Q. Which would be safest and offer the best long-term results for my 401(k) --- a stable value fund or an inflation-protected bond fund?
---O.C., by email
A. Go for the inflation-protected bond fund. Long term, it will provide you with a small premium (probably something over 1 percentage point) over the inflation rate. With the CPI running year-over-year annual increases just over 4 percent so far this year, investments like stable value funds and guaranteed investment contracts (GICs) are hard-pressed just to match the inflation rate.
Q. I am looking at rolling my 401(k) into an IRA. I am also considering turning it into a Roth IRA because of my concerns about future income tax rates.
A. Why pay a penalty when you can do an IRA rollover to a Roth IRA conversion? Provided your income is not too high to allow it, you should be able to convert simply by paying taxes. You can maximize the value of the Roth IRA conversion by paying the taxes from a source outside the IRA rollover.
For someone your age, converting to a Roth is a very good idea. First, your current tax rate is probably relatively low, so the cost of conversion won’t be punitive. Second, even if future tax rates aren’t higher, the money you put into a Roth IRA won’t engage the taxation of Social Security benefits. Benefits will be taxed for most workers your age because the formula for the taxation of Social Security benefits is not indexed for inflation. You can thank the political weasels of both parties for that. They passed the tax in 1983, knowing they would be long gone when it really began to bite.
Q. My wife and I are considering building our dream home on our dream lot here in East Texas. I am 60, employed and plan to work 5 more years (salary $64,000). My wife is 57 and plans to work until 63-65 (salary $50,000). We owe $45,000 on our lot.
We plan to sell our current home in 2009 and hope to clear about $140,000. We will then rent until our new home is built. We anticipate the total cost of the home and lot to be about $305,000. We plan to put down $100,000 and finance the balance for about 3-4 years. When I retire, we will be able to access the $250,000 in my 401(k). At that time, we will pay off the remaining mortgage with proceeds from the 401(k).
Our retirement income is my pension of about $1,800 a month, my wife's pension of about $2,300/month, and my Social Security of about $1,500/month. Since my wife is in the teacher retirement system, she is not allowed to draw my Social Security after my death but will receive my full pension. We have savings of about $35,000, and she has an annuity that will be worth about $25,000 when she retires. Do you think this is a workable plan, or is it too risky? ---J. E., by email
A. Your plan could work, but unless there is very strong growth of your 401(k) plan assets, it is likely to leave you “house poor” and with minimal flexibility. Here’s why.
Basically, you’re talking about doubling the operating expense of your shelter just as your income is cut by about 40 percent. Similarly, paying off the mortgage will make a major dent in your financial assets, leaving you with limited flexibility. Worse, every dime you take from your 401(k) to pay off the mortgage will likely put you in a high tax bracket.
While you and your wife have the security of two pensions, unless those pensions are indexed to inflation (most aren’t), you’ll start retirement pinched for spending money and it will quickly get worse as inflation reduces the purchasing power those pensions provide.
Most retirees should be trying to go in the opposite direction, scaling back their shelter to liberate their equity and increase their income.