelance work can sometimes be volatile, I opt to deal with it because of the liberties it affords but also because I am able to command better compensation. I have bought two condos (one to live in and one for investment that has a tenant that pays 95% of the mortgage) in the last year. The down side to consulting independently is that I've exhausted my 401k during lean times. I have about $10k in a basic savings account, but I really dont have any retirement or investment accounts. Based on advice given in your article I guess it would be best to keep the $10k as an emergency fund. My question is, whats the best way for me to begin saving for my retirement at ground zero considering my unique earning circumstances?

Martha M. Hamilton: I think I would dedicate a percentage of any contract payment to retirement savings and put it in an IRA. You might qualify for a Roth IRA. If so, I think I'd put the limit in a Roth for starters.

Anthony Webb: Two things concern me about your situation: First of all, your portfolio is heavily weighted in favor of property and you are vulnerable to a down turn in the housing market. Second - none of your income is guaranteed - the tenant could leave and the consultancy work could dry up, but you have two mortgages to pay, so you really need to build up your emergency fund. I would make the latter my first priority and then follow Martha's advice and open an IRA. I would even think of selling the investment property.

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Washington, D.C.: I am 23 and have been in my first job since graduating from college in 2005. I have a relatively good salary ($35,000), but am thinking about going back to graduate school in fall 2008 (I will not need to set aside funds for grad school tuition). What are the options for savings methods at this point that will serve me well as I earn for another year and then stop working to go to school? Thank you!

Martha M. Hamilton: You could open a Roth IRA with funds you've already paid taxes on and let that money grow tax-free.

Anthony Webb: The only comment I would add is that you are likely to be drawing on the funds in the fairly near future and therefore probably want to invest fairly conservatively.

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Rockville, Md.: I loved your column this week because it's addressing the questions I consider often. I'm 26, trying to save for a house, and am paying off 30k in student loans. I put away 14% of my salary now into my 401k, and I get a 6 percent match as well. To be honest, I thought I was doing pretty well--20 percent of my salary in retirement, I have enough for my home downpaymeny, and I pay my student loans off on time every month. However, I read some of the guidance that mentioned putting the full contribution into the 401k. At my salary, that's more than 25% of my paycheck, which just seems untenable. How exactly are people in our 20s--at the age we want to buy a house, pay off loans, and save for retirement--supposed to do it all?

Martha M. Hamilton: I think you're doing a great job of saving. I believe the guidance suggested that folks save the entire amount at an older age. For instance, in the case of Negest Hayes, Sue Stevens suggested that she do so at age 35, and that also reflected that Hayes wanted to retire early.

Anthony Webb: I entirely agree with Martha. Twenty-somethings have a hard time. They have to deal with student loans, retirement savings, and house purchase. It seems to me that you are doing just fine and that there is plenty of time for increasing your savings in the future.

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Maryland: My wife has paid off her personal credit card, but has one that she got with a now-ex that is still open with a $10K balance. the ex is in charge of that account, but shows no interest or effort in paying it off. The expenses on that account are only the ex's, but it's in both of their names. Is my wife better off just telling the ex to get out of the way and paying it off with her income, or letting the ex continue to carry a balance on an account that she is linked to, focusing on setting aside money for our future goals of family and house?

Anthony Webb: That doesn't sound fair. I am not an attorney, but the first thing I would do is cancel the card. That way no further charges can be put on it.

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Washington, D.C.: Looking for some general advice as I transition from law school back into the work force... I am 29, my husband 26. We have about $18,000 in rollover IRAs (all in a 2045 target fund) and $40,000 in student loans. We're selling our house in DC moving to a lower cost area - using the proceeds to get out of credit card debt and have a down payment on a small house.

When all of this is done, our plan is to build up a 6-month emergency fund, pay down student loan payments (which will be about 10% of our income from the monthly payments alone), and put as close to another 10% into retirement (401(k) up to matching, then Roth). But the idea of being able to max out our 401ks is daunting - $11,000 a year, ouch! Plus when kids enter the picture, how do you suggest balancing this when the student loans are locked in for 20 years. It feels like we're never going to get ahead...

Anthony Webb: My first advice would be to get rid of that credit card debt. It is most unlikely that you will earn a higher return on your investments than the credit card interest rate. My second piece of advice is that you need to work out a budget on an excel spread sheet, and then stick to it. Yours is a common predicament. You have come out of grad school, landed good jobs, and then suddenly find that you are broke.

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Takoma Park, Md.: I realize that a lot of young people are living with their parents until they get on their feet these days. But the young lady profiled in this week's article is 29 - HARDLY what I would call young. Isn't one of the best ways to learn good money management to live independently? Maybe I'm just jealous b/c making 80k my parents would have put me out a long time ago...(I'm 25 and and have been living on my own for 3 years now)

washingtonpost.com: Profile of Negest J. Hayes (Post, April 29)

Martha M. Hamilton: I think many parents would consider helping a child to save for a mortgage as a good investment. But different families--and different individuals--have different imperatives. And I do consider 29 young!

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Denver, Colo.: Thanks for taking my question. (I actually just turned 30, but I think my question still applies to those saving in their 20s.)

My wife and I have done a good job at saving since we graduated from college at age 22. We currently have a combined income of about 120k, and have roughly 400k in savings. We both currently max out our 401k ($15,500 x 2) and roth IRAs ($4,000 x 2). I also max out my 457 plan ($15,500). Including our employer matching benefits, we currently save approximately $63k/yr. We have a mortgage on a reasonable house, one young child, emergency fund, and are quite happy living well beneath our means. The plan is to retire with 2.5 million at age 45 (assuming a 7% rate of return before retirement, 5 percent RoR during returement, 3.9 percent raises, 3.3 percent inflation rate, living to age 95). (Yes, while I've done all of my own calculations, I think it IS possible to retire at a young age...)

Great you say, but what should someone in our position do with any extra money that we come across in the future? (We don't right now, but it's good to plan!) There seems to be -very- little information available on other investment opportunities beyond that of the 401k/IRA. I've heard about tax deferred annuities, but I've only begun researching them and they seem to have higher fees than I'd like.

What do you suggest looking into?

Anthony Webb: I can't over-emphasize the impact management charges can have on retiremen wealth. Do your calculations again, only assuming a 6% return, and you will see what I mean. What concerns me about many, but not all variable annuities is the high level of management charges. The alleged countervailing benefit is that variable annuities offer investors the ability to defer tax. But recent academic research suggests that tax deferral is of limited value, most especially after the reduction in the maximum tax rate on qualifying dividends. I would check out the following paper before making a decision: http://www.nber.org/~confer/2005/tpe05/poterba.pdf

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Portland, Ore.: Hi, my husband and I both work full-time and earn about the same hourly wage ($23/$20). He is 60 and I am 46. Is that enough information for you to comment on the relative merits of a Roth IRA vs. a traditional IRA for one or both of us? Thanks.

Anthony Webb: With a Roth IRA, you get no tax deduction now but don't face a tax charge on withdrawal, with a regular IRA you get a tax deduction, gross roll-up of investment returns, but a tax charge on withdrawal. So an important consideration is whether you expect your marginal tax rate to be higher or lower in retirement than its current level. An added complication is that taxable IRA withdrawals in retirement can increase the proportion of your Social Security benefit that is subject to tax. You might want to talk to a financial planner.

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Washington, D.C.: My fiance is in his early 30s and I am in my late 20s. We have both contributed the max to our retirement plans since graduating from college (some employers have matched, others haven't) so we have a sizable amount saved towards retirement already. He recently started a new job with a small firm that won't allow him to contribute any of his own money to the retirement plan until he has been there for 1 year. I am currently still contributing 12 percent of my salary to my retirement fund, partially matched. We each own a condo (live in mine, rent his out for a little less than the mortgage payment), and have no student loan debt anymore. We also have an emergency fund of cash set aside that will cover 2-3 months worth of expenses, and each have a Roth with some money in it. Here's the question... During the year that he can't contribute to the corporate retirement plan, do we use the extra cash to pay down our combined credit card debt (about 8K, which would take us 7 months to pay off) or do we split the extra cash and invest half and use the other half to pay down credit card debt, meaning it would take twice as long to rid ourselves of the balance. He says we need to invest half and use the rest to pay down debt.....I say we need to pay down all debt first and then begin investing all extra cash. Who's right? Will the loss of a year or so without his retirement savings put us extremely far behind?

Martha M. Hamilton: It sounds like you have a great start on retirement savings, so I wouldn't worry about a year of not saving your fiance's salary. I would pay the credit card debt before investing. As Tony mentioned in another answer, the interest rate on the credit card debt is likely to be higher than what you might earn on investments. Get rid of it and then build an emergency fund so you don't end up running up credit card debt again.

Anthony Webb: As I've said in another response, you are most unlikely to earn a high enough return on your savings to offset the credit card interest.

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Fairfax, Va.: Hello Martha and Anthony,

I read the piece, "Saving for Retirement -- and Everything Before Then" and the three connected segment pieces yesterday. I found them very helpful, and could relate to those spotlighted as I find myself anxious to save for retirement. For the past three years, I have accumulated some savings with a fixed amount off the top from each paycheck. I have also been contributing to my 401k. I also have some other scattered investments set up by my parents years and years ago. Until recently, I really didn't know how well they were performing until I pulled out years of statements and tracked them in spreadsheets. To my dismay, I've found them to be very weak. I would like to seek the guidance of a finance professional to improve my investments and develop a comprehensive savings plan. I see lots of ads on TV with companies claiming to help you reach that, "retirement goal". What is the best approach to finding, and utilizing, a finance professional without spending a lot of money in the process?

Thank you!

-Steve

washingtonpost.com: Saving for Retirement -- and Everything Before Then (Post, April 29)

Martha M. Hamilton: I've written a couple of columns on how to find the right financial adviser. Don't deal with anyone who earns commissions on the investments he or she is recommending. And, when it comes to a fee-for-services adviser, ask friends for recommendations. When they recommend someone, ask specifically what they like about the adviser. If they like her because she takes charge of their finances and handles everything and you want someone who can advise you while you manage your own finances, it might not be a good fit.

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washingtonpost.com: Blind Dates With Financial Advisers by Martha Hamilton, Nov. 5, 2005

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Anthony Webb: To access Issues in Brief and working papers on retirement income issues, such as pensions, savings and Social Security, please visit www.bc.edu/crr.

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washingtonpost.com: Investment Candy From Strangers By Martha Hamilton, Oct. 1, 2006

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re Portland Oregon: Also, regular IRAs require manditory withdrawls starting at age 70 1/2. Roth IRAs do not. If they have additional savings and might not need to pull from the IRA(s), Roth might be the way to go.

Martha M. Hamilton: good point. Thanks for adding that.

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Laurel, Md.: Dr. Webb, based on what I learned about you from Google search, let me ask a public policy question, not advice about my own situation.

One of the most difficult realities of retirement planning is the high variability of longevity -- many people won't last past 75 and others will push 100. This creates a big problem about "how many assets will I need and how fast can I withdraw them?" One solution would be annuities, but almost any person finance book will tell you not to buy them because of high premiums and skewed actuarial tables (people who only expect to live five years don't buy them.)

Do you think we need to create more "insurance-like" retirement products, and what would be the best avenue for doing so?

Anthony Webb: To comment on #1 - Annuities are actuarially unfair, in the sense that the expected present value to somebody with population mortality is less than the premium paid. But, that doesn't mean that they have no value to a retired households facing the problem of how to decumulate their retirement wealth over an uncertain lifetime. For many households the value of the longevity insurance outweighs the actuarial unfairness.

I certainly agree that there is a need for innovative new products to address the risks that households face in retirement. I think that we are starting to see innovation in the annuity market with the launch of inflation protected annuities, an increase in the popularity of variable immediate annuities that enable households to combine exposure to the equity market with longevity insurance, and the development of impaired life annuities.

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washingtonpost.com: Here are some additional resources for savers who are just getting started:

Beginners' Guide to Asset Allocation, Diversification, and Rebalancing

Building Wealth: A Beginner's Guide to Securing Your Financial Future

NASD's 401(k) Learning Center

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Martha M. Hamilton: Many thanks as always for your great questions. And thanks again to Tony Webb for his help with advice to our 20-someethings and his expertise today.

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